The Virginia General Assembly, the New World’s oldest continuous lawmaking body, began its 400th year amid pageantry and an unintended 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. increase on which, thus far, that body has had no say. The House’s ceremonial mace, a symbol of the legislature’s prerogative, was escorted into the chamber by a company of pikemen in colonial garb. But whether and how the legislature exercises that prerogative remains to be seen.
Virginia’s economy is linked to Washington, D.C. in important ways—and so is its tax code, in reverse. The Tax Cuts and Jobs Act (TCJA) cut federal taxes for most Virginians, but for many of them, it means higher taxes at the state level. Although that consequence is not unique to Virginia, the effect is particularly significant in the Commonwealth. In contrast to many other states, moreover, the General Assembly did nothing to address the issue during the 2018 session.
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There’s still time to avoid an unlegislated tax increase on Virginians, but only barely. If legislators follow the path of least resistance, Virginians will face a tax increase of nearly $600 million in 2019, rising to almost $950 million a year by 2023.
Many Virginians Will Lose Their Itemized DeductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s
In most states, increases in state tax liability arise from how the state’s 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. conforms to federal law. That will eventually be a problem in Virginia as well, but there is an even more immediate issue. Virginia is one of only nine states which requires taxpayers who take the federal standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. (now a generous $12,200 for single filers and twice that for married couples) to also take the state’s standard deduction. In Virginia, it’s a comparatively stingy $3,000 standard deduction that about 650,000 filers will have to take, even though it would otherwise be to their advantage to itemize on their state return.
Before the enactment of the new federal tax law, about 38 percent of Virginia filers itemized. State officials expect that to decline to 24 percent under the new law, since so many more filers will be better off taking the much-higher federal standard deduction. And that decline could be more dramatic than these estimates suggest. (Nationally, 30 percent of filers used to itemize; 12 percent are expected to do so now.) Suddenly, a lot of people are saving on their federal taxes by shifting to the standard deduction—but at the same time, they’ll be earning themselves a tax increase in Virginia.
That wouldn’t happen if Virginia didn’t require taxpayers to use the same itemization status for federal and state returns, or of the Commonwealth’s standard deduction were tied to the federal one. The standard deduction issue alone represents a $100 million unlegislated tax increase.
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. Will Raise Hundreds of Millions in New Revenue
Choice of itemization status is a big enough issue on its own. But if and when the Commonwealth conforms to the provisions of the TCJA, the tax increase will be higher still—much higher. That’s because the new federal law broadens the tax base (increasing the amount of income subject to tax) while cutting rates, but only the base-broadening provisions—and not the rate cuts—flow through to Virginia’s tax system.
(Technically, Virginia updated its conformity date to 2018 during last year’s legislative session, but that update expressly excluded all changes from the TCJA from 2018 onward.)
Changes to the mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act reduced the amount of principal and limited the types of loans that qualify for the deduction. , the property tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state/local taxes paid, mortgage interest, and charitable contributions. , and the moving expense deduction will increase 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. liability. Revisions to the treatment of net operating losses, business interest, and manufacturing activity, among others, will increase taxes on businesses. Virginia’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. would even be applied to international income that has little, if anything, to do with Virginia.
What Happens to the Personal Exemption is Unclear
Plus, there’s another looming question of great significance: if Virginia conforms to the current version of the Internal Revenue Code, what happens to the Commonwealth’s personal exemption, which provides a deduction of $930 per person?
The federal personal exemption was functionally eliminated, but due to the peculiarities of the reconciliation process, its effective repeal was accomplished by setting its value at $0, not by taking it off the books altogether. Virginia’s personal exemption is a deduction for “each personal exemption allowable to the taxpayer for federal income tax purposes,” which creates a certain amount of ambiguity.
Some states provide a personal exemption equal to the federal one, or for each exemption claimed for federal income tax purposes. Those state personal exemptions are gone, absent legislative action to restore them. Other states offer one for each exemption allowable under federal law, and those have been retained. Technically, the exemption is still allowed; it’s just that no one can actually claim it.
