WV Center on Budget and Policy > Blog > 2015 & 2016 Tax Reform

A Short History of the 2017 Budget Crisis in West Virginia (So Far)

This week, Governor Justice said he would let the state budget become law instead of signing it because the budget contained so many cuts ( a “travesty”) and that his proposed tax plans failed to become law. Governor Justice mostly blamed Democrats and Republicans in the House of Delegates, along with the Senate Democrats, for the state’s “bare bones” budget because they refused to go along with several income tax cut plans that were put together between himself and Senate Republicans. It is important to recognize that had the legislature gone along with most of the governor’s proposed tax plans, the state would have do to make much deeper cuts next year and beyond.

Given the choice between baking in large-scale future budget cuts with big tax cuts and passing a budget with sizable cuts for one year, it seems like the legislature made the better of two bad choices in refusing to go along with Senate Republicans and the governor.

As Governor Justice pointed out during his budget announcement, there were several tax plans that he and the Senate proposed that failed to pass in the House. While the governor called them “missed opportunities” it is more apt to look back upon each of the tax plans as missed fiscal calamities for the state that would have resulted in deeper budget cuts in the future.

While Governor Justice put together several tax plans during the regular legislative session that raised enough revenue to close the budget gap  – which moved from -$497 million to -$270 million based on agreed to budget reductions – his joint proposal with Senate Republicans during the last night of the 60-day regular session would have led to larger budget cuts in FY 2018 and beyond. Therefore, it is difficult to understand how Governor Justice can see this as a “missed opportunity” if he is concerned about budget cuts hurting the state.

Strangely, Governor Justice told the media  that  “all this [the passed state budget and no tax reform] does is kick the can down the road, and there’s massive budget holes in the out years.” The governor went on to say that the budget gap for FY 2019 is “$179 million” and “$486 million” by FY 2022. A simple look at the revenue impact of each of the “missed opportunities” or tax proposals shows that these gaps would have likely been much larger in outer years if most of these tax proposals would have been adopted.

Below is table that includes the net revenue impact of each of the proposed tax plans from the governor, House, Senate and several that the governor endorsed along with Senate leadership. Outside of the governor’s first tax plan that was included as part of this original budget for FY 2018 and his second proposed tax plan based on agreed to budget cuts (these were not mentioned as “missed opportunities” by the Governor), all of the other tax plans proposed by the Governor (along with the Senate) failed to raise enough money to close the projected budget gap for FY 2018 let alone for future budget years.

In fact, the tax plan the governor put together with Senate Republicans on the last night of the session on April 8th – missed opportunity #1 according to the governor – would have drastically reduced revenues for the state and expenditures absent future tax increases. By FY 2021, the State Tax Department estimated that it would have reduced General Revenue Fund collections by -$220 million and much more going forward, as the income tax was phased down. The House did not fare much better. Two out of three of the tax plans that passed the House lowered net revenue collections by FY 2020, which would require tax increases or more future budget cuts. While the tax plan passed by the Senate last Thursday increased net revenue by $93 million in FY 2018 – presumably close to enough revenue to pass the governor’s FY 2018 budget during the special session along with the new revenue estimates – the estimated revenue for FY 2019 was $30 million less, leading most likely to more budget cuts next year.

While Protect WV,  WV Center on Budget Policy,  and some lawmakers (see here and here) put forth a several revenue proposals for avoiding the deep cuts included in the FY 2018 budget, the legislature unfortunately could not agree on any revenue enhancements. Despite this inaction, the state’s fiscal health and funding of future budget priorities would have been much worse had most of the “missed opportunities” become law. On top of the tax proposals not bringing in enough money to fund budget priorities, most of the compromise tax plans between the Governor and Senate  (see here, here, here, and here) lowered taxes on the wealthy while increasing them on most West Virginians.

If there is silver lining to the state’s budget crisis this year it is that the budget passed by the legislature last week contains about $122 million more in General Revenue Fund appropriations than the budget vetoed by the governor in April. While it remains to be seen whether the new revenue estimates for next year pan out, they at least helped avoid more severe budget cuts.

Moving forward, the state is in for more hard times as the state faces yet again another large budget gap next year and likely stalemate on the need to pass sufficient revenues to meet the states needs. That said, it would have been a lot worse had the legislature acted on many of the governor’s tax proposals.

 

 

Senate Tax Plan Punches More Holes Into Budget (Updated)

Yesterday, the Senate Finance Committee passed an amended tax bill (HB 107) aimed at addressing the state’s budget shortfall, which was pegged at $497 million (or about 12 percent of the base budget) at the beginning of the year. Unlike the version of the bill passed by House, the Senate version creates net revenue losses beyond the FY 2018 budget.

The Senate bill includes raising the Sales Tax to 7.25 percent from 6 percent, expanding the sales tax base (telecommunications, digital goods, contracting services up to $40k, electronic data processing, health and fitness club memberships, primary opinion research, and ending direct use exemption for communications companies), an increase in the Historical Structure Rehabilitation Tax Credit to 25 percent from 10 percent, ending General Revenue transfer to Road Fund from sales taxes on highway construction, exempting all military retirement income from income tax, eliminating Social Security from income taxes over two years for those with less than $70,000, a new coal severance tax sliding scale based on price, a temporary three year increase in the Corporate Net Income Tax rate to 7 percent from 6.5 percent, and  new Personal Income Tax brackets that will reduce income tax collections by 15 percent in 2018 and 20 percent in 2019. The bill also includes a gradual phaseout of Personal Income Tax rates of 0.1 percent per year based on growth in the General Revenue Fund and inflation. The phase down is estimated to begin by FY 2021.

According to the Department of Revenue, the net impact of the legislation is a one-year increase in revenue in FY 2018 because the sales tax rate hike begins on July 1, 2017 while the personal income tax reduction does not begin until January 1, 2018 (Fiscal Year = July 1 to June 30th). After FY 2018, the Senate bill is projected to lower revenue by $56.1 million in FY2019, $121.5 million in FY2020, $137.4 million in FY21021, and $177.6 million in FY2022 when the Personal Income Tax rates begin to drop.

