Yesterday I went down to my state capital, which happens to be Annapolis, to lobby for the repeal of a six percent sales tax the State of Maryland plans to levy on computer services beginning this July.
How this tax came about is a worthy subject for study by anyone who desires to understand how government operates in what some of us lovingly refer to as “The People’s Republic of Maryland”. Perhaps the lobbyist with whom we argued in the hallway just outside the state Senate Budget and Taxation Committee hearing room can write his Ph.D. dissertation on the subject. But then again, maybe not, since he thinks the computer tax is just dandy and will raise all the money needed to fund the pet projects favored by the special interest groups he was representing, while having no negative impact on Maryland’s economy.
But I digress. Here’s how the tax came about:
Our Democrat governor, Martin O’Malley, who came into office a year ago, suddenly discovered what he called a “structural deficit” in the state’s budget. A structural deficit (for those of you who don’t want to click through to the Wikipedia definition) means the government is spending more than it can collect in taxes in even a robust economy. To deal with it, he called a special session of the Democrat-controlled state legislature this past November.
O’Malley’s Republican critics accused him of grandstanding. They argued that, since the regular session of the legislature was set to begin in two months anyway, there was no need for a rushed special session.
Some people uncharitably speculated that the special session was less about the deficit and more about O’Malley’s Vice-Presidential ambitions. He already had all the attributes he needed to put him on Hillary Clinton’s short list of potential running mates: he was one of her earliest and most enthusiastic supporters, he’s young and handsome — and so would attract younger female voters — and as a governor and former big-city mayor, he would bring some administrative experience to the ticket. Calling a special session of the legislature to raise taxes would make him look farseeing, bold and courageous, and could give him the inside track for the second spot on the ticket. Besides, even if he didn’t get picked, it’s better to raise taxes your first year in office than in a year in which you’re asking the voters to give you another term.
O’Malley wanted the special session to raise state income and sales taxes, and to extend sales taxes to some services that presently aren’t taxed. Among the services suggested were massage therapy, tanning salons, health clubs, arcades and property management firms. At some point, the state Senate’s Budget and Taxation Committee proposed adding computer services to the list, but quickly dropped the idea.
On the final evening of the special session, there was no provision for a tax on computer services in the versions of the bill coming out of the House of Delegates or the state Senate. But, by the time the session adjourned shortly before 3 a.m., computer services had been slipped into the tax package, and all other services that were to be subject to the tax were exempted.
This was done, mind you, without any hearings, without any opportunity for computer services firms or other interested parties to present their case, without any debate of any kind, even among the delegates and senators themselves. This was a new low even for Maryland’s ethically- and constitutionally-challenged legislature.
How did this happen? The answer to that question is easy: the massage parlors, tanning salons, health clubs and real estate firms all had their well-paid lobbyists on station to make sure nothing was done to harm their clients. Computer services firms weren’t as well organized. Nor did they see the need to be, since what they naively thought was the “final” bill contained no provision for taxing computer services.
A smiling Governor O’Malley quickly signed the bill, and that was supposed to be that.
The decision to tax computer services was motivated in part by a “study” by the state’s Department of Legislative Services that purported to show that the state would reap $200 million in additional tax revenue by levying a six percent tax on computer services. The agency apparently came up with this number by the simple expedient of multiplying estimated revenues of computer services firms by 0.06. No attempt was made to account for the loss of business volume that always accompanies a price increase — which is what adding a six percent sales tax amounts to — or the losses in income and property taxes that would result from computer services firms leaving the state.
For O’Malley, the special session did not have the desired result. Although a few editorialists and columnists initially hailed him for his “courage” and “foresight” the voters thought otherwise. His approval rating immediately plunged to a level almost as low as President Bush’s. To add insult to injury, Democratic voters overwhelmingly rejected his beloved Hillary in the February 12 primary.
Even more significantly, both the Baltimore Sun and the Washington Post — normally reliable supporters of higher taxes for Marylanders, could not go along with this one, or with the way it was snuck through.
Yesterday, several hundred computer services providers — most of them small businesspeople like myself — descended on Annapolis to try to persuade our elected representatives to get rid of this new tax before it takes effect in July. It turns out we were mostly preaching to the choir: a majority of legislators had already introduced or signed on as co-sponsors of bills to either repeal the tax outright or water it down to nothing. So, we’ve won, right? Well, not quite…
There were two jarring notes, one technical and one political.
