Testimony: ITEP’s Nick Johnson weighs in on revenue options for the District of Columbia

Chairman Mendelson and members of the Council:

Thank you for holding this hearing today. I am Nick Johnson, a Senior Fellow focusing on state and local tax at the Institute on Taxation and Economic Policy, a nationwide nonprofit research organization. From 2022 to 2024, I was research director for the DC Tax Revision Commission.

The benefits of progressive revenue options

The District’s need for additional revenues results from our current economic circumstances. Federal layoffs, tariffs, and budget cuts have caused a regional recession. Since 2024, the District has lost 30,000 jobs, and our suburbs have lost 45,000 jobs. These economic losses are reducing tax revenue across the region at a time of rising costs. OCFO predicts that the local economy will not return to its pre-DOGE or pre-pandemic growth rate until 2030.

Because state and local governments must balance their budgets even as costs are rising, they commonly seek new revenue during recessions to reduce the depth of cuts to education, health care, public safety, infrastructure, and other services. Looking around the region, the City of Alexandria and Arlington, Montgomery and Prince George’s counties all raised taxes or fees this year, and several may do so again next year.

In raising revenues, improved progressivity should be a goal. Research shows that increasing tax progressivity is associated with better outcomes for children and workers and stronger overall economic growth, and it makes a place attractive for businesses and households of all income levels, including the very wealthy. People want to live, work, and conduct business in places that invest in the community and that treat everyone fairly.

In recent years, the District has moved to make its overall tax system less regressive. But, despite this progress, the wealthiest 5 percent still pay taxes at a lower effective rate than most other income groups.

A truly progressive tax system, one where the highest income groups pay at the highest effective rates, remains within the District’s reach. Such a tax system would be good for DC families and for the DC economy by making living here more affordable for most people while raising revenue to fund public services and infrastructure.

Several of the options put forward by the Council for this hearing would be progressive in their distributional impact. These include increased income tax rates for upper brackets, a Net Investment Income Tax, a pied-à-terre tax, and a Business Activity Tax. A sales tax increase would be clearly regressive. Other proposals are less clear in their distributional impact.

My written testimony (attached below) provides more information on the benefits of tax progressivity and the pros and cons of the specific tax measures put forward today. It also identifies some other revenue options that the Council may wish to consider.

In addition to increasing progressivity, the Council should address existing flaws or gaps in the current system that treat similarly situated households or business entities differently. Doing so can make the tax system not just fairer but also more resilient by broadening the tax base. With that in mind, I turn now to the proposed Business Activity Tax.

Business Activity Tax

A D.C. Business Activity Tax, or BAT, is an idea that was first put forward by the 1998 Tax Revision Commission. Value-added taxes like the BAT are used widely around the world and in the U.S. have been implemented in New Hampshire, Michigan, and, in a somewhat different form, Texas. A BAT meets commonly held standards for sound tax policy.

First, a Business Activity Tax would advance tax fairness. It would expand the range of businesses paying entity-level taxes because it would include, for example, big law firms and lobbying firms with non-DC owners that are currently exempt under the Bishop vs District of Columbia.¹ The BAT also would reach prosperous large corporations where the owners and top executives are making a lot of money – and relying in part on DC public services to do so – but are using a variety of mechanisms to minimize the taxable income they report. Meanwhile, businesses that already pay substantial tax to the District would be able to credit BAT payments against their existing liability, thereby avoiding an increase. Very small businesses would be exempt.

Second, a Business Activity Tax would promote revenue adequacy and stability. In a report that I cowrote with the DC Fiscal Policy Institute last year, we estimated that a 2 percent BAT could raise over $500 million per year. Once implemented, the BAT would be more stable than the corporate franchise tax because its broader base does not depend solely on taxable profits.

OCFO reported last month that, despite record earnings, large multinational corporations paid much less corporate franchise tax in the last fiscal year because increased tax write-offs reduced taxable profits.² Reporting elsewhere indicates that these tax write-offs include large AI capital investments. Whatever the economic merits of those corporate actions, the result is less revenue for DC schools and services. A BAT would be less vulnerable to such tax avoidance.