As shown above, the Senate tax plan not only fails to provide enough revenue for next year’s budget, but it also creates large future revenue holes that will likely result in more deep cuts to higher education, schools, and health and human services. This is especially important since next year is an election year when legislators often shy away from raising taxes.

Similar to previous tax plans from the Senate, this plan increase taxes on most West Virginians while lowering them for higher-income residents. According to the Institute on Taxation and Economic Policy, the Senate tax plan increases taxes on 60 percent of West Virginia households while lowering taxes on the top 40 percent of households. This is because lower income West Virginians pay more in sales taxes than income taxes, while the opposite is true for higher income people. Overall, the top 1 percent in West Virginia would receive an estimated tax cut of $2,245 on average while those making $26,000 would see a tax increase of $88 dollars on average.

Over the next couple of weeks, the Senate and House will take their tax plans to a conference committee to work on amenable plan that can pass both chambers so they can finally pass a budget from the upcoming year. The plan will have to include additional revenue if it aims to avoid more draconian cuts, especially in the outer years. One item that needs to be taken off of the bargaining table is the deep cuts to the personal income tax that largely benefit wealthier West Virginians. Only when this happens, can we ensure that we are not going down the Kansas road of a fiscal inferno with deep cuts to important programs, more credit downgrades, and weaker economic growth.

A good place for negotiations to start would be to adopt a simple tax plan, like the one we have endorsed or Delegate Pushkin has introduced that asks everyone to pay their fair share to avoid a government shutdown and cuts to essential services for families, children, and seniors.

 

What is the impact of the “compromise tax proposal” on the budget and working families?

Earlier this week, the West Virginia Center on Budget and Policy examined the fiscal impact of the proposed compromise tax plan between Governor Justice and Senate leadership that will influence how the budget is finalized. It appears House leadership is saying “nope” to this plan and it is unclear how the plan would close the state’s looming budget gap of $500 million for FY 2018, since a corresponding budget plan hasn’t been put forth. As we noted in our recent report on the budget, the state budget that passed – and was later vetoed by the Governor  – included about $90 million from the Rainy Day Fund and no new revenue increases, along with significant cuts to the Governor’s proposed budget, including Medicaid, higher education, and other programs.

As Phil Kabler notes in the Gazette-Mail, it is also unclear what is currently included in the so-called compromise tax plan being advanced by Governor Justice. It has been rumored the tax plan is the same as Senator Fern’s amendment to SB 484 with the exception that the plan includes the Governor’s tiered severance tax rate changes and not the ones in the Fern’s amendment that significantly reduce severance tax collections.  If this is true, the revenue impact to the budget would be significantly reduced. (For more detailed account of the Ferns Amendment aka the proposed compromise tax plan, see our previous post here)

According to estimates provided by State Tax Department (via email), the proposed severance tax changes in  the Fern’s Amendment would result in a loss of an estimated -$135 million in severance tax collections in FY 2018 and between -$140-$150 million thereafter. Overall, the net result of the Ferns Amendment on the General Revenue Fund, according to the State Tax Department,  is an increase of +$50 million in revenues in FY 2018, and a net reduction of an estimated -$170 million in FY 2019 and FY 2020, and a reduction of -$220 million by FY 2021.

For FY 2018, this includes +$280 million in sales tax increases (7 percent rate and broader base), +$49 million in additional revenue from the new and temporary CAT or commercial activities tax (0.045 percent) and high-income tax surcharge, an increase of +$12 million from ending sales tax transfer to Road Fund from sales tax collected on highway construction, and approximately -$156 million less in personal income tax collections. (Note: The reduction in the personal income tax is -$380 million upon full impact. The income tax reductions do not begin until January 1, 2018, while the other tax changes take effect July 1, 2017 – the beginning of FY 2018 – but start June 1, 2017). It is also important to keep in mind the CAT and high-income tax surcharge expire on July 1, 2020 or the beginning of FY 2021).

If the severance tax changes in the Ferns Amendment are swapped for the Governor’s proposed severance tax rates that are estimated to be close to revenue neutral, this means that the net revenue impact on the General Revenue Fund would be an increase of +$185 million ($50m + $135m) in FY 2018, then a decrease of -$30 million in FY 2019 and FY 2020, and then a reduction of  -$70 million by FY 2021 assuming there is no phase-down of income tax rates.

While incorporating the Governor’s severance tax proposals into the tax compromise plan provides a significant revenue boost during the FY 2018 budget year, the sharp reductions in the income tax when it is fully implemented leads to revenue losses beginning in FY 2019 that will grow the state’s budget deficit and lead to additional cuts to vital programs and services. These declines will grow more over time, with the phase down of the income tax and the expiration of the CAT and high-income surcharge by July 1, 2020.

When all of the tax changes are fully implemented in their first year (not including sales tax transfer from Road Fund), it adds up to $280 million in additional sales tax increases, $49 million in increased revenues from the CAT and high-income surcharge, and $380 million in cuts to the personal income tax. This means the proposed compromise tax plan is actually reducing taxes on West Virginians upon full implementation, not increasing them when it comes to the General Revenue Fund budget.

While the compromise tax plans leads to one year of positive revenue growth for the General Revenue Fund and growing deficits thereafter,  the proposed revenue changes to the State Road Fund would increase revenues by about +$130 million in FY 2018 and +$138 million thereafter (if you do not include the transfer of sales tax collections from the Road Fund to the General Revenue Fund).

Altogether, the revenue changes in the proposed tax compromise plan – including General Revenue and State Road Funds – increase state revenues by approximately $315 million in FY 2018 and $108 million in FY 2019. To be clear, these estimates are subject to change at any time since there is no agreed upon tax bill or a full disclosure of what is being proposed between the Governor and legislative leadership.

The overall impact of these tax and revenue changes on households in West Virginia is the same as as has been reported in previous post, which did not include any severance tax changes because the tax is mostly exported out of the state and unable to be modeled because of difficulties obtaining proper information for the process.

