Eliminating the Income Tax and Creating a New Consumption Tax: Bad Law and Worse Policy

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Mischief is well on its way to becoming law in West Virginia. The Republican-controlled Senate Select Committee on Tax Reform is about to propose to the full Senate the passage of SB 335, which would phase out the state income tax and transform the current 6% sales tax into a broader 8% consumption tax. The conceptual basis for the proposed law is that the state provides the marketplace in which sales can take place so that vendors and purchasers who engage in transactions should be required to pay for the privilege of using that marketplace. If that silliness weren’t enough, the Bill’s legislative findings provide the following gem of a non sequitur. “The Legislature further finds that, in the free market system, the best judge of a purchaser’s ability to pay, for the purchase of the goods and services, is the purchaser, and, thus a broad-based consumption tax is firmly based on that principle of sound and fair taxation.” There is nothing sound or fair about this revolutionary change in West Virginia’s tax structure and it should be stopped in its tracks.

The fiscal soundness of SB 335 will be addressed in the next post on this site, upcoming promptly. But it is on the question of fairness where SB 335 fails us badly. Consider the point in the legislative findings that the purchaser is in the best position to know whether he has the ability to pay for a purchase. That may be true in the abstract, but completely misses the point when it comes to a consumption tax. There are many of our fellow citizens who are poor and spend only on the necessities of life – food, clothing, shelter, and the like. For them these purchases are not optional. They are not in a position to ponder whether “ability to pay” might lead them to decline such a purchase. For consumption by low-income citizens there is no magical marketplace of free choice like that existing in the dream world of some legislators.

Contrast this with the choices available to the financially comfortable. The purchaser of school clothes for kids in a well-to-do family has many options and certainly could choose to purchase less expensive clothing. But really, the ability to pay for a purchase is not the question for these consumers. It is their willingness to pay for the purchase plus the tax. And suppose the well-to-do purchaser decides not to make a purchase because of the tax. That would only hurt state tax revenues and thereby the operation of state government. The ideological foolishness of a consumption tax is quite apparent from this. The logical effect of making every business transaction 2% more expensive will be to make those transactions smaller in amount, less frequent, or avoided altogether. One can imagine many purchases being made across the border in states with a lower consumption tax.

One thing is certain – enacting SB 335 will shift a greater tax burden onto West Virginia’s poor and working class and away from wealthier taxpayers. Low income taxpayers, including seniors dependent on social security, are not currently subject to high income tax rates and do not pay much in total income taxes. Higher income taxpayers pay considerably more income tax. Contrast a consumption tax, which doesn’t concern itself with how wealthy you are, only how much you spend and on what things. As mentioned, SB 335 proposes to raise the state consumption tax from 6% to 8%. If it passes, the total tax paid by the low income taxpayer will rise slightly because of the additional 2% tax on his purchases, while the wealthy taxpayer will get a nice overall tax reduction. This is because the additional 2% sales tax paid by the wealthy taxpayer on her purchases is far less than the income tax she would avoid.

Sen. Robert Karnes (R-Upshur, 11), the same legislator who chairs the Senate Select Committee on Tax Reform, has sponsored two bills that are apparently intended to blunt criticism of the fairness of SB 335. One, SB 377, calls for a payment of up to $200 to be made by the state to low income senior citizens who file a yearly claim to receive it. The actual amount of the payment would be based on a declining percentage of the taxpayer’s income above the federal poverty level. SB 378 would create a similar payment, called an “earned income credit,” for low income workers. This is a misnomer because there would be no West Virginia income tax against which to credit it.

The inadequacy of these two sops is obvious. First they do nothing for the low-income unemployed who have no earned income to report. This omission is consistent with the view of many conservatives that if you are poor and unemployed it must be your fault. Second, these “credits” bear no relationship to the amount of additional consumption tax low-income individuals will be forced to pay. For example, a person earning $20,000 who is forced to spend it all to survive will pay an additional consumption tax of 2% on all purchases — a total of $400 in additional tax. Neither of the proposed “credits” could ever be more than $200. Finally, they require the taxpayer to file an additional tax document and wait for approval of the once per year payment. This does nothing to help him make ends meet on a day to day basis.

