More dealing likely before bonds tax added to D.C. budget

A move to tax D.C. residents’ income on interest from out-of-state bonds has emerged as a key battleground in the debate over revenues ahead of a final vote scheduled for Tuesday on the city’s $10 billion fiscal 2012 budget.

Some council members were wary of the proposal — put forth last month by council Chairman Kwame R. Brown in lieu of a proposal by Mayor Vincent C. Gray to raise the income tax increase on the city’s highest earners — noting that retirees on fixed incomes tend to hold the bonds, and public opposition had killed similar measures in the past. The bonds proposal is expected to raise $13.4 million annually.

The tax break has protected D.C. residents who buy bonds issued by other states and localities selling them to fund infrastructure improvements.

Local governments typically don’t tax in-state municipal bonds as an incentive for residents to buy them. The District is the only jurisdiction in the United States that does not tax out-of-state bonds, largely because the bonds have not been available in the city in the past.

While the tax on out-of-state bonds passed an initial budget vote last month and is expected to remain in the final spending plan, some council members are still debating when the tax should take effect and whether it should be rolled back if the District exceeds its revenue projections.

With no clear resolution stated so far, the matter could be settled from the dais in much the same way as the bonds tax was introduced into the budget last month.

“I think it’s a dynamic situation,” said council member Mary M. Cheh, whose Ward 3 constituents hold a large percentage of those bonds.

Currently, people who hold the bonds will be taxed on their earnings since January.

Mrs. Cheh voted against an amendment introduced by a council contingent led by Tommy Wells that devotes any additional city revenues to social services spending instead of using the funds to grandfather in D.C. residents who purchased out-of-state bonds before October, when the fiscal year begins.

Mrs. Cheh criticized the amendment from Mr. Wells, Ward 6 Democrat, because many of the members who supported an income tax instead of a bonds tax turned around and pushed the bonds tax full-tilt when the income tax was defeated.

Mrs. Cheh said she supported the bonds tax in its prospective form. She said she and other opponents of the income tax hike on households making more than $200,000 thought it “sent the wrong signal,” reducing the competitive stature of the District and potentially harming small businesses that must file taxes in a manner similar to households.

If the bonds tax issue cannot be resolved, Mrs. Cheh said she may have to push “Plan B,” an amendment that raises the income tax from 8.5 percent to 8.9 percent on personal income above $400,000 — “a burden far more manageable for small businesses.”

Council member Jack Evans also has a plan to address the issue. He said he will introduce an amendment on Tuesday to grandfather in current holders of out-of-state bonds so they are not taxed retroactively to Jan. 1 of this year.

Mr. Evans, chairman of the council’s Committee on Finance and Revenue, said his office has received “literally hundreds” of phone calls and emails from concerned bond-holders in recent weeks. To ensure the grandfather component of the bonds tax, Mr. Evans’ amendment would place the issue first on a list of the chairman’s priorities if additional revenues flow into city coffers.

“I will not support a Budget Support Act that does not incorporate this change,” Mr. Evans said.

Ms. Cheh said she will not introduce her amendment if Mr. Evans’ is successful.

In a memo to Mr. Brown’s office, Mr. Evans noted he does not support an income tax or the bonds tax.

“In short, as of today, District residents have the largest selection of tax-free bonds of residents of any state, since they can buy bonds with tax-free interest from any jurisdiction,” he said. “If the new tax is not repealed, District residents will have the smallest selection.”

Mr. Evans, confident that revenue projections will rise, also noted that the proposed bonds tax would have a sunset provision in the version put forth by Mr. Brown that “would have automatically repealed the law in the next month or two when our new revenue estimate came in, before the law would have ever taken effect.”

“The amendment our colleagues supported, however, ensures that the municipal bond tax in fact will become law if the action I propose is not taken on second reading,” said Mr. Evans, Ward 2 Democrat.

Vincent B. Orange, who returned to the council in a special election in April, played a decisive role in passing the amendment that caused Mr. Evans such chagrin.

While Mr. Orange did not support an income tax, the at-large Democrat provided Mr. Wells’ voting bloc the deciding vote on the bonds tax in exchange for $500,000 for Emancipation Day festivities and $500,000 for the Lincoln Theatre as part of the amendment package.

Whether the deal holds or not remains to be seen.

“I’m sure there are people that are working on it,” Mr. Orange said.

Mr. Orange said he suggested the elimination of tax-exempt status on out-of-state bonds on the campaign trail. He also introduced a bill that requires the District’s chief financial officer to examine investment opportunities for D.C. residents and market its bonds, so neighboring areas like Prince George’s County do not “take business out of the city.”