Several legislators told us that in order to get the computer tax repealed, we’d have to find $200 million in tax revenue elsewhere. This presents a false choice, because the $200 million the computer tax supposedly will raise is a complete fantasy. Taxing computer services not only will not raise $200 million, but likely will have a negative impact on total state tax revenue.
Just look at a map of Maryland. It looks like it was wedged in as an afterthought between Pennsylvania and Virginia (which, historically, actually is how Maryland came to be). I can be in Pennsylvania in 20 minutes. In Montgomery County, where most of Maryland’s high tech industry is located, you can be in Virginia in 20 minutes (except during rush hour). It would be very easy for computer services firms to move across the state line or bill their services from offices across the state line. If American firms can provide their services from India, Maryland firms can certainly provide them from Virginia. Or they can just move to Virginia.
When these businesses leave, they take not only the six percent of revenue the state would have collected, but they also take the corporate taxes, property taxes, and employment taxes they and their employees would have paid. And this is no idle threat: between visiting legislators and buttonholing them in the hallways, most of us were talking about scarcely anything else. Many have received letters from economic development officials in Pennsylvania and Delaware inviting us to check out their more business-friendly tax environments, and a number of us are actively making plans to leave the state or open or expand out-of-state offices if this tax goes into effect.
The other side of that choice — finding $200 million in tax revenue elsewhere — is also a fantasy. Probably more than any other state legislature in the country, the Maryland General Assembly is dominated by special interests. The reason computer services got stuck with this tax in the first place is that other industries that could have been taxed had their lobbyists on guard while computer services didn’t. Shifting the tax to other industries is not politically expedient and probably impossible. The mostly powerless Republican caucus has proposed cutting projected spending by some $200 million, but expecting the Maryland legislature to cut spending is tantamount to expecting pigs to fly.
The biggest political obstacle to repealing the computer tax comes from the legislature’s leadership, particularly from Senate President Thomas V. Mike Miller Jr.. Miller pretty much has the power to prevent any bill he opposes from even coming to the floor of the state Senate. As an indication of the kind of power he wields, he managed to get the new state Senate office building named after himself. Usually buildings aren’t named after politicians until after they’re dead, or at least until after they’ve left office.
Miller has taken an over-my-dead-body stance on efforts to repeal the tax. In doing so, he has effectively painted himself into a corner, because now he can’t change his mind without looking weak and vulnerable. He has even taken to lashing out at fellow Democrats who disagree with him. The state Comptroller, Peter Franchot, has been an outspoken opponent of the computer tax, and Miller has been threatening to slash the Comptroller’s budget in retaliation — which is sort of amusing, when you think about it, because it will be the Comptroller’s responsibility to collect this tax.
Even if a bill to repeal the tax makes it out of the legislature, it still must go to Governor O’Malley for his signature. But O’Malley has painted himself into his own corner. After first saying the tax was a bad idea, he later told technology executives he opposes its repeal. He’ll look weak if he signs the bill after saying the tax is necessary, and incompetent if he vetoes it.
Personally, I came away from my day of lobbying with mixed feelings. I was, of course, happy to see such a tremendous turnout on such short notice. But I was dismayed after talking to some legislators and their staffers — and these were people who mostly agreed with us — who told me how difficult getting rid of that tax is going to be.
This tax not only will negatively impact Maryland’s computer services companies, but it will hurt any Maryland business that uses their services — which in turn means anybody who buys what those businesses are selling. If you live in Maryland, or even if you don’t, and you want to know more about this issue, you can visit the Fight The Tech Tax coalition website, or the website of the Maryland Computer Services Association.
Addendum: Since posting this column I’ve discovered the methodology the Department of Legislative Services used to project revenue from the computer tax. They assumed the tax base, i.e. billed charges for computer services, would decrease by six percent as a result of the sales tax due to users of computer services purchasing fewer of them and due to providers of such services moving out of state. This percentage is the same as the tax rate, so the legislature’s analysts seem to be assuming users’ after-tax expenditures on computer services purchased from Maryland firms will be about the same as they are currently spending. I have no idea how they arrived at this assumption, but at least they acknowledge that the tax would have some negative impact on expenditures on computer services.
Even more puzzling is their assumption that tax revenues would grow at a three percent annual rate thereafter. This is higher than the rate at which the economy is currently projected to grow. If anything, one would expect the growth rate of IT expenditures to come in below the economic growth rate, especially as businesses learn over time how to avoid the tax by purchasing computer services from other states or countries, if they are consumers of such services, or by moving out of state if they are providers of these services.
In both cases, these numbers are nothing but pure conjecture, and fail to take into account the myriad ways by which this tax can be avoided.
From Nolan Chart.