Upon full implementation – which does not include any phase down of the income tax rates or the expiration of the CAT or high-income surcharge –  the proposed tax and revenue changes would, on average, increase taxes on 80 percent of West Virginia households making below $84,000 per year, while lowering them on the 20 percent of West Virginians that make more than $84,000 per year. Those making on average $11,000 per year would see their annual taxes rise by $121 or 1.1 percent of their income, while those making on average $778,000 (top 1 percent) per year would see an average tax cut of $3,713.

This means that the compromise tax plan – if this is in fact it – raises taxes on most West Virginians to help pay for tax reductions for higher-income West Virginians while leaving some revenue to spare in the first year.

The table below breaks out the tax changes for each income group in West Virginia. It includes the full-implementation of income tax reductions in 2018 and the high-income surcharge. While every income group sees an increase in their taxes from the proposed changes to the sales tax, motor fuel tax/DMV fees, and the new commercial activities tax, the large personal income tax reductions mostly goes to the top income groups. In fact, approximately 59 percent of the more than $364 million in income tax cuts go to the top 20 percent, according to the Institute on Taxation and Economic Policy. This is why higher income West Virginians are estimated to receive an overall reduction in taxes while low and middle-income West Virginians see an increase in taxes.

A closer look at the proposed changes to the income tax illuminate this point further. The proposed tax compromise plan condenses the state’s five income tax brackets into three brackets and reduces the rates. For example, instead of a top marginal tax rate of 6.5 percent on income over $60,000, the tax compromise proposal replaces this rate with a top rate of 5.45 percent on income over $35,000. This change will benefit those who have more income.

As the chart below highlights, the personal income tax in West Virginia is based on the ability to pay. This is largely because personal income tax rates increase as income increases. Sales taxes on the other hand, are regressive, taking a larger share of income from low- and middle-income West Virginians. And because those at the bottom and middle spend more of their income on necessities than the wealthy, shifting from the income tax to a greater reliance on sales taxes is a shift in “who pays” from those with more income to those with less income.  Phasing out West Virginia’s income tax would also make the state’s upside down state and local tax system even more regressive over time.

As discussed in a recent report, shifting from the income tax to the sales tax is a poor strategy for economic growth. Academic research and real-world evidence from other states show that there is little evidence that such a shift will significantly boost economic growth, attract more people, or grow small businesses. However, there is compelling evidence that the income tax is a more reliable source of income than the sales tax over the long-term and that the states with more regressive tax structures increase income inequality.

As the Governor and legislature work out a compromise on the budget, including tax changes, they should keep in mind that setting West Virginia on a path of further cuts and just one year of revenue gain is not going to help build a stronger West Virginia where communities can thrive. While it is great to invest additional resources in our state’s crumbing roads and bridges, those gains could be washed away be shortchanging our state’s other needs – including our public colleges, schools, public safety, and health-care services.

Just any tax plan is not a good tax plan. It must be grounded in realistic assumptions and be sustainable over time.  A sound plan cannot rely on false claims about trickle-down economic growth or a sudden surge in coal mining or natural gas extraction. It must provide a reliable source of revenue that can pay our state’s debts and sustain public investments.

As developments of the tax and budget compromise unfold, we will continue to analyze and review them as they are released to the public.

 

Compromise Tax Bill Falls Onto Working Families, Makes Budget Crisis Worse

On the last night of the 2017 Legislative Session, the Senate and the Governor appeared to have worked on a tax plan compromise bill that would make sweeping changes to the state’s tax system that would exacerbate our state’s budget crisis and shift the tax load onto working families to make room for tax breaks for the wealthy. This included severance and income tax reductions, a sales tax increase with base broadening, a temporary Commercial Activities Tax (CAT) on gross receipts and a high-income surcharge tax, and increases in motor fuel taxes and Division of Motor Vehicle fees dedicated to the state’s roads.  Altogether, these changes would lower General Revenue Fund collections by an estimated $115 million and increase State Road Fund revenues by nearly $118 million in the first year of full implementation.

The table below provides an overview of the tax changes included in the compromise tax plan that were offered as an amendment to Senate Bill 484. While the plan raises revenues by increasing the sales tax and enacting a temporary tax on businesses (CAT) and high-income earners, the deep cuts to the personal income and the severance tax lead to a sharp decline in revenues for the upcoming fiscal year of 2018. The tax plan lowers revenue collections in future years even further since both the CAT and high-income tax expire by FY 2020, and the personal income tax is phased out over the coming decades.

The changes to the State Road Fund include an 8-cent increase in the motor fuel tax and increases in various DMV fees. This totals approximately $118 million in additional revenue for FY 2018 or about $60 million less than the Governor proposed in his FY 2018 budget.

On top of the $115 million in lost revenues that punch a bigger hole in the state budget, the proposed tax changes would on average increase taxes on 80 percent of West Virginia households making below $84,000, while lowering them on the 20 percent of West Virginians that make more than $84,000. Those making on average $11,000 would see their annual taxes rise by $121 or 1.1 percent of their income, while those making on average $778,000 (top 1 percent) would see an average tax cut of $3,713. This means that the compromise tax plan – excluding severance tax changes – raises taxes on most West Virginians to give large tax breaks to those that need them the least.

As noted in previous tax proposals, these changes will not only exacerbate income inequality and make it harder for low- and middle-income families to make ends meet, but they will lead to large future budget shortfalls that will damage our state’s ability to invest in the building blocks of our state’s economy.

Cutting income and severance taxes – while phasing out the income tax – is not going to pave a strong future for the state. Instead of moving in this direction, lawmakers need to work together to ensure tax reform is addressing the state’s looming budget crisis together not making it worse.

 

House Tax Plan Comes Up Short

Today,  the House approved a tax plan (SB 484) that broadens the sales tax base and lowers the rate to balance the House’s budget (HB 2018). Altogether, the tax plan is expected to increase tax revenue in its first two years, while lowering tax revenue by year three. This is because of revenue triggers in the bill that lower the sales tax rate each year based on the prior year’s revenue. If enacted, this legislation will mean more budget cuts or revenue increases next year because of the backed-in reductions of the sales tax. The bill also means that low- and middle-income West Virginians will pay more in taxes as a share of their income than higher income residents.

