by James A. Bacon
Virginia faces long-term budget stress due to a slow economy and an outdated tax structure, contends Sara C. Okos, policy director of the Commonwealth Institute, in the latest edition of the Virginia News Letter. “What Virginia needs,” she says, “is a 21st century revenue system for a 21st century economy.”
Okos makes a number of valuable points in this analysis, which renders it worth reading despite its chosen focus on the revenue side of the equation. Needless to say, any budgetary analysis is incomplete if it ignores the dramatic spending increases that preceded the 2007-2008 recession. But one can say only so much in a 14-page publication, so I’ll set that objection aside for the purpose of exploring her revenue-enhancing ideas.
Individual income tax. The state income tax has lost whatever progressive attributes it once had when last updated in 1987. The top tax rate — 5.75 percent — kicks in for taxable income over $17,000. Median income is much higher than it was a quarter-century ago, with the result that more than 60% of Virginia taxpayers pay the top marginal rate. If the top tax bracket had been indexed for inflation, it would be roughly $33,400 today.
Her analysis is indisputable. Her conclusion misses the mark. “Virginia,” she says, “would benefit from altering its individual income tax brackets and rates to reflect the realities of today’s modern economy, demand for public services, and income distribution in the state.” Translation: Make the tax code more progressive. If your goal is making the rich pay their “fair share” (however you define “fair”) then maybe so. If your goal is a stable source of tax revenue, then not. One thing we’ve learned about progressive tax rates in the federal government and state governments like California is that they bring in loads of money when they economy is booming but revenues collapse when the economy slows. Why? Because the income of upper-income Americans is much more volatile.
Sales tax. Two broad economic trends are limiting the take from Virginia’s sales tax, says Okos. First, the sales tax applies only to goods, yet consumer spending is growing more rapidly for services. The majority of states with a sales tax apply the tax, on average, to 40 of 168 potentially-taxable services. Virginia taxes a mere 18, including such blockbuster categories as diaper service, gift-wrapping and tuxedo rental. Secondly, federal law forbids the taxing of Internet sales, which now exceeds more than 4.0% of total retail sales.
Taxing a broader array of services could net the state as much as $900 million annually. Among the advantages, Okos notes: “Bringing services into the sales tax base could reduce the year-to-year volatility of sales tax collections.” Good point! She should think about applying the same principle to her analysis of the income tax. She makes one other interesting point. Taxing services is more “equitable” because the rich spend a larger percentage of their income on services than goods, while the poor spend a higher proportion on goods than services. If your goal is to increase the progressivity of the tax code, this is a better way to do it than increasing the income tax rate. Better it is to tax consumption (the sales tax) than hard work and success (the income tax).
One more note: If we expanded the sales tax to services, I would recommend using the resulting income to reduce some other tax — not to increase spending.
Corporate income tax. Virginia’s corporate income tax stands at 6%. The share of total tax revenue paid by corporations has declined by half since the 1970s. Part of the problem, says Okos, is that a big majority of corporate income tax collections (87 percent in fiscal 2006) are paid by multistate corporations with subsidiaries in different states. These corporations shift income between states to take advantage of jurisdictions in which taxes are lower or where corporations aren’t taxed at all. One possible remedy might be to make Virginia’s corporate tax rate more competitive by lowering it but she doesn’t consider that option. Instead, she says Virginia should mandate the filing of a “combined return,” in which corporations add the income from all their subsidiaries and apportion it to the states where the money was made.
To be perfectly honest, I don’t know enough about the corporate tax law to critique Okos’ recommendation, so I shall keep my mouth zippered on this one.
Tax expenditures. Spending through the tax code in the form of credits, deductions, exemptions and the like costs Virginia roughly $2 billion a year. These loopholes are accumulating and growing. The General Assembly has passed or changed 60 tax expenditures since 1990. Okos suggests, as a first step to plugging these loopholes, that Virginia publish an annual tax expenditure report that is more comprehensive than the partial report issued currently. Writes Okos:
In order to be useful, a tax expenditure report must include several key features. It should contain the intended purpose of each tax break, who benefits and how much they get, and an estimate of total cost. A solid tax expenditure report can shed light on under-performing programs or those that cost far more than was anticipated when the tax break was established. Such a report can also highlight programs that are meeting or exceeding expectations and that yield a high return on investment.
Sound thinking! She also suggests attaching a sunset provision to any new tax-expenditure legislation. I am in 100% agreement with both of her suggestions.
All things considered, there seems ample room to reform Virginia’s tax structure. There are broad areas — broadening the sales tax and limiting tax loopholes — where liberals like Okos and conservatives like me actually agree. The ultimate goals should be a broader, more stable tax base that makes Virginia more economically competitive. Let’s get started!