Extending Payroll Tax Cut and Unemployment Benefits Thousands of West Virginians

Last night, in his State of the Union address, President Obama asked Congress to pass an extension of the payroll tax cut without delay. The original tax cut, which reduced the employee share of Social Security taxes, expired at the end of 2011 and was extended for two months. Along with the payroll tax cut, Congress also passed a two month re-authorization of extended federal unemployment insurance, which provides unemployment benefits to the long-term unemployed. 

Both of these provisions will expire at the end of February without Congressional action, and a report released yesterday from the Joint Economic Committee outlines the economic impact of these two policies, underscoring the importance of their extension to West Virginia and the nation.
According to the report, failure to extend the payroll tax cut and federal unemployment insurance benefits for the rest of 2012 could reduce GDP growth by 1.7 percentage points in 2012, due to the negative impact on disposable personal income.
Extending the payroll tax cut increase the median take home pay in West Virginia by $724 for the remainder of the year, while keeping federal emergency unemployment insurance benefits would prevent 10,000 long-term unemployed West Virginians from losing their benefits on June 2.
Both the payroll tax cut and the extension of emergency federal unemployment benefits are effective economic stimuli, providing a large bang for the buck. Both bolster consumer demand, putting money in the pockets of those who are most likely to spend it. In addition, the payroll tax cut does not harm the financial security of social security, as the temporary reduction in payroll tax revenue has been and would continue to be made up by reimbursements from the Treasury’s General Fund.
While the economy in West Virginia and the nation overall has been making progress in recent months, the premature expiration of these policies could put the brakes on the recovery, and hurt the pockets of working families who are already struggling. 

Marcellus Revenues Already Offsetting Business Tax Cuts

We’ve brought up creating some sort of trust fund with the state’s severance tax revenue time and time again, so it was good to read about state Republican legislators talking about a severance tax fund in the Gazette this morning. However, it was disappointing to see that their proposal was to use a severance tax fund to finance business tax cuts, rather than building a permanent source of sustainable wealth.

The proposal would take a portion of the revenue generated by the severance tax on natural gas and place it into a “tax reduction fund.” The tax reduction fund would be used to offset the loss in revenue for local governments and schools from the proposal’s major goal – the elimination of the business personal property tax, the idea being that increases in severance tax revenue from the development of the Marcellus Shale can be used to offset the tax cut.
There are two big problems with this proposal. First, growing severance tax revenue is already effectively offsetting other business tax cuts. The state is currently phasing down and out the corporate net income and business franchise tax, a process that began in 2007 and is scheduled to be completed in 2015.
The lost revenue from the tax cuts was not replaced with any corresponding tax increase. However, recent growth in severance tax revenue from the natural gas boom has masked the lost business tax revenue, minimizing its impact on the state budget.
Revenue from the corporate net income and business franchise taxes has declined by $174 million since FY2006, the year before the cuts went into effect, a decline of over 50%. Severance tax revenue has grown by $131 million, an increase of 41.5%, almost enough to offset the losses. 
While some of the lost revenue could be attributed to the recession, other revenue sources sensitive to the economy have not seen such sharp declines. Over the same time period the consumer sales and use tax revenues have increased by 5%, while personal income tax revenue has increased by 27%. 
According to the state tax department, when fully enacted, these business tax reductions will cost the state $200 million in revenue per year, effectively negating even large gains in severance tax revenue on the state’s budget.
The second problem with the proposal is due to the future of the severance tax. While it’s true that severance tax revenue from natural gas is projected to grow substantially, severance tax revenue from coal is projected to decline. In addition to acting as an offset to current business tax reductions, natural gas severance tax revenue gains will soon be offsetting losses from coal.
Because of the diverging paths of coal and natural gas revenue, even a partial offset of the elimination of the business personal property tax would be very damaging to the state’s budget, even when natural gas revenue is at its peak. Here are the numbers.
In 2010, we estimated that the elimination of the business personal property tax would cost local governments and school boards $187 million, after adjusting for the school aid formula. During the past decade, total property tax revenue has grown at a rate of 4.3% per year. Pushing that out to 2035, when severance tax revenue is at its highest in our projection, eliminating the business personal property tax would cost $536 million to fully offset.
In 2035, the severance tax is projected to bring in about $632 million ($319 million from gas, $300 million from coal, and $12.6 million from other minerals). Under current law, about $75 million would be distributed to local governments and $24 million would be put into the West Virginia Infrastructure fund, leaving $533 million for the state’s general revenue fund. This is less than what would be needed to fully offset the tax cut. 
If we assume that only half of the lost revenue is replaced for local governments ($268 million), that would leave only $265 million of severance tax revenue in the state’s general revenue fund for FY 2035, far below the FY 2012 level of $440 million. 
Growing severance tax revenue has allowed the state to offset recent business tax cuts without much budget pain, but has also made the state’s general revenue fund more reliant on the severance tax. Financing even more business tax cuts through expected gains in natural gas severance revenue not only ignores the current role the severance tax is playing in offsetting business tax cuts, but also ignores the coming decline in coal severance revenue, and would leave gaping holes in future budgets.