The House tax plan will drop the sales tax rate from 6.0 percent to 5.5 percent beginning next year on July 1, 2018, and then to 5.0 percent on July 1, 2019. Thereafter, the sales tax rate will continue to drop based on a revenue formula, but not drop below 4.75 percent.

Several services and goods that are currently exempt in the sales tax base would now become taxable. These include telecommunications, personal services (barbering, massaging, manicuring, hair setting, hair washing and dying, shoe-shining, and non-medical personal care services, contracting services (on first $40k), electronic data processing, and opinion research. The bill also lifts the direct use exemption for all sales, services machinery, supplies and materials directly used or consumed in transportation (except coal) and communications. Almost all states have broad direct use exemptions because of concerns about tax pyramiding and business-to-business taxation.

Though SB 484 faces an uncertain future, it is clear it is not enough revenue to stop large budget cuts in the House and Senate budget bills and it creates future budget gaps that could lead to even bigger budget cuts to important programs and services in the future. While SB 484 increases revenue by $138 million for FY 2018, revenue drops to $55 million in FY 2019, followed by a decrease of -$15 million by FY 2020. This creates a budget hole of $83 million in FY 2019 and $153 million by FY 2020 if the House passes it’s budget bill than already cuts millions from important program and services.

 

 

 

House and Senate Tax Proposals Shift Tax Load Onto Working Families (Updated)

The House and the Senate have advanced two similar tax bills that make substantial changes to the state’s personal income and sales tax, which account for over 75 percent of state general revenue fund collections. Both of these bills will shift the tax load from the wealthy onto working families. It is unclear how either of them will help balance the state’s looming budget deficit or make the investments needed to address many of the state’s major problems.

House Bill 2933, which was amended and passed out of House Finance Committee late on Friday without a fiscal note, makes several changes to the sales and personal income tax. On the sales tax side,  HB 2933 broadens the sales tax base to include mobile homes, telecommunications (e.g. cellphones), professional (legal, accounting, etc.), personal (barber shops, messages, etc.), and contract services (e.g. home repairs/renovations), lowers the sales tax from 6 percent to 5 percent, and taxes groceries at 3 percent.

On the personal income tax side, HB 2933 eliminates the state’s long-standing graduated income tax structure and replaces it with a new 5.1 percent flat income tax rate. It also replaces the state’s low-income family tax credit with a new $10,000 standard deductions for tax filers with income (AGI) below $50,000. And it eliminates the state’s $2,000 personal exemption.

Upon full implementation, HB 2933 would increase taxes on approximately 75 percent of West Virginia taxpayers, while giving those in the top 1 percent with average incomes of $778,000 a tax break of over $6,500. Those with average incomes of $11,000 would see a small tax decrease of $17, while those with average incomes of $66,000 would see an increase of $325. All together, HB 2933 is estimated to  increase tax revenue by $11 million by FY 2020.

Senate Bill 409, which passed out of the Senate Committee on Tax Reform (with no fiscal note) and is on the agenda of the Senate Finance Committee on Monday, makes changes to the state’s sales tax, personal income tax, coal severance tax, and property taxes.  On the sales tax side, SB 409 increases the sales tax rate to 7 percent from 6 percent, taxes groceries and mobile homes at 3.5 percent, broadens the sales tax base to include telecommunications, several personal services, electronic data processing services, and several other services (e.g. solid waste disposal, fitness club memberships, music instruction, artistic performances, summer camp tuition, newspaper delivery, funerals, public opinion research, travel agency fees, etc.).

SB 409 also lowers the coal severance tax from 5 percent to 2.5 percent, while increasing the thin-seam coal severance tax to 2.5 percent from 1 percent and 2 percent. According to an earlier fiscal note of SB 335, this would reduce coal severance taxes by $68 million by FY 2019.

SB 409 abolishes the 5 current income tax brackets and puts in its place three new brackets. These include 1.5 percent on income below $20,000, 3 percent on income between $20,000 and $40,000, and 4.5 percent on income above $40,000. An analysis (handout) by WVU found that a similar proposal with three brackets (1.6 percent under $20k, 3.3 percent on $20-$35k, and 5 percent above $35k) reduced personal income taxes by $575 million in FY 2019.

The bill contains a sales tax revenue trigger to reduce each of these income tax brackets by 0.1 percent for each $50 million in revenue from the sales tax that is above $1.8 billion. For example, if sales tax revenue increases to $1.9 billion than each income tax rate will drop by 0.2 percent (e.g. 2.8 percent in income between $20-$40k). Eventually, this will led to the income tax being fully repealed (e.g. when sales tax revenue is $3.3 billion, the 3 percent rate on income between $20k-$40k will be zero). According to the State Tax Department, sales tax revenue will exceed $1.8 billion by FY 2021.

The last substantial change to the state’s tax system in SB 409 is removing property tax revenue caps. Currently, property tax revenues cannot grow by more than 1 percent per year for counties and municipalities, and 2 percent per year for county school boards unless it is because of new construction or improvements to existing property. SB 409 would allow some counties that are growing to take this additional property tax revenue and deposit into a new fund for schools.  While removing these revenue caps is sound policy, it is unclear from the language in the bill how this would impact local government finances or the school aid formula.

According to an analysis  by the State Tax Department, SB 409 will increase revenues by $61.1 million in FY 2018, but is expected to lower revenues by $90.6 million in FY 2019.

A flat income tax won’t significantly boost growth 

One common argument given for a flat income tax is that it will boost our state’s economy because it lowers taxes on businesses and the wealthy. This is a strategy that is not supported by evidence from other states or mainstream economic research. Since 2010, more than a dozen states have cut their income tax rates, with Kansas, Maine, North Carolina, Ohio, and Wisconsin embracing the largest reductions in income taxes. Of these states, only North Carolina has experienced faster employment and income growth than the nation as a whole in the years immediately following their cuts.

While North Carolina experienced slightly higher income and job growth than the nation as a whole after shifting to a flat income tax in 2014, the state is adding jobs more slowly than most of its neighboring states.

