WASHINGTON — A U.S. Supreme Court ruling that found a Maryland personal income tax scheme unconstitutional will cost localities in the state millions of dollars but may not impact their credit ratings, said rating analysts and government officials.
Moody's Investors Service said the ruling is "credit negative" for Maryland counties and Baltimore and could also be credit negative for some localities in other states. It said that a friend-of-the-court brief in the case pointed out that residents of Detroit, Philadelphia, St. Louis and other localities file income taxes under similar laws.
The Supreme Court justices ruled 5-4 on May 18, in Comptroller of the Treasury of Maryland v. Wynne, that the tax scheme, under which Maryland residents do not receive a full credit against income taxes paid to other states, violates the "dormant commerce clause" of the U.S. Constitution.
The Maryland Comptroller's office collects income taxes used by the state as well as income taxes that are then sent to the state's counties and to the City of Baltimore. If Maryland residents earn income in other states and pay income taxes to those states, Maryland allows the residents to get a credit against the "state" tax, but not the "county" tax. A majority of Supreme Court justices took issue with the lack of a credit against the "county" tax.
At this point, the state comptroller's office has more than 8,000 refund claims totaling an estimated $202 million. The office will review, verify and process the claims, said Michelle Byrnie-Parker, deputy communications director for the comptroller's office. The ruling is also estimated to collectively cost localities in Maryland $42 million a year going forward.
Under Maryland law, refunds will be paid from the state's local reserve account, and localities will reimburse the state for their share of the refunds and interest. If local governments don't reimburse the reserve account in a timely manner, the comptroller will withhold the amount owed to the account over the course of nine quarterly income tax distributions starting with the first quarterly distribution made after June 2016.
Moody's stated that the ruling is credit negative was in its weekly credit outlook for public finance. This is because there will be a loss in tax revenue and the timeframe to make the refunds is relatively short, Moody's analyst Jennifer Diercksen told The Bond Buyer.
But Diercksen noted that a lot of the affected governments have "budgetary flexibility." Eight of the governments have room under the state's local income tax cap to raise their rates, and most of the counties and Baltimore have unlimited property taxing authority, Moody's said in its report.
By calling the ruling credit negative, Moody's is saying that it's bad for Maryland local governments but will not necessarily affect their ratings, said Julie Beglin, a vice president and senior credit officer at the rating agency.
Michael Rinaldi, senior director in U.S. public finance at Fitch Ratings, said that he doesn't believe the ruling will affect the long-term credit ratings of local government issuers in Maryland. He pointed out that Maryland issuers are generally highly rated, have healthy reserves and good revenue raising capacity.
Maryland issuers have begun to prepare for the ruling by being more conservative with estimates and by putting money aside to pay refunds, Rinaldi said.
Montgomery County, Md. is likely to be the county that is most affected by the ruling. The wealthy jurisdiction in the Washington suburbs is estimated to lose $10 million in income-tax revenue in fiscal 2016, about $55 million in each of fiscal 2017 and 2018, and about $25 million a year after that, said Tim Firestine, chief administrative officer for the county.
However, the county's operating budget is about $5 billion. While the ruling will have an impact on the county, "clearly we can manage it within our operating budget," Firestine said.
"As we have done in the past, we will continue to work closely with the council to jointly and comprehensively address this challenge to maintain the county's strong financial position going into the future and ensure the continuity of essential services," Montgomery County executive Ike Leggett said in a memo to the county council president.
The county had an $85 million write-down of income tax revenues in its fiscal 2015 budget to prepare for the ruling, but it was eliminated to help offset underperforming revenues, Moody's said in a March report on the county.
Because the ruling only affects tax revenue that is remitted to local governments, and not to state taxes, the ruling is unlikely to impact Maryland's triple-A rating, sources said.
"We don't see a credit impact on the state at this time," said Sussan Corson, director in Standard and Poor's states group. And Moody's said the ruling is not credit negative for the state.
Susanne Brogan, Maryland deputy treasurer for public policy, also said she doesn't anticipate Maryland state bonds to be affected by the ruling.