Inequality Driven by Growing Shift Toward Capital Income

When we last talked about growing income inequality, the CBO had released a report showing that incomes for the richest households in the U.S. have been growing much faster than the incomes of the poor and middle class. Another study, this time from the Congressional Research Service (CRS), has confirmed that income inequality is on the rise in the U.S.

The CRS report looked at after tax income from 1996 to 2006, and the findings echoed the CBO report. On average, after tax income grew by 25% between 1996 and 2006, while low income families saw their incomes shrink, middle class incomes grew at half the rate of the average, and incomes at the very top nearly doubled. The figure below shows the change in income by quintile and for the top 1% and 0.1%, as well as the average income in each group.
Growth in Real After Tax Income by Income Group, 1996-2006
Source: Congressional Research Service
The CRS report also found that the tax system is doing less to alleviate inequality than in the past. While still progressive, the income tax system has grown less so since 1996. While the average effective tax rate fell from 23% to 20% between 1996 and 2006, it fell from 33% to 25% for the top 0.1%.
One explanation offered in the CRS report is that the rise in income inequality is due to the growth in capital gains and dividends income. Overall the share of income from capital gains in dividends grew from 10% to 14%, but it grew from 31% to 38% for the top 1%. For the bottom 80%, their share decreased from 1.4% to 0.7%. In addition, the tax rate on long term capital gains fell from 28% in 1996 to 15% in 2006, after the 2001 and 2003 Bush tax cuts, further creating after tax income inequality.
On the other hand, the share of income from wages and salaries fell, from 91% in 1996 to 79% in 2006. Yet for the the bottom 80%, their share of income from wages and salaries remained the same, at 82%. It was income earners at the top who saw their share of income from salaries and wages decline.
The data show a growing shift from labor income to capital income, with capital income much more concentrated at the top, contributing a great deal to income inequality. And while capital income grew, wages in the middle and bottom did not. Factors that kept wages from growing cited in the report include a declining real minimum wage affecting low income earners and declining unionization affecting middle income earners.
Equally as distressing as the growing income inequality are new reports that income mobility is lower in the U.S. than in other countries, with those born into poor households likely staying at the bottom of the ladder their while lives.

Business Tax Cuts – No Free Lunch

While the state should be doing all that it can to stimulate economic growth and jobs, cutting business taxes is an inefficient, regressive and poor choice for creating broadly shared prosperity. As Sean has pointed out, there are much better ways to accomplish this goal.

As AP points out today, the corporate net income tax rate will fall to 7.75% this year and the business franchise tax will be eliminated by 2015 (see chart below).

In terms of inefficiency, the business tax reductions will likely offer little in terms of creating new jobs or in enticing new businesses to located in the state. Also, there is not guarantee that businesses (mostly large out-of-state businesses pay corporate taxes) will reinvest that money or hire people in West Virginia. Most likely, it will flow out of state to (mostly) wealthy shareholders.

The one thing that is almost certain to happen, however, is a severe drop in state revenue because the cuts were not offset with additional revenue. According to the WV Department of Revenue, the tax cuts will reduce business tax revenues by over $191 million per year by 2017 (see graph below). This means less money for investing in children, public education, health care and other important budget priorities.

Working West Virginians know that if you want something you have to pay for it. There is no free lunch. Giving big tax cuts to businesses while we jeopardize our ability to ensure a better future for the next generation is not a path to prosperity. We need to be investing in the kinds of things that really create jobs, like education, infrastructure, and community development.