The mediocre results in states that have cut their income tax rates is aligned with the findings of mainstream academic research, which typically finds that income tax levels provide little to no impact on economic growth. After reviewing major studies published in academic journals since 2000 that examined the effect of state personal income tax levels on broad measures of state economic growth, the Center on Budget and Policy Priorities concluded that “of the 15, 11 found no significant effects and one of the others produced internally inconsistent results.” This means for every one academic study that found personal income taxes boosted state economic growth, there were about four that found no significant effects.

A recent study conducted by the nonpartisan Tax Policy Center further undermines the claim that states can improve their economies by cutting personal income taxes. It found that personal income taxes have a statistically insignificant impact on growth. This study replicated a 2008 study by economist Robert Reed that many tax-cut proponents often cite that found evidence that income tax cuts increase economic growth. The TPC study mirrored the findings of a 2006 study by economist Rex Piesky that showed that higher tax states either are associated with stronger growth or have a statically insignificant impact on economic growth. Piesky concluded that the “conventional wisdom about the impact of taxes on economic growth rests on a weak foundation.”

Part of the reason that state income tax cuts fail to unleash economic growth is because the vast majority of tax payers are in no position to create any jobs. According to a recent national study
by the U.S. Treasury Department, only 2.7 percent of income-tax payers own a small business with an employee other than the owner. In West Virginia, the average taxable income for businesses that paid the personal income tax in 2013 was just $21,656. Even if these businesses made enough
money to have to pay the state’s top income tax rate of 6.5 percent, they would only pay about $1,400 on average. So reducing their taxes by perhaps a hundred dollars would produce nowhere near enough money to hire an additional worker. Since most new jobs are grown organically by in-state firms and small businesses, income tax cuts will do little to attract new out-of-state companies.

Flat Income Taxes Can Grow More Slowly

According to a recent paper by the Federal Reserve Bank of Kansas City, states with progressive, graduated personal income tax brackets have faster revenue growth compared to states with flat income taxes.

Structures that are more progressive and not indexed for inflation will experience faster growth and more volatility in revenues. Colorado is the only state in the Tenth District with a flat income tax, where all incomes pay the same tax rate. The long-run and short-run elasticities for Colorado show that its personal income tax revenues have grown more slowly than in other states and are also less volatile.

While the volatility of personal income tax collections from states with graduated income tax brackets is higher, these states tend to produce lower revenues over time.

Expanding the Sales Tax to Pay for More Taxes on Working Families

While lowering the sales tax rate and expanding it to include more services is generally sound policy if revenue neutral, the addition of new sales taxes on business to business sales such as accounting and legal services could create “tax pyramiding” where some business may choose to produce these services themselves (vertical integration). Since only a few states tax professional services (none that border West Virginia and all below 5 percent) a new sales tax on these services may reduce employment and firms in West Virginia as business choose to locate across the border. Business will also be hurt by an increase in taxes they pay. In FY 2015, business paid $500 million in sales taxes in West Virginia compared to just $200 million in personal income taxes.

Both HB 2933 and SB 409 expand the sale tax base in an effort to pay for reducing income taxes that mostly go to high-income tax payers. This means they are shifting the tax load onto working families because sales taxes are regressive and take a large chunk of income from low and moderate-income tax payers. This is especially true with the addition of the sales tax on groceries or food for home consumption. Only 13 states tax groceries, with four states taxing them below 3 percent. Virginia is the only border state with a tax on groceries, which is 2%.

The tax bills being proposed by the Senate and House do little to nothing to address the state’s looming budget shortfall. In fact, SB 409 is expected to lead to a large decrease in revenues by FY 2019, while HB 2933 only slightly increases revenue collections. That said, it is clear that both aim to shift the tax load onto working families to pay for tax breaks for those on the top. This will not only further exacerbate growing income inequality in West Virginia, but it could lead to major cuts in services down the road like we’ve seen in Kansas that embarked on a similar tax cut and tax shift crusade. Instead of moving in this direction, lawmakers should be working to ensure that the state has the resources it needs to invest in the things communities need and asks everyone to contribute. Cutting taxes for the wealthy while increasing taxes for most West Virginians is not going to get us there.

Constitutional Amendment Would Cripple State Finances Further

Today, the Senate Select Committee on Tax Reform will consider a joint resolution that calls for a constitutional amendment (SJR 8)  that would transform the state and local tax system in West Virginia. Called the “Fair and Simple Tax Reform” amendment, it is part of an upside down tax package that includes SB 335 that creates a new eight percent sales tax while phasing out income taxes and reducing severance taxes.

In order for the amendment to be placed on the ballot in 2018, it would require the approval of two-thirds of legislators in the Senate (23 out of 34 members) and House ( 66 out of 100 members). To be ratified, a simple majority of voters is needed.

Property Tax Changes Proposed

Personal Property: SJR 8 would immediately abolish the personal property tax on vehicles and phase out over 10 years other (business) personal property taxes except public utility personal property. In 2016, personal property taxes accounted for $589 million or 34 percent of total property taxes ($1.735 billion) in West Virginia.

New Property Classes, Assessments, and Tax Rates: Currently West Virginia has four classes of property for property tax purposes. Class I includes all personal property used exclusively for agriculture, however, all Class I property is currently exempted from property taxes. Class II property includes owner occupied residencies and farm property. Class III includes all other real and personal property (including commercial real estate, business personal property, and personal vehicles) that is located outside a municipality, and Class IV includes all other real and personal property located inside a municipality.

Under the current property tax system, property is assessed at 60 percent of its value before the levy rates are applied. Levy rates vary by levying body. Maximum Class II rates are 28.6 cents/$100 for counties, 45.9 cents/$100 for school districts, 25 cents/$100 for municipalities. Maximum Class III and IV rates are 57.2 cents/$100 for counties, 91.8 cents/$100 for school districts, and 50 cents/$100 for municipalities.