Virginia’s statute, however, provides not only that the exemption must be allowable, but that it must be allowable “for federal income tax purposes.” The personal exemption no longer appears on federal tax returns, and no longer has a clear “federal income tax purpose.” So, for Virginia’s purposes: in or out? Provisionally, tax officials in Virginia seem to be saying that it’s still in place—but given how much is at stake (around $400 million), that’s an ambiguity the legislature ought to clear up as part of any conformity update.
Revenue Implications and Possible Solutions
According to an analysis commissioned by the Virginia Department of Taxation, full conformity would increase state revenues by $594 million in 2019 ($532 million of it on individual taxpayers). And it would rise rapidly, particularly on the business side, leveling off around $943 million by 2023. At that point the impact on individuals will be $520 million, with another $423 million falling on businesses. The business tax changes won’t happen unless Virginia updates its conformity statute, but a significant share of the additional tax burden on individuals is already underway, even if lawmakers do nothing.
Add to this the roughly $78 million a year the state anticipates collecting from online 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. es and Virginia is looking at a very sizable revenue increase—well over $1 billion a year in additional collections within five years.
Governor Ralph Northam (D) would like to keep that revenue, at least as a baseline. “Conforming our tax code to the federal tax code is a straightforward process, and we should do it this year, as we do every year,” he said in unveiling his biennial budget. “After that, and only after that, should we begin a conversation about tax reform.” But most years, a clean conformity bill doesn’t cost Virginians hundreds of millions of dollars.
Several legislative proposals already circulating would reform Virginia’s tax code, or at least avoid the unplanned tax increase, in tandem with a conformity update. Delegate Dickie Bell (R) has a bill allowing Virginians to itemize on their state returns even if they take the federal standard deduction, a change which would benefit nearly 650,000 Virginia taxpayers to the tune of about $150 million in 2019 (and about $100 million a year thereafter). Bills introduced by Delegates Chris Peace (R) and Nick Freitas (R), based on recommendations from the Thomas Jefferson Institute, would tie conformity to a higher standard deduction ($6,000 for single filers), a lower corporate income tax rate (down from 6 to 5 percent over two years). That proposal would also set aside new TCJA-linked revenue in fiscal year 2020 in a new fund to pay down future tax reform.
Delegate Vivian Watts (D) has proposed increasing the standard deduction and phasing in the refundability of the earned income tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (based on federal levels), meaning that, once fully phased in, tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. s to some low-income households could exceed $6,000.
Senators Siobhan Dunnavant (R) and Richard Stuart (R) take a similar approach to Peace and Freitas, but also address some of the business provisions by exempting previously untaxed international income (GILTI) and decoupling from a narrowing of the interest deduction. Some members are said to be contemplating individual income tax rate reductions as well.
If anything, these approaches are relatively restrained given the estimated scope of the new revenue at Virginia’s disposal. Other proposals, like one-year relief or a refund in the form of a temporary tax credit, fall well short of reflecting the magnitude of the new revenue Virginia can expect.
If the goal is to avoid a tax increase, legislators should prioritize longer-term structural reforms. That can include giving filers a choice of itemization status, a higher standard deduction, or rate cuts. There are many possible permutations, but one-off refund checks would be the least economically beneficial approach, and they would likely fall by the wayside in a year or two, yielding a tax increase.
Legislators shouldn’t forget about businesses, either. The initial impact on business taxpayers is modest, but according to state estimates, it will skyrocket in a few years. Legislators should get ahead of that problem, not wait until it’s already a part of the budget baseline.
Ultimately, it is up to Virginia policymakers whether to keep some or all of this windfall or to return it to the taxpayers. Given the figures involved, however, the issue deserves a robust and public debate. This time, at least, conformity is not a straightforward process to be handled like any other year. If legislators don’t take action on conformity before tackling the consequences for taxpayers, they might not find another chance to address the issue any time soon.
This post has been updated to include additional conformity bills pending consideration in the General Assembly.Share