Third, a Business Activity Tax would have positive economic impact on the District. A BAT would benefit the District’s economy because it would raise revenue for local services from businesses owned elsewhere but operating here. Economists widely admire value-added taxes because they are economically neutral and spread obligations broadly at relatively low rates. Contrary to some assertions, a BAT is unlikely to drive businesses from the District because it taxes economic presence, as measured by local sales, rather than physical operations. As is already the case with our existing business franchise taxes, an entity doing business here will be liable for the tax no matter where its desks are located.

The Tax Revision Commission two years ago explored a BAT as a mechanism to reduce other business taxes, and, similarly, our DCFPI report suggested using some of its revenue to cut business payroll taxes. If it works as intended, the BAT could eventually support business tax cuts. But given current economic circumstances, the District would be wise to wait to reduce or repeal existing revenue sources until we know whether the BAT raises as much as we expect.

Fourth, a BAT will be relatively straightforward to comply with and administer. As a new tax, the BAT will take time to develop and implement. The District has begun by commissioning an OCFO feasibility report. Experience in Michigan, New Hampshire, and Texas suggests that once enacted, compliance and administration will be relatively straightforward because it relies largely on existing tax definitions, calculations, and common accounting items.

Thank you for the opportunity to speak with you today.

Written testimony: Additional information on tax progressivity, the Net Investment Income Tax, and other revenue options.

Progressivity

Using the ITEP Tax Microsimulation Model, which draws on dozens of data sources and extensive economic research to paint a comprehensive picture of the state and local tax systems in all 50 states plus the District of Columbia, we analyzed the distributional implications of several of the proposals before the Council today. The ITEP Tax Microsimulation Model’s structure mirrors models at the federal level maintained by the congressional Joint Committee on Taxation, the U.S. Treasury Department, and the Congressional Budget Office, and at the state level by the Minnesota Department of Revenue and other state agencies.

• The Net Investment Income Tax (NIIT), sometimes called the Wealth Proceeds Tax, would be among the most progressive proposals. This tax on annual passive investment income of more than $500,000 would be paid by just 3.3 percent of D.C. households, essentially all of whom are among the highest-income 5 percent of residents. See further discussion of the NIIT below.
• The personal income tax proposals are mixed in their impact. Simply raising the top rates would generate significant revenue, paid almost entirely by households with incomes over $500,000. Combining some rate increases with bracket adjustments, by contrast, would likely not raise new revenues; instead it would cut taxes for middle-to-upper-income households while raising them for the very rich.
• As a share of income, a sales tax increase would cost low- and middle-income taxpayers seven to 10 times the cost to the highest-income taxpayers.
• A straight property tax rate increase also would be regressive unless targeted to more expensive homes and/or paired with an improved Schedule H circuit breaker, as under the proposals considered by the Tax Revision Commission.
• A pied-à-terre tax is explicitly designed to fall almost entirely on non-residents who have more than one home and use their D.C. property only occasionally.
• A land value tax could help the District achieve important economic development goals. The bill before the Council calls for separate, accurate calculations of the values of land and property for each parcel. Among other important pieces of information, such calculations will allow us to determine whether a land value tax in the District will be progressive in its distributional impact. If not, it could be paired with improvements to the Schedule H circuit breaker to achieve progressivity.

Net Investment Income Tax (NIIT)

The NIIT is an existing tax at the federal level that was created in the Affordable Care Act to balance the federal payroll tax on wages and salaries. It addresses the problem that the overall U.S. tax system tends to favor proceeds generated from wealth. At the federal level, capital gains and other gains from wealth are generally taxed at effective rates 40 percent lower than earned income. Partly because of this disparate taxation, labor’s share of GDP is declining while wealth proceeds are rising.

Only households that currently pay the federal NIIT – a small fraction of all households – would potentially pay the new DC tax. Because incomes are higher in DC than nationwide, the proposed DC NIIT would offer an even higher threshold than the federal tax.