SJR 8 would restructure the property tax system into three classes. Class A would include real property used for farming and real estate. Class A would be assessed based upon economic output and would be taxed at a rate of 50 cents/$100 of value. Class B would include residential real property, including rental property. Class B property would be assessed at market value an taxed at a rate of $1.50/$100 of value. Class C would include all other real property, including commercial property. Class C property assessed at market value and would be taxed at a rate of $1.75/$100 of value. The levying bodies would be allocated a share of the total, counties would be allocated 15 percent, municipalities would be allocated 10 percent, and school districts would be allocated 65 percent. Ten percent would be set aside for a State Equalization Fund. In addition, levying bodies would have to vote if they wanted to have a tax rate greater than 80 percent of the maximum rate.

Based on FY 2017 assessed values and levy rates, SJR 8 would reduce total property tax revenue by approximately $385 million, assuming maximum rates under the new proposal. Businesses would be the big winners under the proposal, with commercial property taxes being cut nearly in half, from $1.189 billion to $607 million, once personal property taxes are fully phased out. On the other hand, property taxes on homeowners would dramatically increase. Property taxes on residential property would increase from $418 million to $726 million, a $308 million increase. This would be offset somewhat by the exemption of personal vehicles, which amounts to about $128 million.

Personal & Corporate Income Tax Proposed Changes

Flattening and Abolishing the Personal Income Tax: Currently, West Virginia has a graduated income tax structure that includes five tax brackets, including a top rate of 6.5 percent on income over $60,000 and a bottom rate of three percent on income under $10,000. SJR 8 would enshrine in our state constitution that the state’s personal income tax could be no higher than a flat three percent tax rate and that it shall be phased out within 10 years of passage. It also allows each taxpayer the current deductions allowed under law. According to a recent fiscal note of SB 335 that includes the adoption of a 2.65 percent flat income tax rate, it would reduce income tax revenue by $890 million in FY 2019.

Capping the Corporate Net Income Tax: Currently, the corporate net income tax rate is 6.5 percent. Under SB 335, it would eventually be repealed depending on a number of triggers but it could take several decades. This provision says if it is ever reinstated, it cannot be greater than three percent. This would reduce the rate by half. In FY 2018, the state is expected to collect $137 million in corporate income taxes.

Other Proposed Tax Changes

Phase down of all state and local taxes except (income, property, sales): It is unclear if this is an error, but according to SJR 8:

Any state tax levied at the time this amendment is ratified, which is not specifically authorized or prohibited by this amendment, may continue to be levied for a period of not more than ten years following ratification of this amendment.  Any municipal tax levied at the time this amendment is ratified, may continue for a period of not more than ten years following ratification of this amendment.

This could potentially mean that local government would have to remove its current Business & Occupation taxes and rely only on property and sales taxes. At the state level, this would mean the phase out of the Business & Occupation Tax, Insurance Tax, Tobacco Taxes, Alcohol Taxes, Health Care Provider Tax, Special Reclamation Tax, Severance Tax, Motor Fuel Taxes, Property Transfer Tax, Soft Drink Tax, Solid Waste Fees, and other smaller taxes. Altogether, these taxes are over $1.3 billion annually. At the local level, it would wipe out the municipal Business & Occupation Tax, Hotel Occupancy Tax, and some other small ones. The B&O Tax in Charleston, West Virginia is 43 percent or $43 million of city revenues.

Tax Expenditures: Currently, the state spends hundreds of millions each year through the tax code on tax credits, exemptions, preferences, deductions, property abatements and other tax incentives. SJR 8 would allow tax expenditures that are currently in state law but would limit the creation of new ones unless they are approved by 3/5 of the legislature.

Altogether, these proposed changes would have a profoundly negative impact on the state, creating a near certain fiscal disaster. While costing the state and local governments more than $1 billion, low- and middle-income families would likely pay more in taxes, in order to finance the enormous tax cuts for businesses and the wealthy that would be enacted. These changes would leave the state and local communities crippled and unable to provide even the most basic of public services. Schools and colleges would be closed, parks and libraries would be abandoned, thousands would lose healthcare coverage, and infrastructure would be neglected as these tax proposals bankrupt the state.

A Marriage Not Made in Heaven: A State EITC Without an Income Tax

Last Friday, the Senate Select Committee on Tax Reform explored the idea of amending SB 335 to include a version of a refundable state Earned Income Tax Credit. As noted previously, SB 335 would replace the personal and corporate income tax, along with the sales and use tax, with a general consumption tax of 8 percent. One major problem with this idea is that if West Virginia ceases to have an income tax , how could it create an WV EITC that is based on someones state income tax liability (see here for how a WV EITC would work)? How big would a WV EITC have to be to offset the increased tax liabilities for low-income West Virginians if SB 335 is enacted?

Let’s look at the first question. Washington State is the only state in the country that does not have a state income tax that currently has a refundable state tax credit based on the federal EITC (10%) called the Working Families Tax Exemption (WFTE). While the WFTE was enacted in 2008, it has never been activated or funded because of ongoing budget problems. Another major problem with the WFTE is that it has very high administrative costs because the state does not have an income tax ($4.4 million) which complicates the application process. So, while it is possible to have a refundable state EITC without an state income tax, it is not a marriage made in heaven.

Another issue that came up during the committee meeting on Friday was how large a West Virginia EITC would have to be to offset the tax increases imposed on the bottom 40 percent of tax payers in West Virginia under SB 335. As the graph below highlights, those in the bottom 20 percent (less than $19,000) would see an average tax increase of $500 while those in the second 20 percent (less than $33,000) would see a tax increase of $946.

In order to offset the tax increase of those under $19,000 (bottom 20 percent), it would cost approximately $233 million, and to offset everyone under $33,000 (bottom 40 percent) it would take approximately $412 million. If lawmakers wanted to use a state EITC to make sure the average taxpayer in the bottom 20 percent was held harmless it would require a state EITC that is 65 percent of the federal EITC and 115 percent of the federal EITC to offset everyone in the bottom 40 percent making under $33,000. However, if just a state EITC is used to offset the $412 million in increased taxes under SB 335 for the bottom 40 percent, many people would be left behind while some EITC recipients would see a large tax cut. This is because a good portion of those in the bottom 40 percent of taxpayers are not eligible or receive very little from the EITC (97 percent of EITC benefits goes to households with children).