Even if such a major change to our tax system could solve our budget problems (more on that later), how can it be called fair when it benefits the rich and further burdens the low income residents of the state?

Corporate Tax Cuts to Stimulate Job Creation: They Never Work

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We should be open to any legislation or tax policy that stimulates job creation. But we should also be on guard against legislation or policy that merely sounds good, without subjecting it to a rigorous evaluation of its costs and benefits. Among the West Virginia Legislature’s new Republican majority, it is fashionable to call for corporate tax cuts as a way to unleash job creation. Unfortunately, this thinking is more the product of ideology than of solid analysis. The idea of corporate tax cuts to stimulate job growth has one main problem – it never works.

New Senate President Mitch Carmichael (R-Jackson, 04) recently formed a Select Tax Reform Committee in the Senate, saying

We must examine every method to improve the West Virginia economy, and that certainly will include         comprehensive tax reform. Our focus is to create private sector jobs and opportunities for our citizens… Other states have achieved significant growth as a result of fundamentally overhauling their tax code. Why wouldn’t the West Virginia Senate pursue tax strategies that have a proven record of success in other states?

West Virginia is now facing a $400 million budget deficit. If the tax reform Sen. Carmichael describes will raise revenue now, he and his colleagues can be political heroes. On the other hand, if he intends to cut taxes – losing present revenue – in exchange for uncertain future job growth, he is on a fool’s errand.

West Virginia has relentlessly cut corporate taxes in the past decade. In the period 2007 to 2014, the Legislature reduced the business franchise tax from .7% to zero and reduced the corporate net income tax rate from 9% to 6.5%. Yet West Virginia is still a laggard in job creation and there are many of our fellow citizens unable to find work. It is regrettable that our leaders do not demand a thorough evaluation of the effectiveness of these earlier tax cuts before embarking on new ones. But West Virginia is not alone in this.

Our neighbor Ohio has shot itself in the foot over the last decade by cutting corporate taxes almost to zero in the hopes of stimulating job growth with no real success. Between 2005 and 2010, Ohio sharply reduced income tax rates and eliminated Ohio’s corporate income tax. While the country as a whole has gained jobs since then, Ohio has lost jobs. More recently, Ohio passed a tax-cut package that included income tax reductions and business-owner tax breaks. Yet Ohio job growth continues to lag the country as a whole.

Then there is the Kansas experience.  Led by Republican Governor Brownback in 2013, the Kansas Legislature passed a series of tax cuts on owners of “passthrough” businesses that opened up a $420 million budget deficit.  The Topeka Capital Journal later reported the rueful comments of one Republican legislator, who said that the evidence didn’t exist that the tax cuts led to meaningful growth and probably never would.

Why don’t corporate tax cuts work to stimulate job growth? There are several reasons.

  • tax cuts are like handing corporations a big check with no requirement that they spend the money on creating more jobs;
  • often the tax cuts go directly to a corporation’s bottom line to be distributed to out-of-state shareholders and other owners;
  • if the tax cuts are actually spent by corporations they can easily be spent in other states, or in ways that do not create jobs, such as part of bloated CEO pay;
  • corporate income taxes are such a small part of the cost of doing business in a particular state that cutting taxes will not be an inducement to locate new business in West Virginia versus other states; and
  • corporate tax cuts increase the likelihood of budget deficits that will result in spending cuts on public services that corporations value in locating new business, such as police, fire protection, good schools and recreation.

Of course, we expect our Legislature to adopt a workable budget, filling the deficit hole while generating enough to sustain and expand the important work that only government can do. None of us should criticize the Legislature for action and innovation. But corporate tax cuts are not the answer if we simply hope they will stimulate job creation.

