Those who think the legislative process is boring haven’t been watching the drama that has been unfolding in West Virginia in recent days, offering more than its share of suspenseful plot twists. The latest surprise, coming a mere two hours before the legislature was originally supposed to adjourn for the year, was the revelation that Governor Jim Justice (D) and the Republican-controlled state senate had reached a provisional budget and tax deal—one that cuts individual income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es, raises the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate, creates a new gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. , imposes new taxes on high income earners, revises severance tax rate schedules, and hikes the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. , among other provisions.
In the sort of scene that you wouldn’t quite believe if it featured in a television drama, the breakthrough was precariously postponed when the Governor failed to see a crucial text message from Senate President Mitch Carmichael because his cell phone was on silent. The House, which only found out about the late-breaking negotiations when the Governor announced the outlines of a deal, felt more than a little left out. And the Governor’s timeline—passage in as early as two hours—offered a heart-stopping race against the clock.
And then that clock stopped. After all, one part of the process that doesn’t make for edge-of-your-seat drama—properly vetting the legislative language of a far-reaching compromise—takes more than two hours. The new course of action, it seems, is to adjourn sine die, then return within a few days to take up the budget and tax package in special session.
But what’s in the package? That’s a question even legislators were asking as late as last night. The proposal was, however, filed as a last-minute floor amendment to SB 484, so we have an opportunity to take a look at the contours of the plan, if not its full revenue implications.
The SB 484 floor amendment contains tax provisions, not the associated budget, but Governor Justice has stated that the compromise is a $50 million reduction against his previous ask of $450 million, meaning $400 million in new revenue for the state. Previously, the House had proposed a $137 million increase in first-year revenue, offset by reductions in the out years, while the Senate had been pushing a cuts-only budget which provided no new revenue. The $400 million covers a projected revenue shortfall, but also provides for new spending on road construction and K-12 education. Any planned offsetting tax cuts in subsequent years would presumably have to take account of this higher level of baseline spending.
Individual Income TaxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.
The plan’s chief selling point for Senate Republicans is the individual income tax component, which would replace the current five bracket individual income tax, which has a top rate of 6.5 percent on income over $60,000, with a three-rate individual income tax with a top rate of 5.4 percent on income over $17,500.
The proposal would also implement a program of revenue triggers to reduce rates further in subsequent years based on revenue availability. The trigger mechanism is somewhat complex, but basically, here’s how it works:
A “trigger index” is created which consists of the cumulative rate of inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. change over a five year period, plus 0.5 percent per year. So, for instance, if the standard federal measure of inflation (CPI-U) rose 10 percent over five years, the trigger index would be 12.5 percent (inflation plus 0.5 percent per year). Simultaneously, a “General Revenue Fund benchmark” is created, capturing the value of the previous five years’ worth of revenue collections.
Using these data, the state calculates an expected rate of growth for tax collections (basically 0.5 percent above inflation per year, averaged over five years), and whenever actual collections in a given year exceed this benchmark, an across-the-board 0.1 percent individual income tax rate reduction is triggered. There is no limit to how far into the future these cuts could happen, so theoretically they could continue until the individual income tax is eliminated. As a practical matter, however, it is unlikely that the state could keep meeting these trigger thresholds indefinitely without providing an alternative revenue stream.
High Earners Tax
Governor Justice’s “millionaires’ tax” proposal now takes the form of an extremely unusual capitation tax on high earners (per filer), with additional taxes on filers with income over $300,000, ranging from $250 (for filers with West Virginia taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. of $300,000 to $350,000) to $1,000 (for filers with over $500,000 in taxable income). The tax is intended as a temporary expedient, only imposed for three years from 2017 – 2019, though experience suggests that such taxes have a way of persisting.
Traditional income taxes avoid what are known as tax cliffs, where a taxpayer might wind up with less after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income. by earning more. Income taxes are often imposed at a graduated rate, meaning that a greater share of any additional income earned may be subject to tax, but still, it’s always the case that one has more take-home pay by earning an additional dollar than by not earning it. That is not the case under the proposed high earners tax, where going from $300,000 to $300,001 in taxable income triggers a $250 tax bill, or where going from $500,000 to $500,001 increases tax liability by $500. Even for a temporary tax that only applies to a relatively small number of taxpayers, violating the taboo against tax cliffs on individual income would be a troubling development.
To raise additional revenue and help pay down the individual income tax rate cuts, the tentative deal would raise the sales tax from 6 to 7 percent and modestly expand the sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. to include a few transactions currently exempted, including:
- Telecommunications services;
- Electronic data processing services and related software;
- Access to computer equipment;
- Health and fitness memberships and services;
- Opinion research; and
- Construction and maintenance materials for use in highway projects.
Sales tax bases tend to be unnecessarily narrow, effectively (if unintentionally) picking winners and losers in the economy. An ideal sales tax base includes all final consumer transactions, both goods and services, but excludes intermediate transactions (inputs that go into the creation or provision of a final good or service) to ensure that the tax is not levied more than once on any final sale. All states fall short of this standard to some degree, so base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. can be good tax policy, creating a more neutral sales tax.
