Replacing West Virginia’s Income Tax with a Consumption Tax Promises Huge New Deficits for the Future

/in , , , , , /by

West Virginia Senate Bill 335, now pending before the Senate Select Committee on Tax Reform, would phase out West Virginia’s income tax and impose an 8% consumption tax on a broad range of transactions. The legislative “findings” that precede SB 335 assert that a major change like this to our tax structure would be both fair and fiscally sound. As to fairness, this assertion is demonstrably false. SB 355 would increase the tax burden on low income and working class taxpayers and give wealthier taxpayers a substantial overall tax break.

In the face of at least a $500 million budget deficit this fiscal year and perhaps a larger one next fiscal year, West Virginia is in dire need of a tax plan that will grow long-term, stable revenues. Unfortunately, SB 335 would at best provide only temporary revenue relief and portends mounting future budget deficits. This revolutionary change to our tax structure would be bad law and worse policy.

It is important to understand how SB 335 would change West Virginia’s tax structure. The personal income tax is the state’s largest revenue source and makes up approximately 45% of the state’s General Revenue Fund Budget. Income tax collections for FY 2018 are expected to be $1.8 billion. Under SB 335, the personal income tax would be repealed on January 1, 2018 and replaced with a flat tax rate of .6% in 2018, .4% in 2019 and .2% in 2020. According to the fiscal note attached to the Bill, this would result in decreased income tax collections of $650 million in FY2018, $1.8 billion in FY2019 and $2.0 billion in 2020.

To replace that revenue, SB 335 would create a broadly based 8% consumption tax that would apply to the same sales as the current sales tax, but with the following enhancements: (1) food for home consumption, (2) non-medical professional services such as legal, accounting, engineering, architecture, real estate, advertising, funeral, and the like, (3) personal services such as hair, nails, skin care and non-medical personal home care, (4) public utility services such as electricity, natural gas, water, sewer, telecommunications, solid waste, and the like, and (4) numerous direct use purchases by business, electronic data processing, mobile home sales, health fitness services, and much more.

These consumption tax changes would result in tax collections to the General Revenue Fund of around $1.2 billion in FY2018 to $1.33 billion in FY2019. The figures do not account for “leakage” of sales by consumers who would make purchases in surrounding states with a lower consumption tax. Matching the projected decrease in income tax collections with the increase in projected consumption tax collections, the fiscal impact of SB 335 would be the following:

  • FY2018 — $550 million
  • FY2019 — ($370 million)
  • FY2020 — ($440 million)
  • FY2021 — ($610 million)

The increased revenues in FY2018 are produced only because the consumption tax increases would begin in July 2017 while the decreased income tax collections would not begin until January 1, 2018.

The fiscal note by the State Tax Department makes the following observation:

The proposed bill represents the most massive tax reform effort of any State in recent memory. Most states commit significant resources toward adequate measurement of tax reform impact on businesses and residents prior to adoption of a significant change. The resources and timeframe for the preparation of this fiscal note are woefully inadequate to properly measure the cumulative extent of all consequences associated with proposed changes.

Why then rush to consider SB 335? One argument for this change in the tax structure is that it would stimulate economic growth. But eliminating the state’s income tax can’t be counted upon to do this. The fiscal note states that SB 335 would effectively increase taxes on business inputs by an amount that is at least double the potential income tax savings on business profits. Meanwhile, the West Virginia Center on Budget and Policy notes that for the period 2005 to 2015 the nine states with the highest income tax had 5.6% GDP growth while the nine states with no income tax grew GDP only 3.2%.

Ask any merchant whether she would prefer to pay income tax on business income or be the state’s collection agent for a hefty consumption tax on her customers. My bet is that the income tax would be favored overwhelmingly. A consumption tax relentlessly faces the customer in each transaction and so discourages sales. This would be particularly true for businesses that deal in products and services that have never before been subject to the state’s sales tax. On the other hand, a business can plan for and sometimes mitigate the effects of an income tax through lawful deductions, credits and deferrals. Not so with a consumption tax.

If the West Virginia legislature truly wants to create stable future revenues for all the important work government has to do, while keeping West Virginia “open for business” as our state marketing slogan once promised, it needs sober up about what replacing the income tax with a consumption tax would really do.

 

 

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

/in , , , , , , /by

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?

Republican Senators Propose Replacing West Virginia’s Income Tax with A Higher New Sales Tax

/in , , , , /by

Only nine states in the nation have no state income tax. However, there is considerable support in the West Virginia Senate to phase out our income tax completely by 2021 and replace lost revenue by raising the state’s sales tax to 8% from 6% and eliminating many sales tax exemptions. The effort in the Senate is being led by Sen. Robert Karnes (R-Upshur, 11) sponsor of SB 335. If the Bill in its present form is enacted, West Virginians would soon begin paying sales taxes on new items such as groceries, internet streaming services, haircuts, professional services, and more. The Bill is co-sponsored by eighteen other Republican Senators, including Panhandle Senators Craig Blair (R-Berkeley, 15) and Charles Trump (R-Morgan, 15).

Karnes told the Huntington Herald-Dispatch that West Virginia currently collects $1.9 billion from the income tax, which is 45% of the state’s $4.5 billion general revenue fund. The state collects approximately $1.2 billion from the sales tax. If all sales tax exemptions were eliminated, Karnes said the state would receive an additional $2 billion in revenue. Of course, there is no way all sales tax exemptions would be ended, particularly for things like medical services, day care services, and the like. The whole situation is fluid but the Senate Select Tax Reform Committee, of which Karnes is Chair, wants to move quickly. It rejected a motion to await the preparation of a “fiscal note” designed to predict the fiscal impact of the Bill.

Without a fiscal note, adopting a major change to the state’s tax structure seems reckless. Governor Justice has said that it would be “phenomenally risky” to make major changes to the state’s tax laws during a budget crisis. In fairness, the Select Committee will probably not take final action until there is a fiscal note. But there seems little point to working on a major change to the tax structure that may end up being a non-starter because it won’t raise more revenue. West Virginia is facing a $500 million budget deficit this fiscal year and perhaps a larger deficit next fiscal year. What we want is our Legislature to get busy working on a fair tax system that generates enough revenue to close the budget gap and promotes economic growth that will form the basis for stable future revenues.

There is reason to doubt that eliminating the state’s income tax will actually promote economic growth. The West Virginia Center on Budget and Policy reports that for the period 2005 to 2015 the nine states with the highest income tax had 5.6% GDP growth while the nine states with no income tax grew GDP only 3.2%. Perhaps there is no causal relationship here, but it makes one wonder and should cause the Republican sponsors of SB 335 some concern.

On the question of fairness, 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. This is the nature of a progressive tax. Contrast a sales tax, which taxes consumption. The sales tax doesn’t concern itself with how wealthy you are, only how much you spend and on what things.

Consider two hypothetical taxpayers. A taxpayer making $30,000 spends every dollar of his income supporting his family with shelter, food, clothing and other necessities. A taxpayer making $250,000 supports her family with relative ease and also consumes luxury goods, but still saves 20% of her income. Unless there are exemptions in the sales tax structure for necessities, under SB 335 our low-earning taxpayer will pay an additional 2% sales tax on 100% of his income, while the wealthier taxpayer will pay an additional 2% on only 80% of hers. In most cases, the total tax paid by the low income taxpayer will rise slightly, while the total tax paid by the wealthy taxpayer will drop considerably. This is because the additional 2% sales tax paid by the wealthy taxpayer on consumption is far less that the income tax she saves.

Sen. Patricia Rucker (R-Jefferson, 16) removed her name as a sponsor of SB 335. Perhaps she had second thoughts about the wisdom of the Bill. So should the rest of the Republican members of the Select Committee.