January 10, 2004

Reforming Virginia’s Tax Code

Considering the anti-tax reputation of Virginia voters, it is not surprising that most state officeholders take a pledge not to raise taxes when they’re up for re-election. Governor Mark Warner (D) was no exception, nor was Republican State Senator John Chichester.

By late 2003 those promises were forgotten as Gov. Warner submitted a budget that included $1 billion in tax hikes under the banner of “tax reform,” and Senator Chichester responded with a tax hike almost 4 times bigger.

So far the truly anti-tax House of Delegates has opposed both tax hike plans, but even the House eventually passed a budget that raised some taxes.

Our concern is not with party, or even so much with revenue-raising. Our concern is with tax policy. Not one of the plans that have been put forward deserves the name of tax reform, and not one will improve Virginia ’s business climate.

In our annual ranking of the states’ business tax climates, Virginia ranked 21st, which is remarkably poor for a state with a comparatively low state-local tax burden. Gov. Warner was right that Virginia needs tax reform, but he is wrong to think that his plan is real tax reform.

The General Assembly needs a distinctly different plan that can raise needed revenue and deliver honest-to-goodness tax reform.

We have devised such a plan (see Tax Foundation Special Report, No. 127, described on page 10). It follows the principles of fairness and simplicity, and it would give Virginia one of the most economically competitive tax systems in the country. It is revenue neutral, as all tax reform should be, to put aside any suspicion that the ulterior motive is to raise or lower revenue. Of course, the same sound principles could be adapted to a higher or lower revenue stream.

The “6 and 6” Plan We call our proposal the “6 and 6 plan” because it relies heavily on flat 6% taxes on individual and corporate income. Meanwhile, it targets for repeal the sales tax, the estate tax and the business and professional organization license tax (BPOL).

Scrap the Sales Tax Sales tax collection has become a nightmare and will probably continue shrinking nationwide as a share of state revenue. Internet-shoppers have joined cross-border travelers and catalog users in avoiding the tax. Raising the rate just creates a vicious cycle, punishing “brick-and-mortar” retail and giving shoppers even more reason to avoid the tax. Virginia legislators should reverse the flow of shoppers and bring their business in state.

On the fairness front, sales taxes generally hit low-income people harder because they spend most of their money on basic, taxable products. Meanwhile, higher-income people spend a lot on untaxed services.

Attempts to make the sales tax fairer by extending it from basic products to tax exempt services—the House plan does this—causes “tax pyramiding.” That’s what happens when businesses pay sales tax on equipment and services, then resell their products with another sales tax, effectively charging tax on tax.

Flatten the Income Tax Virginia should replacing its 4-bracket income tax structure with a flat 6% rate, allowing no deductions except for a generous exemption of $3,700 per person.

This higher tax with no deductions for interest or charitable giving would collect a lot more revenue. By itself, this would be a hardship, but as part of the whole package, it’s worth it. Keeping popular deductions would force the rate up into uncompetitive territory.

One major bonus of this heavy reliance on the state income tax is federal deductibility. Virginians would deduct almost $3 billion more every year on their federal 1040s, saving $390 million in taxes. That savings alone could almost finance Gov. Warner’s plans for higher spending.

Match Income Tax Rates for Individuals and Corporations When tax time rolls around, many businesses can guide income into either the “corporate income” column or the “individual income” column. It’s wise, therefore, for the state to keep the individual and corporate rates the same, and with as few deductions and exemptions as possible on both sides. In the matter of tax avoidance schemes, an ounce of prevention is worth a pound of audits.

Raise the Gas Tax 7 Cents Currently, a half-cent of the sales tax is devoted to transportation. This would make up that revenue.

Repeal the Estate Tax Virginia can keep its wealthy retirees and foster small business growth. Warner’s plan comes so close to eliminating the estate tax that one wonders why he can’t pull the trigger. Why keep that monstrous administrative superstructure in law for so little revenue.

Repeal the Business License Tax The obscure business and professional occupation license tax (BPOL) is a job-killer because unlike a corporate income tax that varies with profitability, this gross receipts tax hits even during economic slumps.

Adopting the Tax Foundation’s “6 and 6” plan would greatly improve Virginia ’s business tax climate, and save on federal taxes to boot.

Raising taxes isn’t what tax reform is about, but the General Assembly could do the state a world of good by focusing on true tax reform while it does its revenue business.

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