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

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 Under SB 335, the personal income tax would be repealed on January 1, 2018 and replaced with a flat tax rate of .6% in 2018, .4% in 2019 and .2% in 2020.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.