For example, in 2014, the average EITC credit was $2,241 in West Virginia. At 115 percent of the federal credit, the average state EITC would be $2,577 in West Virginia. If this person is in the second 20 percent, this means that may see a net tax decrease of over $1,600 on average ($2,577-$946= $1,631). The central reason for the discrepancy is only a portion of those in the bottom 40 percent of taxpayers receive benefits from the EITC, as mentioned above. In 2014, approximately 161,000 tax filers in West Virginia received the federal EITC while 513,000 tax filers had income within the EITC income limits that did not receive a EITC.  In other words, EITC recipients only make up about one-third of tax filers below $50,000 (EITC max income range), not including those with low incomes that didn’t file taxes at all. If you only use a refundable state EITC to offset the total tax increase ($412 million for bottom 40 percent as a whole), people that are eligible for the EITC will likely receive a tax cut while others that receive little to nothing from the EITC will continue to see a large tax increase. This was a major point of confusion at the committee meeting, but I hope this helps clarify why a WV EITC would only offset the tax hikes for those that are eligible for an EITC.

Of course, none of this analysis takes away from the fact that this bill would offer huge tax cuts for the wealthy and that to make low-income West Virginians hole would require a large drop in the amount of revenue that the new consumption tax brings to the budget. This would likly mean large budget cuts, which takes us in the opposite direction we want to go when we are facing a $500 million budget gap this year.

 

 

 

 

Replacing Income Taxes with a General Consumption Tax is Radical and Regressive (SB 335)

Senate leadership introduced SB 335 which would would abolish the personal income tax and sales and use tax, phase out the corporate income tax, lower the severance tax, and replace these taxes with an 8 percent broad-based general consumption or sales tax. While it is unclear whether this tax shift would be revenue neutral, it would dramatically increase taxes on most West Virginians and give large tax breaks to the wealthiest people in the state. West Virginia would also be the only state with a general consumption tax.

According to SB 335, the 6 percent sales and use tax would be repealed on July 1, 2017, and the personal income tax would be repealed on January 1, 2018. A new and temporary flat personal income tax would be created on January 1, 2018, but would be phased out by 2021. The flat personal income tax rate would be 0.60 percent in 2018, 0.40 percent in 2019, 0.20 percent in 2020, and zero in 2021 when it is eliminated (see current personal income tax brackets here).

The corporate net income tax would be phased out beginning January 1, 2018, as long as the balance of the Rainy Day Funds (A & B) are 10 percent of the general revenue fund expenditures (it’s 15.1 percent today). If this trigger is met, the corporate net income tax rate would fall from 6.5 percent in 2017 to 5.5 percent in 2018; 4.5 percent in 2019; 3.5 percent in 2020; 2.5 percent in 2021, 1.5 percent in 2022; 0.5 percent in 2023; and zero in 2024. The severance tax (coal, oil, natural gas, and other minerals) rate would drop by 2 percentage points based on the same trigger as the drop in the corporate net income tax rate. This would reduce the rate from 5 percent today, to 4 percent in 2018 and 3 percent in 2019.

While the new general consumption tax is very broad, it contains a number of modifications and exemptions. The modifications include two different tax rates on motor vehicles. The consumption tax rate would be 8 percent on the first $10,000 of a vehicle and then 6 percent rate on anything over that amount. The general consumption tax also exempts many items that are already exempt under law – including nonprofit and government purchases, sales for resale for businesses, and a direct use exemption for agriculture, natural resource production, and manufacturing, to name just a few.

Though it is not clear what the revenue impact of SB 335 would be, if it is revenue neutral (big if) it would need to generate over $3 billion in revenue annually and it would comprise over three-quarters of the state’s general revenue fund budget.

Eliminating West Virginia’s income taxes and its sales and use tax and replacing it with a general consumption tax – which operates the same as a sales tax – would make the state’s upside down state and local tax system even more regressive and it would give large tax cuts to those that don’t need them and huge tax increases to those who are struggling to get by. It would also mean that West Virginia would have the highest statewide tax on groceries.

As the chart below highlights, somebody making on average $26,000 a year (second 20 percent) would pay an additional $946 in taxes under SB 335, while someone in the top one percent would get a tax break of nearly $28,000. This is a “Robin Hood in Reverse” tax plan. If enacted it might be one of the biggest transfers of wealth from the poor and middle class to the rich in the state’s history.

Aside from exacerbating income inequality and reducing consumer spending – which would hurt our state’s economy – it is highly unlikely that the state could implement this legislation within four months. It would take at least six months or longer to make the administrative changes and to inform businesses of the new tax system. West Virginia lawmakers would be wise to learn from the experience in Kansas, which enacted the largest income tax cut in history, that it is a surefire recipe for large budget gaps,  fiscal instability, more debt, and sub pare economic growth. This is why Kansas is now reversing course and rolling back Governor Brownback’s income tax cuts that have devastated the state.

For more on SB 335, see my presentation to the Senate Select Committee on Tax Reform and our new report  on why replacing the income tax with a higher sales tax is poor strategy for growing our state’s economy.

 

 

Expanding the Sales Tax to More Services: Sound Policy?

This week, the House of Delegates will consider a bill (HB 2704) that will extend the state’s sales and use tax to more services  in conjunction with lowering the sales tax rate.  HB 2704 would remove several services currently exempted in West Virginia’s sales tax, including services provided by lawyers, accountants, architects, engineers, investment counselors, contractors, and veterinarians. The bill would also apply the sales and use tax to purchases of mobile homes, advertising, digital downloads, computer software, private fitness club memberships, and electronic data processing. 

The bill would also reduce the sales and use tax from 6 percent to 5.5 percent, while lowering the sales tax rate even further in outer years if certain triggers are met with the balance in both Rainy Day Funds (A and B). The sales and use tax rate would drop to 5.25 in 2018, 5 percent in 2019, and 4.75 percent in 2020 if the Rainy Day Fund is above 15 percent of the General Revenue Fund. Currently, the Rainy Day Fund has a balance of about 20 percent of the General Revenue Fund (notwithstanding the $51.8 million recently appropriated for FY 2016, which would drop this down to 18.5%). 

