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