Two Virginia Income Tax Proposals Would Make the State Less Affordable

Virginia’s 2026 legislative session is underway. Despite the newly elected governor’s campaign centered on making Virginia “more affordable,” multiple proposals have been introduced that would significantly alter the state’s 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. landscape by creating new taxes and increasing other taxes. Two such proposals, HB 378 and HB 979, are targeted at the ordinary income and investment income of high earners, and they pose significant threats to Virginia’s tax competitiveness.

HB 378: New Tax on Investment Income

The first proposal, HB 378, would impose a new 3.8 percent net investment income tax (NIIT) on individuals, trusts, and estates beginning January 1, 2027. Modeled after the federal NIIT, this tax would apply to dividends, interest, capital gains, rental income, and other income from passive business activities once a taxpayer’s federal modified adjusted gross incomeFor individuals, gross income is the total of all income received from any source before taxes or deductions. It includes wages, salaries, tips, interest, dividends, capital gains, rental income, alimony, pensions, and other forms of income. For businesses, gross income (or gross profit) is the sum of total receipts or sales minus the cost of goods sold (COGS)—the direct costs of producing goods (FMAGI) exceeds $500,000. Specifically, the tax would apply to the annual net investment income of the taxpayer, estate, or trust, or to the amount by which the taxpayer’s FMAGI exceeds $500,000, whichever is less.

Combined with Virginia’s existing top marginal 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 rate, the proposed NIIT would push the top marginal rate on investment income to 9.55 percent. If HB 378 were enacted on its own, Virginia would have the ninth-highest top marginal rate on investment income in the country, after California (13.3 percent), Hawaii (11 percent, with a lower rate on long-term capital gains income), New York (10.9 percent), Minnesota (10.85 percent on certain capital gains income), New Jersey (10.75 percent), the District of Columbia (10.75 percent), Oregon (9.9 percent), and Washington (9.9 percent on certain long-term capital gains income only).

HB 979: Increasing Income Tax Rates on High Earners

The second proposal, HB 979, would establish two new individual income tax rates that would also take effect beginning January 1, 2027. Specifically, an 8 percent rate would apply to income over $600,000, and a 10 percent rate would apply to income over $1 million. Like Virginia’s existing income tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat., the proposed new brackets would not be indexed for 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 spendin, so more Virginia taxpayers (and more of their income) would be subject to the proposed new rates over time as nominal income rises, a concept known as “bracket creep.” Furthermore, without changes to Virginia’s Spouse Tax Adjustment (STA), which is a tax credit capped at $259 that offsets the marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. under Virginia’s current bracket structure, HB 979 would create a massive marriage penalty.

Table 1. Individual Income Tax Rates and Brackets in Virginia, Current and Proposed (HB 979)

Source: HB 979 and state statutes.

To provide modest relief targeted toward the lower end of the income spectrum, HB 979 would increase the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. Taxpayers who take the standard deduction cannot also itemize their deductions; it serves as an alternative. to $10,000 for single filers and $20,000 for married filers (up from $8,750 and $17,500, respectively), and these amounts would be indexed for inflation beginning in 2028. While indexing the standard deduction for inflation would be a structural improvement, raising Virginia’s top marginal rates by 4.25 percentage points and introducing a sizeable new marriage penalty would make Virginia significantly less attractive to owners of pass-through businesses and others who would be exposed to such a sharp tax hike.

Virginia Would Become a High-Tax State

If Virginia were to adopt a top marginal rate of 10 percent on ordinary income under HB 979, Virginia would have the sixth-highest top marginal state individual income tax rate in the country, behind only California (13.3 percent), Hawaii (11.0 percent), New York (10.9 percent), New Jersey (10.75 percent), and the District of Columbia (10.75 percent).

From a regional perspective, even when considering that neighboring Kentucky, Maryland, and West Virginia impose local income taxes in addition to their state rates—with an average local rate of 1.39 percent in Kentucky and 2.66 percent in Maryland—HB 979, with its proposed 10 percent top rate, would put Virginia behind only the District of Columbia (10.75 percent) for the highest combined state and average local income tax rate in the region.

Table 2. Virginia Would Have the Second-Highest Combined State and Average Local Income Tax Rate in Its Region Under HB 979

Combined Top Marginal State and Average Local Income Tax Rates, Virginia and Neighboring States (Under HB 979)

Note: The Combined rates for Maryland and Kentucky include average local rates of 2.66 percent and 1.39 percent, respectively, calculated using local income tax collections as a percentage of AGI. Some localities in West Virginia impose weekly wage taxes that do no appear in Census data.
Source: US Census Bureau; HB 979 and state statutes; Tax Foundation calculations.

Should HB 378 and HB 979 both pass, Virginia would impose the nation’s highest top marginal state individual income tax rate on investment income at 13.8 percent, even higher than the rates on investment income in California, Hawaii, New York, and Minnesota.

