The Path to Reforming Virginia?s Tax Code

Download Special Report No. 127

Special Report No. 127

Executive Summary The last time Governor Mark Warner campaigned for a tax increase was in 2002, when despite a campaign promise not to raise taxes, he supported a referendum in Northern Virginia to raise the sales tax. That referendum was soundly defeated, and many pundits concluded that if voters in Virginia’s most liberal, high-income region would not support higher taxes, the issue was decided for quite a while. However, by late 2003, Warner had announced his campaign for “tax reform,” claiming Virginia’s tax system was outdated and that he needed to “strengthen Virginia’s competitiveness.”

Two questions about taxes cover the waterfront:

• How much is collected as a percentage of what the people earn? and
• Are taxes collected efficiently and fairly so that the tax system does not distort the taxpayers’ economic decisions?

Economists refer to these two issues as the tax burden and tax neutrality. In Virginia, the combined state-local tax burden has been moderate by national stan-dards, ranging from 8.9 percent to 9.5 percent of income during the last decade. Meanwhile, the national average has ranged from 9.6 percent to 10.2 percent.

Measured by its tax neutrality — whether a state’s tax system maintains a “level playing field” for all types of economic activity — Virginia ranks roughly in the middle of the pack on a nationwide comparison.

Governor Warner was right that many worthwhile improvements could be made to the state’s tax code, but when he unveiled the details of his so-called reform, it was mostly indistinguishable from dozens of tax increases proposed or enacted by various states over the last 20 years. It includes higher income taxes, higher sales taxes and higher taxes on specific products. Smaller, targeted tax cuts are included in the mix. Among the details are a few meritorious changes that would simplify tax collection and would qualify as reforms, but they are trivial compared to the overall impact of the plan. In fact, as flawed as the current tax code is, the Virginia legislature would actually be better off keeping the current tax structure intact than passing the Warner or Chichester plan unamended.

Despite this disappointing proposal, fundamental tax reform is always possible. True tax reforms foster economic growth by keeping rates low and the tax base broad so that citizens’ economic decisions are not prejudiced by the tax code. True tax reforms make the tax system simpler, both to enforce and to comply with, because tax compliance is a deadweight loss to the economy. Finally, true tax reforms keep the overall tax burden in check, mindful that regional competition is unavoidable, and business will expand where taxes are most reasonable.

The Tax Foundation proposes a revenue-neutral tax reform plan for Virginia that would maximize growth in the state economy by:

• replacing the current income tax structure (4 brackets with rates up to 5.75 percent) with a flat 6-percent income tax, the same rate as the corporate income tax;
• repealing the state and local sales tax;
• repealing the estate tax and the local business, professional and occupational tax (BPOL); and
• raising the fuel tax.

While many taxpayers might point out that economic growth could be helped more by a plan that lowered taxes, some would argue for higher taxes. A revenue-neutral plan has one overriding advantage. It removes the suspicion that “reform” is just a fig leaf to cover a tax cut or a tax increase.

The Tax Foundation’s reform proposal, outlined above and described in greater detail in this report, would catapult Virginia into the ranks of the top ten state business tax climates in the nation.