CORE ISSUE

SUMMARY: A dramatic decline in State tax revenues combined with diminished federal assistance, stagnant economic growth and increased state and local government expenses resulted in a fiscal crisis in Maryland during the early 1990's. Improvements in the economy and cutbacks in state and local government spending eased the pressure for almost a decade, but predictions of a structural deficit early in this century and recent shortfalls in anticipated revenues have kept legislators searching for new ways to raise additional cash for state coffers.

State government presently relies on two taxes--the personal income tax and the retail sales and use tax--to raise most General Fund revenues. Other sources of state income include franchise and insurance taxes, alcohol and tobacco taxes, and the State lottery. In addition, dedicated taxes (revenue sources levied to fund specific purposes defined by law) include transportation taxes (motor vehicle fuel tax, title tax and registration revenues), a percentage of corporate income tax receipts, and the State property tax. Maryland also receives revenue from the federal government, although the percentage of the state budget funded by this source has been decreasing in recent years.  Finally, the receipt of billions of dollars from the lawsuit against tobacco companies will be used over the next 25 years to fund specified programs.

Local governments (23 counties and Baltimore City) depend primarily upon two revenue sources, the property tax and the income tax, which are subject to certain restrictions imposed by the State. Some subdivisions also have local admissions and amusement taxes, recordation and property transfer levies, trailer park taxes, and local sales taxes.

While Maryland's sales and use tax is the state's third most important source of revenue, accounting for about 15 per cent of its income, the consumer base for this tax is one of the narrowest in the country. There are two major reasons for this atrophied consumer tax base: (1) Over the years a wide range of retail commodity products including food for home consumption, prescription drugs, medical appliances, non-prescription drugs, and residential utilities have been exempted from the state sales tax; and, (2) there are few taxes on retail services, and those must be enumerated in statute.

The recession of the early 1990's highlighted the deficiencies in Maryland's tax structure when it became apparent that revenue projections were inadequate to meet spending forecasts. Proposals to address the problem through hiring freezes, expanding working hours, eliminating government waste, consolidating programs, requesting early retirements, mandating furloughs on a selective basis, requiring unpaid holidays, and reducing the services provided by State government met with resistance from State employees and those groups benefitting from the programs that would be affected by the cuts. Legislators in the 1991 session, fearful that the public adamantly opposed any general tax increases, swiftly killed a proposal from an executive branch study group (Linowes Commission) that would have added over $800 million to State coffers.

Throughout the early 1990's, the General Assembly removed some tax exemptions, increased other taxes selectively, and cut a few programs and the amount of aid to local governments. The 1994 election, in which the defeated gubernatorial candidate nearly won a stunning upset by proposing drastic reductions in the state income tax rate, sent politicians of both major parties scrambling to find new ways to respond to this strong public sentiment. These efforts culminated in the 1997 Tax Reduction Act, legislation that provides for a 10% cut in state taxes over a five year period. The time frame for implementing these reductions was accelerated in 1998 from 2% to 5% the first year, and from 4% to 6% in 1999.

In order to compensate for the anticipated revenue reductions that will come about as a result of the income tax cuts, some legislators began to focus more attention on increasing taxation of personal and professional services. Fear of the firestorm of negative reaction that would be generated by an across-the-board levy on services led legislators in previous sessions to reject all taxes of this sort except for those on janitorial, telephone, credit reporting and security services. But it is difficult to ignore that personal and professional services are the most vibrant sector of the Maryland economy, accounting for over 20% of the state gross product. Adding a wide range of services to the base would have a dramatic impact upon state and local revenue forecasts and could pave the way for additional adjustments to property, income, and commodity sales taxes.