The only states in the country that tax some professional services are Hawaii, New Mexico, Delaware, North Dakota and Washington State and each of them do so in a myriad of ways

According to the most recent Tax Expenditure Report (2016), these tax exemptions amount to about $365 million in forgone revenue in 2016. Since veterinarian services are not itemized in this report, an estimated revenue impact (based on the 2012 Economic Census) would be approximately $8 million based on total receipts of $135 million in 2012. As the Figure below illustrates, this brings the total to approximately $373 million.

Taxing Services

Total sales and use tax revenue for FY 2017 is projected to be $1.379 billion. Included in that figure is $60 million from Governor Tomblin’s proposed tax on telecommunication services, which is not included in HB 2704, and will most likely not be passed by the legislature this year.

Dropping the proposed telecommunications tax and reducing the sales tax rate from 6 percent to 5.5 percent would reduce FY 2017 sales tax revenue by an estimated total of $169.9 million. With the sales tax lowered to 5.5 percent, eliminating those exemptions would increase revenue by $341.9 million (grey bar above) under the assumption their would be no change in behavior (static instead of dynamic score)

All told, cutting the sales tax rate to 5.5 percent, eliminating the exemptions in HB 2704, and canceling the planned telecommunications tax would increase net sales tax revenue by $56 million for FY 2017 since these changes do not take place until the second half of FY 2017. This is about the same amount of revenue that the Governor estimated from his proposal to apply the sales tax on telecommunications for FY 2017. 

Triggering Sales Tax Cuts to Rainy Day Funds Unsound Policy

Now that we have a ballpark idea of how this bill will impact the budget, it is important to determine whether this is sound policy. One of the most troubling aspects of the bill is that it contains triggered reductions in the sales tax rate based on the size of the Rainy Day Fund, which usually only receives deposits from surplus revenue at the end of each fiscal year. Instead of tying the sales tax rate reductions to the Rainy Day Fund, it would be much more prudent to tie them to revenue benchmarks or not include them at all. As we experienced with the reductions in the business tax cuts that were triggered in the same way, we could see cuts in programs and services at the same time that we are building our Rainy Day Fund.

Is it Good for Working Families?

It is hard to tell. At one level, having a broad sales tax base with a lower rate is sound tax policy, leading to less revenue volatility. It is what tax nerds like myself call horizontal equity. or the principle that people in similar circumstances with the same ability to pay should pay equally. Moreover, the inclusion of professional services also makes the sales tax more progressive. As deputy editor of Tax Analysts David Brunori notes in this Forbes article:

The sales tax should fall on all final consumption — preferably at a very low rate. So everything we buy should be subject to tax. There are several reasons for this. First, there is no economic or tax policy reason to tax the purchase of a toaster oven but exempt the purchase of a haircut or accounting service. They’re both consumption. Second, exempting services narrows the base and results in higher taxes on everything else. Third, exempting services creates a government-led incentive to spend money on services over things that are taxable. But the tax laws shouldn’t be used to mess with markets in that manner. Fourth, taxing services would make the system less regressive; rich people buy more services than poor people. Finally, the exemption in a service-dominated economy is very expensive.

While expanding the sales tax to more services is in line with promoting horizontal equity, how does it impact vertical equity or the principle that people with the greater ability to pay should pay more? While West Virginia does not use tax incidence modeling, other states do that may be able to provide some insight. For example, according to a recent report from the Texas Comptroller on tax exemptions and tax incidence,  sales and use taxes on several professional services are more progressive than most sales taxes and more of the revenue is generated out of state.  Texas incidence

For example, the sales tax on legal services is mostly flat  – averaging about 0.1 percent of household income across the income distribution compared to the state’s overall sales and use tax that falls relatively harder on low income households. Another important aspect is the exportation of taxes, which is a big factor in West Virginia since the state has a very large exportable tax and industry base.

Overall, only 21 percent of sales and use taxes in Texas are paid out of state compared to 25 percent for legal services, 41 percent for architectural and engineering services, and 35 percent for accounting services. Taxes on professional services are also paid more by businesses and than individuals. While businesses in Texas pay about 42 percent of all sales and use taxes, this share grows drastically with professional services where businesses pay 75 percent of legal services, 59 percent of architectural and engineering services, and 92 percent of accounting services.  Based on the make up of West Virginia economy, it would be surprising if these figures where not higher in West Virginia.

While the above analysis only included some of the services included in HB 2704, many of the others would follow a similar pattern in terms of tax incidence – such as internet purchases (digital downloads), private gym memberships, investment counseling, advertising, and computer software – while others like taxing mobile homes may fall much harder on low-income households.

It is also important to consider how lowering the sales tax rate would impact low and moderate income families. Would this reduction, along with the broadening of the sales tax base to include more services, increase or decrease the share of income low and middle income families pay toward sales taxes? At this point it is hard to say, but my guess is that it would slightly lower the effective tax rates on these families. It also depends on how these changes will impact important services and programs that these families receive in the state.

Another important factor to consider is how it will alter business behavior. Will adding professional services provide incentives for more vertical integration, which will could put small businesses at more of a disadvantage, and how will West Virginia administrate sales that take place in other states? How will taxing business-to-business sales of services effect state competitiveness or potentially harmful tax “pyramiding” that occurs from taxing business inputs? These are all important considerations, among others.

In the final analysis, having a broader sales tax base is sound policy insofar that is doesn’t hurt state investments or low and moderate income families. This is especially true if the expanded base of the sales tax includes services that are predominately purchased by more affluent households. At the same time, when adopting sales tax increases it is also important to keep in mind the fairness of West Virginia’s state and local tax system. Currently, low and middle families in West Virginians pay a higher share of their income in taxes than wealthier families.

If the legislature is intent on expanding the sales tax to more services and are worried about the impact it might have on low and middle families, than they should consider including a refundable state Earned Income Tax Credit (EITC). A state EITC would not only improve tax fairness, but it could also boost the state’s labor force, reduce poverty, and have a positive on impact on social and economic outcomes in the future.