Gov. Martin O'Malleyand Maryland Democrats developed a creative yet questionable fix for their budget woes in a special session of the General Assembly last month. Governor O'Malley performed budgetary acrobatics by leveraging Maryland's geography and the federal tax code's idiosyncrasies. Thanks to Congress, big spenders in Annapolis are now dining at federal taxpayers' expense.
When Governor O'Malley first came into office in 2007, he needed a way to pay for all of his campaign promises, so Annapolis used a "millionaire's surtax" to raise the money. With this tax, Marylanders would pay 6.25 percent on earnings greater than $1 million and 5.5 percent on earnings over $500,000. The state coffers would then increase by $330 million in three years. However, the flight of high earners and the recession shattered those hopes, and Maryland only took in about one-third, or $120 million, from the surtax.
Stung by the fickle nature of progressive taxation, Maryland's lawmakers got wise and knew they needed to tax a base of people with guaranteed and stable incomes. As a taxing target, they chose the federal government and its employees.
Maryland's population center is located outside Washington, D.C.The combined suburban counties of Montgomery and Prince George's are bigger and much wealthier than the Baltimore area. Montgomery County's median household income of $92,000 is almost twice that of Baltimore County.
These suburbs are rich precisely because they are adjacent to Washington and are home to federal employees, contractors and lobbyists. More than 300,000 civilian federal employees and retirees live in Maryland. One out of 20 residents works or worked for Uncle Sam directly, by far the highest proportion of federal employees in the United States. (Only D.C. is higher, where 1 out of 3 residents can be called a "fed").
Federal employees earn much more than the average American, pulling in $25,000 more a year, and D.C.-based feds earn even more than that. The average salary for a federal employee in the D.C.-Maryland-Virginia area is $95,000. Annapolis chose to raise income taxes on individuals earning more than $100,000 and households taking in more than $150,000, including many federal employees. Since these federal employees' jobs are secure — 99.5 percent of them earn successful performance reviews annually — and their salaries keep growing automatically, based on seniority and inflation, Governor O'Malley knows he can count on their tax revenue and the safety net of the federal government.
The federal tax code gives Maryland's big spenders yet another incentive to raise taxes on $100,000-plus earners and their families by making it painless for those taxpayers. The federal tax code allows taxpayers to write off their state and local taxes from their federal taxable income. The more Maryland taxes federal employees, the less money Uncle Sam can ask from them in taxes. This exemption subsidizes some of the highest-tax states and localities, while reducing federal revenues at the same time. According to the Tax Foundation, Maryland took $10 billion in federal tax subsidies from this exemption in 2009.
This tax code quirk allows states like Maryland to balance their books on Uncle Sam's back without inciting a tax revolt. Governor O'Malley and his allies in Annapolis also know that the lion's share of this new revenue comes directly from the U.S. Treasury, since the federal government pays its civilian employees living in Maryland well over $14 billion yearly in salaries alone (excluding pensions, health care and other generous benefits). At the same time, these federal employees see their federal tax liability fall as their state liability rises, and only the U.S. Treasury feels the pinch.
American taxpayers should be outraged that Congress is subsidizing irresponsible spending in Annapolis and other state capitals. Also outrageous is the fact that so many federal employees are paid such lavish wages and benefits that they qualify as top-income earners. Congress needs to get serious about our budget woes, rein in government employee salaries, and reform our tax code to promote growth, rather than using budget gimmicks to cover out-of-control spending.