Originally, both the House and Senate looked at expanding to much broader bases, including professional services, groceries (at a partial rate), and other goods and services. The compromise would be much smaller, and includes a mix of inputs and final transactions.
Commercial Activity Tax
The pending deal would create a new gross receipts tax modeled after Ohio’s Commercial Activity Tax (CAT), imposed on all business receipts (not just net income or profits) at a rate of 0.045 percent. Although the rate is low—at least initially—gross receipts taxes are imposed on businesses without regard to profitability or ability to pay. They also “pyramid,” meaning that the tax is imposed again at each transacted stage of the production process, resulting in the tax being embedded in the price of a final good or service multiple times over.
Businesses with high profit margins and which perform most production activities in-house do well under a CAT. Other businesses, including many startups or smaller businesses, which operate on slim margins (or even a loss) or outsource certain activities (manufacturing, packaging, distribution, marketing, accounting, legal services, etc.) take a larger hit.
Economists across the spectrum have long warned of the adverse effects of gross receipts taxes, but many states adopted them during the Great Depression because they felt that they had little choice but to grasp at every available revenue source. After World War II, however, states started moving away from them. Not a single state adopted a new statewide gross receipts tax in the latter half of the 20th century, and when West Virginia repealed its former statewide gross receipts tax, the Business & Occupation (B&O) tax, in 1987, there were only three states left (Delaware, Indiana, and Washington) with such a tax.
Since the mid-2000s, gross receipts taxes have made something of a resurgence, a disturbing trend. Now West Virginia is on the cusp of bringing back an economically inefficient method of taxation it abolished at the state level three decades ago, even as for years legislators have been grappling for years with how to complete the abolition at the local level (a difficult task).
Motor Fuel Tax
Currently, West Virginia’s gas tax is comprised of two components: a flat rate of 20.5 cents per gallon plus a variable rate of 5 percent of the average wholesale price, or 11.7 cents per gallon, whichever is greater. The actual language of the variable rate provision establishes that the average wholesale rate cannot be less than $2.34 per gallon for purposes of calculating the tax, which yields an 11.7 cent per gallon floor. Under the pending compromise, the flat rate would increase to 25 cents per gallon, while the variable rate floor would increase to 15.2 cents per gallon, based on a minimum wholesale rate of $3.04 per gallon. The minimum possible tax, then, would be 40.2 cents per gallon.
The deal would replace the current severance tax rates on coal and natural gas production with rate schedules based on gross income from sales of the resource, meaning that tax rates would decline when the industry experienced lower rates of return. For instance, on steam grade coal, the rate would be 3.5 percent when such coal is fetching $70 or more a ton, but could go as low as 1.25 percent if steam grade coal were grossing less than $30 per ton This means that with current prices hovering around $40 per ton, the rate would either be 2.0 percent ($35 – $39.99 per ton) or 2.25 percent ($40 – $44.99 per ton). Even beyond their variability, these rates would represent a severance tax reduction.
A Note on Drafting
As a minor aside, the amendment offered Saturday evening has several typographical errors. Part of a clause is missing in the motor fuel tax section and a rate is improperly set out on severance taxes. These perfectly understandable errors, almost inevitable given the incredibly short deadline with which drafters were working, are very easy to resolve. However, they also make the case for why there’s value in additional time to review the bill, particularly to ensure that there are not more substantive errors, and to provide members adequate time to consider the consequences of such wide-ranging changes to the tax code.
The SB 484 floor amendment, which is intended as the language of the tax plan to be taken up in a forthcoming special session, is wide-ranging and merits far more detailed analysis than can be provided in this quick overview. Nevertheless, it is worth noting that it contains both significant individual income tax reform and, unfortunately, economically damaging provisions like the taxation of intermediate transactions (business inputs), the high earners tax, and most significantly, the CAT.
Throughout the legislative session now coming to a close, the Senate has prioritized using higher consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. revenue to pay down income tax reform, while the House has proposed competing reforms which draw the line at raising the sales tax rate. Both sets of proposals have had both merits and drawbacks, but until now, both sides have opposed turning back the clock to reestablish a statewide gross receipts tax.
Options may be constrained in special session, but there are theoretically several paths forward. The House and Senate could find a compromise based, perhaps, on the Senate’s previous offer (SB 409 as amended) or the House’s sales tax broadening and lowering plans. They could revise the emerging deal, possibly stripping out some of the most economically damaging provisions (like the CAT). They could adopt it as-is. Or, for that matter, they could fail to come to any agreement at all. Some options are, of course, far less attractive than others.
There are indications that things could move very quickly, with members returning for special session within a few days. It’s also possible that special session is still weeks away, and that negotiations could drag on for some time. What any final agreement might look like is anyone’s guess—but it would be a cruel irony if a legislative session so dominated by the goal of pro-growth tax reform concluded with the adoption of two new taxes, one of them the revival of an idea already deemed hopelessly antiquated when the state abandoned it in 1987.Share