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Soldiers of Fortune

Proposal to Eliminate Income Tax For Military Retirees Will Put Greater Tax Burden On Other Taxpayers

Frank Klein
THEY ALSO SERVED: Retired Naval officer Ed Kreiner says Maryland will lose military retirees to other states if it doesn't exempt military pensions.

By Edward Ericson Jr. | Posted 2/8/2006

On Feb. 6 veterans groups rallied at the state capitol. They did so not to commemorate the anniversary of a great war victory but to press a war against taxes that some of the state’s most well-off vets have fought for years.

“I think you’re gonna see success this year,” Maryland Secretary of Veterans Affairs George Owings III says of tax breaks for veterans. “The presiding officers in both chambers have indicated that” the measure will pass in some form.

These military heroes are not fighting for a general tax break, though. They’re fighting for a tax break for themselves—actually, only for an elite subset of veterans: those who spent at least 20 years in the military and earned a military pension.

While about 6 percent of all veterans qualify for military pensions, about 10 percent of Maryland’s veterans are pensioners—about 49,000 of them, according to the Uniform Services Almanac. That’s because Maryland attracts veterans to good-paying jobs at places like the National Security Agency and Bethesda-based Lockheed Martin, the world’s largest military contractor.

On average, the military pensioners enjoy about twice the household income of the average Maryland resident. Their relative wealth makes them attractive to the state, according to proponents of the tax break. Gov. Robert Ehrlich urged passage of the tax exemption in each of his last two State of the State addresses.

Now before the legislature in three separate and slightly different bills, the measure would, for vets 55 and older, exempt all military pension income from state and local income taxes. The Senate and House versions of the bill are currently in committee and have dozens of co-sponsors. They would phase in the tax exemption on all military-retirement pay over the next five years. Smarting from a surprise failure to pass a similar bill last year, Ehrlich has submitted a bill that would make the tax break retroactive, completing the phase-in a year sooner. Ehrlich has been pushing the idea since he first ran for governor in 2002.

With the reflexive patriotism surrounding the ongoing war in Iraq, the income-tax exemption has faced no vocal opposition in the legislature. But a tax expert says it’s a bad idea in principle.

“It’s great politics, and nobody is ever gonna argue about it,” David Brunori says. “Except they should argue about it, because it makes lousy tax policy.”

Brunori writes “The Politics of State Taxation,” a column for State Tax Notes, a magazine for tax attorneys and policy-makers. He is a research professor of public policy at George Washington University, where he also teaches state and local tax law. Brunori says good tax policy, as seen in 300 years of tax history, is to tax broadly and lightly, so that the burden falls equally on everyone and no one gets special breaks. Ideas like the veterans exemption, he says, are “more than a political gimmick, because there’s a real cost involved.”

Proponents of the exemption claim it would cost about $2 million in its first year. In reality, it would cost at least $12 million, according to figures provided to the task force and a budget analysis by the Maryland Department of Legislative Services. By 2011, when it is fully phased in, the exemption would cost the state more than $60 million per year. Backers of the exemption say that more military retirees will move to Maryland, pay other taxes, and make up for this shortfall, though they offer no evidence of that.

The proposed exemption is a hit with retired vets, whose votes Ehrlich hopes to court (or keep) as he runs for re-election. But the idea has flown below the radar of the taxpayers who will pay for the exemption. An Ehrlich-assembled task force to study the matter was stacked with military retirees.

“They were all for what we were looking at,” says task force chairman Bruce Kahl, a retired National Guard lieutenant colonel and president of the National Guard Association of Maryland. His Task Force to Study the Financial Impact of Retired Military Service Personnel on the Economy of the State held a public hearing on the idea but invited only proponents to testify.

“They didn’t call us, no they didn’t,” says Harold Lloyd, a member of the Baltimore County chapter of the Maryland Taxpayers Association’s board. Told of the task force’s vet-heavy makeup, Lloyd replies, “they’re biased then.”

In decades past, military pensions were modest. But today they can be substantial, and they often begin at a young age. In general, anyone who serves at least 20 years of active duty is entitled to receive a military pension. Those who stay longer see their pensions increase. An Army colonel retiring in 2005 after 26 years of service would collect an annual pension in excess of $66,000. He would be about 44 years old.

But that $66,000 pension will increase each year according to inflation. Called a cost of living adjustment—COLA for short—it’s meant to make sure retirees don’t end up destitute. Unlike private-sector employees, federal workers of all stripes may receive pensions with COLAs upon retirement. This year’s COLA is 4.1 percent.

There is no government fund from which these pensions are paid, so soldiers’ and sailors’ retirements come mostly out of federal tax dollars (some comes from postage rates; this year’s 2-cent postage increase is purely to cover the pensions of retired military people now working second careers at the U.S. Postal Service).

The Congressional Budget Office estimates that military retirements will cost the federal government $419 billion over the next 10 years. Military pay and pension sweeteners instituted in 1999 will, just by themselves, increase pension costs by $15 billion per year, according to an analysis by the Center on Budget and Policy Priorities.

According to the governor’s task force report, the median Maryland household’s income in the year 2000 was a little more than $42,000. But the average Maryland-based military retiree had a household income of more than $83,000.

The report says giving military retirees the tax break, then, is good business—similar to corporate tax breaks designed to attract jobs. “We went in with a bill that was an economic-development bill for the state of Maryland,” says Ed Kreiner, listed as a “citizen representative” on the task force, but actually a military retiree and the organizer of the effort.

Kreiner, a retired Navy lieutenant and veteran of WWII, Korea, and Vietnam, says Maryland is losing highly skilled, highly paid military retirees to surrounding states—particularly Pennsylvania, which does not tax pension income, no matter the source. The task force report includes a list of nearby states and their “net gain” or loss of retirement-age people between 1995 and ’00. It makes Maryland look bad. But the data does not measure numbers of military retirees or even military veterans. And Pennsylvania is not on the chart.

According to U.S. Census figures, Pennsylvania’s population of veterans decreased by more than 11 percent between 1990 and ’00, yet Maryland’s vet population decreased by 6 percent during those years.

The task force’s report to the governor provides no statistical evidence that military retirees are fleeing Maryland or declining to move here. Kreiner says he knows it is happening, though—or it will happen without the tax break.

“You got stuff like BRAC,” Kreiner says, referring to the Pentagon’s Base Realignment and Closure program. “All of a sudden Aberdeen is going to get roughly about 30,000 people over about five years [to fill new military contract jobs]. A lot of vets are saying they don’t want to come to Maryland because—why the heck should they come to Maryland and take a cut in pay?”

But according to the editor of the Uniformed Services Almanac, a reference for military information, Maryland currently has 48,940 retired veterans—a more than 6,000 increase from the 42,577 cited in the task force report, which is based on tax records from 2000.

Even with no tax break, Maryland is gaining military retirees rapidly. And the more military retirees come to Maryland and don’t pay income tax, the more money Maryland forgoes and the more the state has to tax its other residents.

“My philosophy in a nutshell is one man’s tax credit is another man’s tax burden,” says the Maryland Taxpayers’ Association’s Lloyd.

“That’s not true,” Kreiner protests. “For 20 years I wasn’t in my home state of Maryland. And I paid taxes. And I was not a resident. I was in three wars. Not one, three! I’m saying, if Pennsylvania says they’re not going to take my retirement money, why isn’t it beneficial to Maryland to say the same?”

Kreiner, who says he retired in 1968 and now collects—after 38 years of COLAs—about $24,000 each year from his military pension, sounds surprised when told what today’s pensions are worth. “But they earned it,” he says, adding that the larger payments do not change the principle of the matter.

“The logic of it is so simple,” he says, “and people want to make it a convoluted thing.”

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