If tax reduction is so important, why not link it to job creation in some accountable way? Why couldn’t we offer a tax credit to small business that would be eliminated for that business the next year if it has not created a certain number of new jobs? This scheme is familiar to state and county development authorities because it is sometimes used in the arrangements with corporations that receive tax inducements to open a new factory. And it would be similar to the “pay for performance” that corporations love. But in this case if corporations don’t perform by creating new jobs, they don’t get paid with state tax revenues.

More Corporate Welfare In the Midst of a West Virginia Budget Crisis

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Several committees met December 5, 2016, as part of the Interim Session of the West Virginia Legislature. The pall of a significant revenue shortfall hung over everything.

At a meeting of the Standing Committee on Education, Chancellor Sara Tucker of the Community & Technical College system did an admirable job explaining how the institutions in the system were adapting to the reduced revenue situation. Community colleges have begun a program of sharing personnel resources – not every college needs its own Human Resources Director or General Counsel. She was followed by Dr. Jerome Gilbert, President of Marshall University, who described the measures taken at his institutional to deal with the sharp decline in state funding.

Immediately following that meeting the Joint Committee on Tax Reform, Subcommittee A gathered to hear two presentations. It was almost as if this Subcommittee was functioning in an alternate universe. Here’s why.

Incoming Senate President Mitch Carmichael (R – Jackson, 04) has announced a goal for the upcoming session to make West Virginia’s tax structure “competitive” with surrounding states. In a statement reported in the State Journal on December 4, Carmichael said that cutting taxes on manufacturer’s equipment and inventory will be considered. This and other measures would serve the laudable goal of “creating an environment that the private sector can hire people and put them back to work.”

At the Subcommittee meeting, Mark Stowers, Vice President of Asset Management for Alpha Natural Resources made a presentation about corporate property tax on mining machinery. Alpha is one of the largest coal companies in the country and operates numerous mines in West Virginia. Stowers was plain spoken and direct about what Alpha wanted.

West Virginians pay personal property tax on vehicles they own on July 1 of each year. It’s the same for corporate equipment and machinery. Stowers explained that not all of Alpha’s mining machinery is in use at once. Of course, if a piece of equipment is in productive use at a West Virginia mine on July 1, Alpha pays the property tax on it. But if the equipment is idle, Alpha moves it out of state before July 1 to avoid the West Virginia property tax. Virginia and Kentucky have no such tax.

Stowers described a depot in Wise, Virginia with 900 pieces of equipment, most of which was moved there to avoid West Virginia property tax. This is not obsolete equipment. Stowers claimed simply that it was expensive to transport that equipment back to West Virginia, implying that Alpha might decline to move it back here to start up a new mine job.

One would expect an official of a large taxpayer to be reticent about admitting conduct that was undertaken for the sole purpose of tax avoidance. Under West Virginia law, a willful attempt to evade taxes in any manner is a felony, although it is unclear whether this provision applies to corporate personal property tax. But none of the legislators seemed concerned in the least that moving equipment out of state to avoid tax might be inappropriate. In fact they were generally sympathetic. The discussion focused on how the West Virginia Code could be amended to provide relief to Alpha and other similarly situated corporations.

For example, Sen. Mike Hall (R – Putnam, 04) mused aloud about whether the Code could be amended so that idle machinery could be valued at little or nothing, thereby producing tax revenue of little or nothing. Del. Rupert Phillips (D – Logan, 24) declared that the coal industry was “near and dear to my heart” because of the number of coal industry jobs in his district. The one Panhandle legislator present, Del. Eric Householder (R – Berkeley, 64), appeared to be busy with his cell phone and had nothing to say.

With the express intent to avoid corporate property tax Alpha is playing a shell game that ordinary citizens could never get away with. Imagine moving your automobile to a county just over the state border on June 30 and then claiming that no property tax was owed because it was not within a West Virginia county on tax day. This would be a non-starter because the law taxes “all personal property belonging to persons residing in this state, whether such property be in or out of the state.”

If providing Alpha and other coal companies with property tax relief had the effect of increasing employment or coal production upon which the state’s severance tax would apply, then maybe there would be some logic to the property tax relief. But shouldn’t that first require some hard evidence that the property tax is actually causing coal companies to decline mining opportunities in West Virginia? Are we simply going to take a coal company’s word for it? A real loss of severance tax, if there is one, could be compared with the amount of revenue to be lost from cutting corporate property tax and then a proper policy choice could be made. But there was certainly no inquiry of this sort from the Subcommittee.

Really, in a time of starkly reduced revenue for all the important things the West Virginia government does, why does our Legislature spend any time considering tax relief for coal companies? If West Virginia actually collected the property tax on machinery taken out of state to avoid tax, instead of letting coal companies get away with this shell game, imagine how useful the revenue would be for our universities and community colleges. Relief from property tax sounds like just another example of corporate welfare we simply cannot afford.

Why Excessive CEO Pay Matters to the Rest of Us

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Corporate Chief Executive Officers have done very well for themselves during and after the Great Recession. By 2015 the ratio of CEO annual compensation to that of a typical worker had risen to 276 to 1, a much higher ratio than in other developed countries. CEO compensation has gradually taken up a larger and larger share of all corporate revenues. But shouldn’t a corporation be totally free to establish the compensation of its chief executive? Actually, no. The reason is that the rest of us pay for excessive CEO compensation – literally.

Two recent studies reveal how successful CEOs at the largest U.S. corporations have been in skimming the compensation cream. The first produced by the Economic Policy institute in July 2016 dealt with CEO compensation, defined as salary, bonus, restricted stock grants, options exercised and long-term incentive payouts. It found that between 1978 and 2015, inflation-adjusted CEO compensation rose 940.9% — this was 73% faster than stock market growth for the same period. The typical worker’s annual compensation over the same period grew just 10.3%.

CEOs were spectacularly successful because of their power to direct compensation to themselves within their corporations, not because they were correspondingly more productive, more talented or better educated than other workers. This is demonstrated by the facts that between 1978 and 2015 CEO pay grew faster than corporate profits, the pay of others in the top .1% of wage earners, and the pay of college graduates in general.

U.S. tax law has also contributed to the explosion in CEO pay. A 1993 tax reform law capped the tax deductibility to corporations of executive compensation at $1 million, except that corporations could still deduct any amount of “performance-based” pay from their income taxes. What happened? You guessed it – performance based pay has been heavily adopted. The Joint Congressional Committee on Taxation estimates that closing this loophole would generate more than $50 billion in additional tax revenues over 10 years.

The second important study was produced in December 2016 by the Institute for Policy Studies. It focused on wealth inequality in retirement savings between corporate CEOs and the rest of us. Among the key findings were that the 100 top CEOs have company retirement funds worth $4.7 billion, an amount equal to the entire retirement savings of the 41% of U.S. families with the least retirement savings.

CEOs have amassed such huge retirement accounts because U.S. tax laws favor executives. If you have a 401(k) at work, you have strict limits on how much you can set aside tax-free each year. Workers 50 and older can contribute a maximum of $24,000 each year. But most CEOs of big corporations have no contribution limits because they enjoy special unlimited deferred compensation plans. In 2015 roughly half of Fortune 500 CEOs invested in these plans a total of $227 million more of their pre-tax income than if they had been subject to the same limits that apply to ordinary workers. If they had been subject to the same limits, these CEOs would have owed $90 million more in income taxes last year.

CEOs pay income tax on the money in these special plans only when they withdraw it. At present, the top income tax rate is 39.6%. President-elect Trump has proposed cutting this rate to 33%. If his proposal were enacted, CEOs who withdraw their money from the special retirement plans would avoid $196 million in income taxes.

If we have the political will we can stop this giveaway to already grossly over-compensated members of society.