West Virginia Legislature Enters Special Session with a Revised Tax Plan on the Table
May 4, 2017
The West Virginia Legislature enters what promises to be a contentious special session today to take up a revenue bill and three spending bills. The tax provisions represent further revisions of Democratic Governor Jim Justice’s earlier negotiations with the Republican-controlled Senate in the waning hours of the regular session, but may do little to appease House Republicans.
The new plan represents a marked improvement from the last in at least one important respect: it drops the governor’s proposal to adopt a statewide gross receipts tax modeled on the Ohio Commercial Activity Tax (CAT). Here’s what the new proposal would do on taxes:
- Overhaul the individual income tax, collapsing five brackets into three and reducing the top rate from 6.5 percent to 5.4 percent, with triggers in place to further reduce the rate in subsequent years, subject to revenue availability;
- Increase the sales tax rate by 1 percentage point while broadening the base to include telecommunications services, electronic data processing services, access to computer equipment, health and fitness services, opinion research, and construction and maintenance materials for use in highway projects;
- Hike the corporate net income tax by 1 percentage point for three years, after which the increase would sunset unless renewed by the legislature;
- Impose a high-earners tax consisting of additional taxes on filers with income above $300,000, ranging from $250 to $1,000; and
- Revise severance tax rate schedules, presumably in line with the proposals embodied in the floor amendment to SB 484 at the end of the regular session.
This largely follows the plan of SB 484 as amended, but replaces the proposed CAT—intended to raise $45 million per year—with a temporary increase in the corporate income tax, slated to raise $18 million. Although no fiscal note is available, so far as I am aware, the proposal is said to represent a net cut of about $120 million per year once fully in place.
The timing of the tax changes, however, is set in such a way as to provide increased first-year revenues to close the budget shortfall and fund several of the governor’s priorities, including additional infrastructure spending and a teacher pay raise. Because the proposal represents a cut (after this year) paired with spending increases, it may create a quandary in future years should the legislature take insufficient steps to plan for this revenue adjustment.
The centerpiece of the proposal is undoubtedly the income tax component, which would bring the top rate down to 5.45 percent on all income above $35,000. The proposal also follows the lead of other states—red and blue alike—in turning to tax triggers, in this case to phase in further reductions in the individual income tax rate in the out years, subject to revenue availability.
This individual income tax relief would be funded in large part by broadening the sales tax base and raising the rate by 1 percent, shifting modestly away from income taxation toward higher reliance on consumption taxes. Broadening the sales tax base is good policy, at least when focused on final consumption, as it enhances tax neutrality and curtails base erosion.
Consumption taxes tend to be more pro-growth than either corporate or individual income taxes. The individual income tax is, essentially, a tax on consumption and savings (or, more precisely, the change in savings). Whatever income an individual earns is either spent or saved, and savings and investment are more growth-oriented activities, so a tax that falls only on the portion of income that is consumed will tend to favor growth. Savings, moreover, can be understood as deferred consumption: we save, after all, for the purchase of consuming. When savings are taxed, and then taxed again at the point of consumption, that delayed consumption is effectively double-taxed. At the margin, income taxes reduce labor force participation.
Whereas the bill increases the neutrality of the sales tax code, and the greater reliance on consumption taxes can be pro-growth, two other elements push in the opposite direction. First, the proposal would increase the corporate net income tax rate, partially reversing the rate reductions which began in 2009, and second, it creates an unprecedented (though also time-limited) tax on high earners which does not exist in any other state.
Traditional income taxes avoid what are known as tax cliffs, where a taxpayer might wind up with less after-tax income by earning more, but such cliffs are an inevitable outcome of the high-earners tax. Even with this element of the proposal, high earners would experience tax relief, since individual income tax reductions would outstrip the cost of this provision, but disregarding the consensus against tax cliffs would still be an unfortunate development. Many states, moreover, have found that temporary taxes are anything but.
Like most tax reform proposals, this one has both pros and cons. Certainly, by dropping the decidedly nonneutral gross receipts tax, it represents a marked improvement from previous iterations. It also provides meaningful individual income tax relief and a mechanism for further reductions, offset by greater reliance on consumption taxes. At the same time, it sets a peculiar precedent with its high-earners tax, imprecisely termed a “millionaires tax” by supporters (it kicks in at $300,000) and would leave the state—at least temporarily—with a relatively high corporate income tax rate.
It is unlikely that the House of Delegates would accept this proposal in its current form. There is an opportunity, perhaps, to negotiate, dropping some of the less attractive features. (The $18 million raised by the corporate income tax increase, for instance, could be offset by only slightly curbing the preliminary individual income tax rate cuts.) The lower chamber, however, has been skeptical of a much more crucial component of the proposal—raising the sales tax rate—leaving the latest plan’s fate very much in doubt.