Table 3. Virginia Would Have the Nation's Highest Top Marginal State Income Tax Rate on Investment Income Under HB 378 and HB 979

Top Marginal State Individual Income Tax Rates on Investment Income in Select States and Virginia (Proposed)

Note: In Hawaii, the effective top marginal rate on long-term capital gains income is lower, at 7.25 percent. Minnesota imposes a surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on individuals, estates, and trusts equal to 1 percent of net invvestment income over $1 million, raising the effective top marginal rate on such income to 10.85 percent. Washington taxes long-term capital gains income only.
Source: HB 979 and HB 378; state statutes.

Furthermore, a top marginal rate on investment income of 13.8 percent would be far and away the highest rate on investment income among Virginia’s neighboring states, with the next highest rate—the District of Columbia’s—being more than three percentage points lower.

Table 4. Virginia Would Have the Highest Top Marginal State Income Tax Rate on Investment Income in Its Region Under HB 378 and HB 979

Top Marginal State Individual Income Tax Rates on Investment Income, Virginia and Neighboring States (Under HB 378 and HB 979)

Note: Maryland imposes a 2 percent surtax on capital gains income for individuals with federal AGI exceeding $350,000.
Source: HB 378 and HB 979; state statutes, Tax Foundation calculations.

Most States Are Embracing Tax Cuts

Over the past five years, many states have viewed tax reform and relief as a means of growing their own economies while becoming more competitive regionally and nationally. Since 2021, 23 states have reduced their top marginal rates, including three of Virginia’s neighbors: Kentucky, North Carolina, and West Virginia. In contrast, only three states (Maryland, Massachusetts, and New York) and the District of Columbia have increased their top marginal individual income tax rates since 2021, and only three others have imposed new or increased rates on capital gains income (Maryland, Minnesota, and Washington). With many legislative sessions currently underway, more states are considering lowering their tax rates even further, while some are working toward the goal of phasing out their income taxes altogether.

A High Top Marginal Rate Would Be Harmful to the Commonwealth’s Small Businesses and Workforce

When evaluating HB 979 and HB 378, it is important to keep in mind that many of Virginia’s high earners are owners of pass-through businesses, paying taxes under the individual, rather than the corporate, income tax code. According to the US Small Business Administration, Virginia’s 880,366 small businesses employ 1.6 million people, representing 45.9 percent of Virginia’s employees. If the new tax rates proposed in HB 979 were adopted, Virginia’s small businesses would be taxed at one of the highest rates in the country.

These high rates would limit small businesses’ ability to grow and reinvest in their business, which could further reduce business profitability. Business owners would face tough decisions that could hinder their economic competitiveness, potentially having to eliminate jobs, lower wages, or increase prices to pay their higher tax bills. Ultimately, these tax increases could lead some business owners to decide they can no longer afford to operate in Virginia, causing them to relocate or shut down entirely.

Workers Commuting from Virginia May Decide to Rethink Where They Live

State reciprocity agreements allow residents working in a different state than their state of residence to only pay income tax where they live, as opposed to where they work. Currently, 30 reciprocity agreements exist across 16 states and the District of Columbia. Both Maryland and Virginia have reciprocity agreements with multiple states. They also have a commuter provision with the District of Columbia that specifies that they will tax their own residents when they commute to work in the District and will exempt DC residents from taxation if they commute to work in their respective states. In essence, residents of DC, Maryland, and Virginia are taxed where they live, regardless of where they work.

The District of Columbia is home to Congress and many federal agencies, so many public and private sector jobs are geographically tied to the District of Columbia. However, as long as these employees can commute into DC as needed, they can live wherever they would like, knowing they will pay income taxes to their home state only, not to DC. As such, to attract and retain federal employees and other residents who work in DC, Virginia must outcompete both DC and Maryland when it comes to tax climate, cost of living, quality of life, and other factors that individuals consider when deciding where to live.

Data from the 2023 Census Bureau American Community Survey (ACS) Public Use Microdata Sample (PUMS) reveals that over 60,000 federal government civilian workers commute from Virginia to Washington, DC, and an additional 10,000-plus government employees commute from Virginia to Maryland. Taking all commuting workers into account, data from the 2016-2020 5-year ACS Commuting Flows Survey indicate that an average of 211,760 Virginia residents worked in Washington, DC, and 68,592 Virginia residents worked in Maryland during those years.

Because Virginia currently has a more favorable tax environment than the District of Columbia and Maryland, many residents are willing to commute from Virginia to their jobs in DC or Maryland. But if Virginia lawmakers decide to adopt a substantial tax increase that makes Virginia’s rates comparable to or worse than the rates in Maryland and DC, government workers, federal contractors, and others may find Maryland or DC a more attractive place to live, depriving the Commonwealth of tax revenue.

Final Thoughts

Despite lawmakers’ professed goals of making the Commonwealth “more affordable,” HB 378 and HB 979 would actually make it less affordable, and Virginians have reason to be concerned. The imposition of new and higher taxes on both ordinary income and investment income would incentivize high earners and businesses to ultimately leave the state for more tax-friendly environments, and in particular for high earners in Northern Virginia to move to DC or Maryland, taking the economic activity they generate with them. These proposals would significantly undermine Virginia’s economic competitiveness. 

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