Because it piggybacks directly on an existing federal tax, a DC NIIT is “shovel-ready” and could be implemented immediately.

The importance of progressivity

Making DC’s tax system more progressive is important for at least three reasons.

• Children and workers do better in progressive tax states: States with relatively more revenue and relatively more progressive tax systems have better outcomes for children, for families, and even for life expectancy. A recent paper in the Journal of the American Medical Association found that infant mortality is lower in states with higher revenue and more progressive tax codes. There’s also research showing that the states with the most regressive tax codes have lower education spending, lower general spending on children, lower wages and lower labor protections. Tax policy can also be a phenomenal tool for reducing child poverty as ITEP found in a study completed in partnership with Columbia University’s Center on Poverty and Social Policy.
• Many economic outcomes are better in progressive tax states: Because of significant increases in wealth and income among the wealthiest taxpayers, states with progressive tax systems are better able to raise money for the public services that help a community to thrive. Because high-income families receive such a large share of overall income, choosing to tax them at rates that are at least as high as other families or higher avoids constraining revenue collections in a significant way and leave states and localities with more resources to fund schools, infrastructure, and other services. Between 2009 and 2019, the states with the highest top income tax rates experienced faster economic growth, faster average income growth, stronger growth per person and lower unemployment rates on average than states with no broad-based personal income tax.
• Wealthy people generally choose higher-tax, not lower-tax states: The vast majority of Americans with extreme wealth choose to live in relatively higher tax states and those states have a higher share of people with extreme wealth than lower tax states. Of all U.S. wealth over $30 million per household, more than 1 in 5 of those dollars is in relatively higher-tax New York, which has the highest concentration of extreme wealth in the nation. Nearly a third of the $26 trillion in extreme wealth is in New York or California, both relatively high tax states. The District of Columbia is also among the top four states in outsized concentration of extreme wealth. Despite extensive dire predictions, even after the federal government capped the amount of state and local taxes that people could deduct from their federal taxes, California, New York and New Jersey nonetheless added a significant number of millionaires to their tax rolls between 2017 and 2018. Millionaire wealth has generally grown in states with higher state and local taxes. While the changes to in-person work in the wake of the pandemic are concerning and may reduce the tendency to live in the most vibrant places, the best research has shown that high income earners do not move to shave a few percentage points off their state tax rates and that millionaires have been less likely to move than other Americans. High earners typically choose to live near business connections, quality of life, and family.

In short, more revenue raised more progressively enables the tax code to reduce rather than exacerbate inequity and generates investment for the very things that help business thrive and create a more vibrant, equitable, sustainable and inclusive D.C. As a community, we’ve been moving in the right direction, something to applaud and continue. It makes D.C. a better place to live, a better place to work, and a better place to do business.

Other revenue options

In its deliberations, the Tax Revision Commission considered additional ways that the District could eliminate or reduce tax breaks and exemptions in the tax code. While some of these measures have since been adopted by the Council, opportunities remain to improve both revenue collections and tax fairness. These include:

• Tax capital gains more fairly by decoupling from the federal capital gains tax break for non-DC “qualified small business stock” payoffs and eliminating the tax break for Incomplete Non-Grantor Trusts.
• Simplify vehicle excise tax by eliminating preferential tax rate for electric vehicles and other high-mileage vehicles.
• Eliminate age-based differentials in assessment caps. Apply the 10% assessment cap to all homestead properties regardless of owner’s age. Seniors would still benefit from a 50 percent homestead credit.
• Encourage use of the income tax standard deduction by increasing the income tax floor on itemized deductions to 7.5% from 5%.
• Modernize the sales tax by extending the sales tax to the sale of targeted advertisements.
• Collect “payments in lieu of taxes” (PILOTs) from organizations that do not pay property taxes but benefit from District-funded services.
• Recognize the extractive use of data by enacting a “data excise tax” on the extraction and use of personal data.

Additional information may be found at https://www.dctaxrevisioncommission.org/proposals.