An example of this renewed interest in professional service taxes was the introduction of House Bill 755 in the 1997 session. Camouflaged under the title "General Service Business Gross Receipts Tax", House Bill 755 would have imposed a 0.4% gross receipts tax on a wide range of professional services. Doctors, lawyers, engineers, accountants, architects and other professionals who collect commissions or fees would have been required to pay modest amounts if the bill had passed, but subsequent efforts to collect greater revenue would have become a matter of shifting a decimal point rather that mounting a major campaign to enact a new tax. Although the legislation first was watered down to simply establish a study of the issue and then failed to pass the Senate, it must be viewed as a harbinger of more serious attempts to impose a tax of this nature in future sessions.

In 2001, an indication of renewed interest in taxing services was the introduction of legislation sponsored by the Chairman of the House Ways and Means Committee to tax dozens of previously untaxed services. While direct legal services were not covered by the bill, some associated activities such as tax preparation, temporary help, and notaries public were included. An array of those groups and services covered by the bills mounted a strong campaign to stop the proposal dead in its tracks, and since 2002 is an election year, any successor to the bill will in all likelihood suffer the same fate.

In addition to legislation imposing direct taxes on legal services, changes in the tax code that could have an adverse effect on the practice of law and law practice management arise from time to time in the General Assembly. For example, in 2001 a proposal was filed to eliminate the 2% public service company franchise tax on telecommunications companies and replace it with a 5% sales and use tax on services such as telephone calls. Businesses and professionals such as attorneys which rely on high volume telephone use would have had to make up the lost state revenue. The proposal failed, but it is an indication that special interest groups seeking changes in the tax code for their own benefit will continue to seek legislation often at the expense of other groups and interests.

MSBA 2002 POSITION: Strongly oppose any proposal to tax legal services. Arguments against a legal services tax should focus on the following areas:

1. Clients, not lawyers, would pay a tax on legal services. A legal services tax is not a tax on lawyers, but a tax on those who seek legal advice. Lawyers may pay the tax bill, but the taxes and the cost of administering the payments will be passed on to the clients in the form of higher bills.

2. A Maryland legal services tax would encourage clients, especially those with high legal bills, to seek legal advice in bordering states.

3. A legal services tax is a disincentive for citizens to seek legal advice. The MSBA places a high value upon access to justice for all citizens. A levy on legal services would hit low and moderate income taxpayers hardest, especially those who do not qualify for public assistance, yet cannot afford to devote a significant percentage of their income to pay for legal advice.

4. Many legal transactions, such as property transfers and administration of estates, require payment of taxes. A legal services tax would impose an additional tax on the same transaction.

5. A legal services tax places an additional burden on those already experiencing financial problems. Clients seeking legal advice on dissolution of marriage, bankruptcy, child support, debt collection and similar matters are those who can least afford to pay an additional charge.

6. An audit of client fund accounts in order to administer the tax would violate the attorney/client privilege.

7. The tax is regressive in that citizens and small businesses would have a disproportionate burden for paying a legal services tax. As many of the larger businesses retain attorneys as staff, they could avoid the tax, while moderate-income taxpayers and smaller business entities would have to pay the tax.

8. A legal services tax could be a tax on tax advice. Many citizens seek advice from tax law specialists as a means of clarifying their tax obligations. A tax on legal services, ironically, would impose an additional tax on those who are looking for ways to reduce their tax burden.

9. A key indicator of a state's economic climate is its tax structure. Passage of taxes on a wide range of services in other states, including legal services, in Florida and Massachusetts, has been a disaster. Boycotts and threats of business relocations led to repeal of the statutes in both states.

10. Taxing a person's ability to defend himself or herself in a criminal proceeding could be challenged as unconstitutional.

11. As many legal services are provided to non-Maryland clients, or a mixture of in-state and out-of-state customers, deciding what services are eligible to be taxed would be an administrative nightmare and would probably be challenged in court. This would result in added administrative and legal costs to the state.

12. Restricting the tax on legal services to "business-related activities" and excluding "personal legal services" would harm a vital center of the state's economy and be aimed at the entities most likely to seek legal services from out-of-state firms.

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Monitor other taxation legislation to determine its effect on law practice management.

SAMPLE LEGISLATION:
House Bill 755, General Assembly of Maryland, 1997.

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