New Revenues to Balance the Budget Don't Have to be Regressive
Last week, Governor Tomblin finally issued the call for the legislature to come back into a special session to balance the FY 2017 budget. The special session will begin today, May 16th, and the governor will once again submit a budget proposal for the legislature to consider.
During the regular session, Governor Tomblin proposed $130 million in new revenue, including applying the sales tax to telecommunication devices and increasing the tobacco tax from $0.55 per pack to $1.00 per pack (along with increasing wholesale price on other tobacco products and taxing electronic cigarettes). These revenue measures, however, did not pass the legislature, and worsening fiscal forecasts now leave a $270 million budget gap to be filled, either with further cuts or new revenue.
Governor Tomblin's spokesperson has indicated that the governor will once again propose a tobacco tax increase, and that the telecommunications tax will once again be on the table, as well as a 1% increase in the state's sales tax.
As we've noted before, while producing enough revenue to balance the budget, these tax proposals would make the state's tax system more regressive, with the proposed tax increases falling more heavily on low- and moderate-income families. States should strive to have more progressive tax systems which exemplify the "ability to pay" principle and are also better for the economy. Increasing progressivity in the tax system stimulates the economy, since low- and middle-income individuals and families are more likely to spend most of their money. When the tax burden on low-income people is higher, they spend less, which lowers demand and hurts the economy. In contrast, higher-income individuals spend only a small fraction of their income, meaning a higher tax burden on them is less likely to decrease economic activity.
The biggest proposal, raising the sales tax from 6% to 7% would fall heaviest on low-income families. Those in the lowest 20% of individual and family income would see their taxes as a share of income increase by 0.6% and those in the middle income range would see an increase of 0.5%, compared to just 0.1% for the top 1%. The sales tax increase would increase revenue by an estimated $196 million.
Raising the tobacco tax would also make the state's tax system more regressive. On average, those in the lowest 20% of individual and family income would see their taxes as a share of income increase by 0.6% and those in the middle income range would see an increase of 0.3%, compared to just a 0.01% increase for the top 1%. The tobacco tax increase would increase revenue by an estimated $71.5 million.
The same is true for applying a 6% sales tax to telecommunication devices. On average, those in the lowest 20% of individual and family income would see their taxes as a share of income increase by 0.2% and those in the middle income range would see an increase of 0.1%, compared to just a 0.03% increase for the top 1%. The tobacco tax increase would increase revenue by an estimated $60 million.
Altogether these tax increases would raise an estimated $327.5 million, but would do so in a very regressive fashion. Overall, taxes on the poorest 20% of West Virginians would increase by 1.4%, on middle income West Virginians by 0.8%, and on the wealthiest in the state by only 0.2%.
These regressive tax increases could be partially offset by pairing them with a State Earned Income Tax Credit (EITC). If all three tax proposals are passed, revenue would increase by an estimated $327.5 million, $57.5 million more than what is needed to close the $270 million budget gap. This leaves room for a sizable Earned Income Tax Credit, that would make the tax increase more fair. A state EITC set at 20% of the federal credit would decreases taxes as a share of income by 1.1% for those earning less than $19,000 in West Virginia and by 0.7% for those earning between $19,000 and $33,000.
While making the tax proposal less regressive, a 20% state EITC would cost an estimated $65.9 million, which combined with the other tax proposals, would leave the state about $8.4 million short of closing the $270 million budget gap. A more progressive tax increase could easily close that gap. For example, West Virginians are provided a $2,000 personal exemption from their state income tax for each household member. Unlike the federal government, which phases out personal exemptions as income rises, West Virginia does not. If the $2,000 per person exemption were phased out for joint filers between $150,000 and $200,000 and eliminated for those over $200,000, it would increase revenue by an estimated $9.9 million and help make the state's income tax based more on the ability to pay.
Phasing out the personal exemption would result in only a minor tax increase for the wealthiest West Virginians. Taxes as a share of income would only increase by 0.05% for those making more than $333,000 and by only 0.08% for those making between $168,000 and $333,000.
Adding a 20% state EITC and phasing out the personal exemptions to the other proposed tax increases brings the total estimated revenue increase to $271.5 million, enough to close the FY 2017 budget gap without further budget gaps, and it does it in a less regressive way than tax increases alone. With the ETIC and exemption phase out added in, those earning less than $19,000 would see their effective tax rate go up by 0.3%, compared to 1.4% with the tax increases alone. Those in the top 1% would see a tax increase of 0.21%, compared to 0.15% with the tax increases alone. For those in the middle of West Virginia's income distribution, their taxes go up by about the same amount under both scenarios.
It is important that West Virginia takes a balanced approach to closing its budget gap that includes additional revenue, rather than a cuts-only approach that threatens our state's struggling economy. While the tax proposals on the table are regressive, adding a 20% EITC and phasing out the personal exemption go a long way to ensuring that we are not balancing the budget on the backs of the poor while asking little of anyone else. Other, more progressive options should also be considered to improve the state's fiscal health and to ensure that more cuts to public investments do not further damage the state's economy.
If one wanted to see a revenue package that balanced the budget in a largely progressive way, there are some options. Here's what such a package could look like:
- 1% sales tax increase: $196 million
- $1 per pack tobacco tax increase: $115.3 million
- Phase out personal exemptions at $150,000, eliminate at $200,000: $9.9 million
- Change corporate net income tax from current flat rate of 6.5% to a tiered system: $0-$10k at 3%; $10-$25k at 3.75%; $25-$40k at 4.25%; $40-$60k at 5.75%; $60-$150k at 6.25%; and $150k+ at 8%: $40.1 million
- Create a new top bracket of 8.3% starting at $120k; cut 3% rate to 2%; cut 4% rate to 3.5%; cut 4.5% rate to 4.3%; cut 6% rate to 5.9%; cut 6.5% rate to 6.3%: -$16.4 million
- Enact State EITC set at 20% of the federal EITC: -$65.9 million
- Total Revenue Increase: $279 million
Here's what that tax increase would be across income levels: