Death By A Thousand Cuts

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The West Virginia Legislature began its main 2019 session on January, 9, 2019. All bills introduced in 2018 that were not then acted upon were re-introduced on the first day of this session. New legislative proposals have also been introduced early in this session. A review of both categories introduced in the House and Senate shows that there are several serious attempts to deal with the state’s problems.

But it also shows that many legislators are in love with tax exemptions and credits, which benefit one class of taxpayer and disadvantage everyone else. Sometimes these proposals have merit, but taken cumulatively they show the Legislature’s willingness to bleed our government of the revenue required for it to function effectively, drop by drop.

Legislators from both parties have proposed tax exemptions or credits, although Republicans have done so by a margin of roughly three to one. Here are some of the many proposals:

  • To exempt law enforcement officers from the payment of personal property tax (HB 2075);
  • To reduce the federal adjusted gross income figure used in West Virginia tax calculations for volunteer fire department and rescue squad members (HB 2208);
  • To exempt firefighters and volunteer firefighters from the payment of income tax, and real and personal property taxes (HB 2403)
  • To permit honorably discharged veterans to hunt, trap and fish without a license (HB 2030);
  • To exempt all motor vehicles from personal property tax (HB 2094);
  • To exempt the pension benefits of Department of Natural Resources police officers from state income tax (SB 12);
  • To exempt income earned by primary and secondary school teachers from personal income tax (HB 2370); and
  • To establish an income tax credit for practicing physicians who locate to West Virginia (SB 80).

For the last several years, this state has struggled with large budget deficits created because in earlier periods, when coal severance revenues were high, we reduced or eliminated other taxes. Among these were the business franchise tax and a reduction in the corporate income tax. Then the coal market, as it always does, went bust. We are now again operating with a surplus from an improved coal market and revenues from gas pipeline construction. But these sources of revenue are not permanent. Tax exemptions and credits, on the other hand, often become permanent.

Effective government costs money. Nobody likes paying taxes, but many of us like even less the failure of our government to create a successful, modern state that we don’t have to apologize for. Jim Justice is right about one thing – we are all tired of being 50th. Yet our tax choices don’t reflect an understanding of how to change this.

I am certain that cogent supporting arguments can be made by the legislative sponsors of each of the proposed exemptions and credits mentioned above. And it is difficult for opponents to argue that, say, school teachers aren’t worthy of tax relief. That sort of debate, though, is limited to the worthiness of the constituency to be favored.

What is missing is an analysis of the opportunity cost of granting exemptions and credits. What more important thing would we be able to do with the money we propose to confer on teachers or DNR police officers? There is very little of this analysis in the Legislature beyond the legislative fiscal notes, which are little more than a bookkeeping of what a proposal might cost. These fiscal notes are routinely ignored. You can be sure, however, that every nick in the general revenue fund created by a tax exemption or credit is ultimately felt somewhere else in the budgetary process.

This is not to say that tax exemptions and credits can’t be useful in achieving important policy goals, so long as they rationally fit those goals and are not one-off gifts to a particular constituency. Some of the recent legislative proposals fit well and seem worthy of enactment. For example, a refundable state earned income tax credit of 50% of the existing federal earned income credit. (HB 2108). This credit would further supplement the incomes of low and moderate income working adults. Doing that would increase the attractiveness of work and reduce the need for other public benefits like food stamps.

The idea of raising taxes is like the third rail in West Virginia politics. Nobody in the Legislature wants to touch it for fear of being punished by voters. But maybe we can be more careful about “spending” the revenues we do have on tax benefits for narrow constituencies. One way to do this is to resist the temptation to open any more small fiscal wounds in the body politic for the sake of momentary political benefit.

Going through all the bills that have been introduced in the Legislature so far, I came upon another idea. In each of the last two sessions, a bill has been introduced in the Senate proposing a five year sunset period for all tax credits in the Code (SB 23 and SB 48). Now that is a breath of fresh air.

 

The Future of West Virginia’s Severance Tax

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In West Virginia a 5% tax is imposed on those engaging in the extraction of coal, oil, gas and other natural resources from the lands of the state. This is the “severance tax.” While the tax is ostensibly on the privilege of engaging in the business of extraction, the tax is calculated based on the volume of production. 

We depend on severance tax revenues for 10% to 12% of the general revenue budget of the state, making us more dependent on this revenue source than most other states. Our dependence subjects the state budget to boom and bust cycles caused by volatility in the price of the commodities. The state’s oil & gas industry is now booming even though coal is in the midst of a long-term decline. Most analysts believe both these trends are likely to continue for decades. So the future is bright for the state’s budget if we manage our oil & gas patrimony carefully.

West Virginia had no severance tax until 1987. Before that we taxed natural resource extraction at a higher rate through the “business and occupations tax” upon the gross receipts of the extraction business. Despite this, the extraction industries complain that the 5% severance tax rate is high relative to neighboring states. But this nominal 5% rate is reduced to an effective tax rate of around 3.2% by various exemptions and tax breaks created by the Legislature. One such break is a reduced tax rate on coal mined from thin seams. Another is a tax credit on oil & gas wells that produce a small volume. Our effective tax rate on severed natural resources compares favorably to our neighbors.

Historically the revenues from coal severance were often four times the revenues from all other severance taxes combined. Given the huge leap in gas production made possible by hydraulic fracturing, this is changing. Table 1 shows that as of 2015 tax revenues from oil and gas production represented more than half of the amount from coal production. By 2030, the revenues are expected to be roughly equal.

Table 1 – Severance Tax Revenue 2011 to 2015 (in 000s)

Source: WV State Tax Department   

Year 2011 2012 2013 2014 2015
Coal $526,817 $531,108 $451,646 $407,148 $375,558
Oil & Gas $72,947 $99,235 $115,014 $229,466 $215,362

How Severance Tax Revenues Are Allocated.

The West Virginia Center for Budget & Policy did a study of the severance tax in December 2011 that is quite helpful in understanding these issues. The CPB described how severance tax revenue was distributed in FY 2011, which is typical of distributions in later years. 

The first $24 million in severance tax revenue in FY 2011 went into an infrastructure fund to cover the externalized costs of extraction industries, such as damage to roads and bridges. This is required by law every year. 

The large bulk of the revenue, more than 86% in FY 2011, went into the general revenue fund with no spending strings attached. 

Finally 8.9% of the tax revenue was distributed to counties and municipalities. This happens in two ways. One formula directs a portion of the revenues to counties from which the resources are actually severed. There is a list of these counties for coal and one for oil & gas. For example, six counties (Marshall, Tyler, Harrison, Wetzel, Doddridge and Ritchie) principally benefitted from the formula for distributing oil & gas tax revenues.

But under a second formula all counties and municipalities benefit from direct distribution of severance tax revenues based on population. For example, in FY 2018 Martinsburg received $20,000 from oil & gas severance taxes, Charles Town received $5,000 and Shepherdstown $6,000.

Should We Increase the Severance Tax Rate on Oil & Gas?

There has been a lot of debate on this question recently. In the April 11, 2018 issue of the Spirit of Jefferson, former Delegate John Doyle argued that we should double the severance tax rate on oil & gas. Then in the Charleston Daily-Mail for April 14, 2018, the former President of the West Virginia Independent Oil & Gas Association (and current lobbyist) Philip Reale argued that we should be cautious in raising the tax and increasing production costs because oil & gas producers might choose to drill wells in other less costly states. In my opinion, Doyle gets the better of this argument.

First, as Doyle points out, if the state’s production of oil & gas continues to expand as predicted, doubling the severance tax could mean an additional $560 million in revenue for the state. That would be a huge shot in the arm for a state struggling to address daunting social and economic problems. The injection of that additional revenue into the state’s economy would also have a multiplier effect. A 2010 study from Penn State found that for every $100 million in severance tax revenue, Pennsylvania would see a net gain of 1,100 jobs from increased state spending in areas such as infrastructure and schools.

The beauty of the West Virginia severance tax is that, for the most part, West Virginians don’t pay it. The tax burden of a severance tax on oil & gas mainly falls out of state in increased consumer prices for gas and oil consumption. Furthermore, most of the companies involved in gas drilling and production upon which the tax would be levied are not West Virginia companies and their stockholders are spread world-wide. Think of the oil & gas severance tax like the hotel/motel tax that travelers to West Virginia pay on their hotel stay. They get the tax burden; we get the benefit.

But what about Reale’s point that raising production costs in West Virginia might discourage drilling activity here in favor of other states like Ohio and Pennsylvania? The empirical evidence does not support this concern. Severance and income taxes are only a small part of the overall cost of operating for an oil & gas company. Pennsylvania has no severance tax whatever, but still West Virginia gas & oil production set a new record in 2016, and our prime producing counties are a stone’s throw from the Pennsylvania border.

A 1999 study in Wyoming and a 2008 study in Utah both came to the conclusion that the severance tax rate had very slight effect on the level of industry activity. Different tax rates and structures between states seem to have little impact on amount of investment in each state.  In 2001 Montana reduced severance tax rates and while Wyoming increased rates. Both states had a boom, but Wyoming experienced better growth in production and revenue. Industry certainly did not flee Wyoming.

The West Virginia Future Fund

In my opinion, the only downside to increasing the oil & gas severance tax rate substantially is that it would make our budget even more exposed to the boom and bust cycle. As severance tax revenue becomes an ever larger proportion of our general revenue fund, the sudden loss of those revenues because of price volatility can wreck budgets. But we may already have a solution to this problem.

In 2014, the West Virginia Legislature exercised rare foresight when it established the West Virginia Future Fund. This is a sovereign wealth fund that is intended to capture and invest 3% of severance tax revenue that would otherwise go into the general revenue fund. The idea is to permit us to benefit over the long term from the interest in the invested funds. Several western states have taken the lead on this type of fund. Wyoming, a large coal producing state, created its Permanent Wyoming Mineral Trust Fund in 1974. As of 2015, the Fund had assets of $6.8 billion and had generated $4.7 billion in interest income for the state’s general revenue fund.

The Future Fund is different than our “rainy day” fund. We actually have two of these – one into which budget surpluses are deposited and the other into which the state’s tobacco litigation settlement payout was deposited. These rainy day funds have been used to make up budget shortfalls in the last two years.

The Future Fund is entirely empty at present because of restrictions on when severance tax revenues can be diverted to it. One restriction is that no deposit to the Future Fund can be made unless the rainy day fund is at least 13% of the state’s general revenue fund budget for the preceding year. Another is that no deposit can be made if the rainy day fund was called upon in the preceding year to make up a shortfall in the general revenue fund budget.

It is hard to quibble with these restrictions, but as anyone knows who is trying to save for retirement, putting money away for the future requires discipline. The Future Fund will never work as intended if the restrictions prevent a deposit most every year. If this continues, the restrictions will have to be revisited.

The interest from the Future Fund can, by law, only be spent on economic development and diversification projects, infrastructure improvements and “tax relief.” It cannot be used directly to smooth out the effects of the boom and bust cycle on the general revenue fund. However, once we begin drawing down interest from the Future Fund for these specified purposes, our tax dollars that would otherwise be spent on them can be freed up to deal with other spending needs — even during years when market conditions create a bust in severance tax revenue.

Increasing our oil & gas severance tax to take advantage of the current boom coupled with actual, sustained use of the Future Fund is smart business for West Virginia.   

 

    

  

The West Virginia Legislature Fails Its Budget Responsibility

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“Do Your Job!” This was a constant refrain heard from the thousands of citizens, many of them teachers, who filled the halls of the state capitol in late February and early March.

They were calling for investment in public education, and for decent salaries for themselves and thousands of other seriously underpaid public employees. The Legislature was dragged kicking and screaming into granting an average 5% raise.

This raise was critically important. But there is another critically important job the Legislature failed to do.

By essentially “rubber stamping” the proposed budget sent to it by the Governor, the Legislature failed to exercise proper stewardship of the public’s money. When it comes to the single most important document the Legislature produces each year, the State Budget, the Legislature did not do its job.

As to my bona fides, I served on the House of Delegates Finance Committee for 19 years (as Vice Chair for 10 years). Later, I was Deputy Secretary of Revenue for 3 years. I have learned the budget process from both the legislative and executive points of view.

Under our state constitution, it is the Governor’s responsibility to propose a budget. It is the responsibility of the Legislature to enact a budget. We on the House Finance Committee took that responsibility seriously and every year we went through the Governor’s proposal carefully, looking for places to economize.

Each of the members of the House Finance Committee was assigned individually to the proposed budget for one or more executive branch agencies to find money that might be cut or used elsewhere. It took us the first 30 days of each annual Regular Session to gather the information and about the next 20 days to compile and analyze it. We would make dozens of changes, sometimes over a hundred, to the Governor’s original proposal. When we reported our completed budget to the House floor during the last week of the session, we were confident that we had done our job up to that point.

But the job wasn’t finished. The Senate Finance Committee would send its budget to the Senate floor at the same time. A Budget Conference Committee for the two chambers would begin meeting as soon as the regular 60-day session was finished. It would usually take between five and seven days to finish. The Governor was always invited into the discussions. I served on this Committee for twelve straight years. The result would be a budget thoroughly vetted.

But that did not happen this year.

In recent years the Legislature has stopped being thorough in analyzing the Governor’s proposed budget. This year the Legislature didn’t even appoint a Budget Conference Committee to discuss ways to improve the budget.

This year’s final budget (FY 2019) included fewer than a dozen changes from the Governor’s proposal. And most of those changes were dictated by the decision (unanticipated when the Governor presented his proposed budget) to grant that 5% pay raise, which cost the state’s coffers about $150 million.

Either our present Governor is the smartest person ever to occupy the office, or the Legislature punted. I think the Legislature abdicated its responsibility to vet the governor’s budget proposal thoroughly. This was fiscally irresponsible.

The West Virginia Constitution permits the Governor to extend the Regular Session for as long as it takes to finish the budget. This is called the Extension of the Regular Session and is different than the Special Session that was required for the FY 2018 budget.  Each day of an extended regular session costs the state approximately $20,000. If this extension averages six days that would cost the taxpayers approximately $120,000. If that work can save at least $500,000 I argue it’s worth the expense. Every year I was on the Budget Conference Committee we saved at least several million dollars.

Because of this work we were able to significantly pay down the unfunded liabilities of the workers’ compensation fund and the various public employee retirement funds, and to establish the rainy day fund. We stabilized the public employee health care program, then called PEIB and now PEIA. The system was so behind in its payments in the 1990’s that medical providers were refusing to see state employees.

Through careful work and negotiation, West Virginia — a financial basket case in 1992 — became recognized as one of the half dozen most fiscally responsible states in the Union by 2012 when I left the Legislature. Our bond ratings were “junk” status in 1992, but had risen so much by 2012 that some were the highest rating (aaa-plus).

In the last four years the so-called “fiscal conservatives” in the Republican Party who lead the Legislature have raided our rainy day fund several times and have overseen a drop in our bond ratings. They have also slowed down paying off some unfunded liabilities. In my view this is fiscal irresponsibility. Their lack of budget scrutiny is another example of irresponsibility.

John Doyle resides in Shepherdstown. He is a Democratic candidate for the House of Delegates from the 67th District.

West Virginia’s High Stakes Stimulus Plan

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The West Virginia Legislature has a single required duty when it meets each year — pass a balanced budget. When the regular session began in early 2017, the revenue available for funding state programs had dropped to $4.05B, approximately $500M less than was spent in the previous fiscal year. Against this backdrop, Governor Justice proposed a number of new revenue sources and programs, few of which got any traction.

Being in no mood to raise new revenues, the Legislature was prepared to force the state to “live within its means” by drastically cutting programs and services. But on June 13, at the proverbial last minute, the Governor sent a letter to the Speaker of the House of Delegates with a revised revenue estimate of $4.225B. This higher revenue estimate enabled the Legislature finally to pass a budget without hyper-cuts to state programs. But the estimate was based on wishful thinking and may force the Legislature to confront an even larger deficit next fiscal year.

Careful readers of the Governor’s revised revenue estimate would have noticed a portentous footnote that made his higher estimates dependent upon the passage of two bills related to roads:

These estimates are contingent on revenues and projected economic activity associated with the passage of Engrossed Senate Bill 1003, relating generally to WV Parkways Authority, and Engrossed Senate Bill 1006, increasing funding for State Road Fund, as recommended by the Governor.

So the final budget commits the state to certain spending in FY 2018 that will be “funded” by uncertain, estimated tax revenues from future economic activity. According to the Governor, that increased economic activity will be generated by ramped up roadbuilding and repair, itself dependent upon the public sale of new bonds. The bulk of these new bonds cannot be issued until voters approve the bond issue in a special referendum to be held October 7, 2017.

In fairness, $140M in new revenues for the roadbuilding effort will be secured by the $.035 per gallon increase in the gasoline tax, increasing the motor vehicle privilege tax and a variety of new DMV fees. Plus $400M to $500M in new bonds will be sold by the West Virginia Parkways Authority and financed by increased Turnpike tolls. The roadbuilding from those bonds will be confined to ten southern West Virginia counties contiguous to the Turnpike.

But the large majority of the new bond revenue will depend on public approval in the special referendum. This will be the second largest roadbuilding bond effort in state history and, if successful, will raise about $2.4B. The last such effort was a 1996 road bond amendment for $550M, or about $859M in today’s dollars. One major worry is whether the bond referendum will pass. Between 1973 and 1996, voters defeated road bond referendums three times and no road bond proposal has been before the public in 21 years.

In his public statements about the issue, Governor Justice has been apocalyptic about the possibility of a failed bond referendum, warning “[i]f it fails, this state is history. That’s all there is to it. . . . You will have a complete melt-down if this doesn’t go through.” Even if the referendum does pass, several months will be required to sell the bonds, issue and award contracts and get construction underway. None of the roadbuilding and repair financed by these new bonds can begin until the spring of 2018. On this schedule the state is unlikely to benefit from any increased economic activity until FY 2019.

There are other problems with relying on future economic activity from roadbuilding to fund the budget. Clearly there will not be a one-to-one return on the dollars spent, at least in the short run. A certain segment of the funds generated by the bonds will be consumed in state administration, and another segment in overhead and profit for the roadbuilding companies. Although wages to laborers will increase while the work is underway, there is no guarantee that these laborers will spend the money in West Virginia or be taxed as residents here.

On the other hand, there is an economic multiplier that always increases the benefit of public spending as it gets recycled through the economy. If we are careful, each stage of this spending can yield tax revenue. Furthermore, better roads will have a long term, although hard to measure, positive impact on the ease of commerce and may be part of attracting new business. The best that can be said for the roadbuilding stimulus is that it can pay off if everything goes according to plan or better. Yet how often does this happen?

The Governor should get some credit for pushing these measures through. He will certainly be the goat if, as seems likely, the expected revenues do not materialize in FY 2018 and the Legislature faces a larger deficit next spring.

The benefits from a roadbuilding stimulus plan, even if they occur, will mostly be short term – while the roadbuilding is underway. What we need instead of short term, stopgap measures, is a serious plan to stabilize and grow revenues. The Legislature knows what revenue tools are available – income taxes, sales and gross receipts taxes, excise taxes on certain items, estate taxes, and others. We need the proper mix of these revenue tools so that we take full advantage of good economic times in the coal and gas industry, but also have solid revenue streams when these industries decline. Above all we should avoid the faddish, trickle-down economics of corporate and personal income tax cutting so favored by some conservative Republican legislators.

 

 

West Virginia’s Budget Disgrace

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The soap opera in Charleston appears to be over. After failing to come together on any meaningful changes for increasing revenues or reforming the tax structure, the Legislature adopted a “bare-bones” budget that cuts more deeply than ever into valuable state programs. This was a default to the lowest common denominator and a failure of statesmanship. It defers many important questions for a later Legislature. One Delegate said that the budget was the result of “complete and utter dysfunction.” The process wasted everyone’s time and money.

While there is blame to go around, this result was the product of opposing positions taken by members of the same political party. Senate Republicans insisted that there would be cuts to personal income taxes or nothing. House Republicans insisted on broadening the sales tax base and were suspicious of income tax cuts in a deficit environment. Week after week neither side moved. The Democrats were impotent on the sidelines and the Governor lurched from one folksy hyperbole to the next, offering some bone-headed proposals of his own. The whole process was a disgrace.

The Legislature gathered in general session knowing in advance that revenues in the state’s General Revenue Fund were projected to fall short of the spending level from last fiscal year. The shortfall was roughly $500 million. There has been agreement on both sides of the aisle that tax reform will be necessary for West Virginia to stabilize and increase revenues and avoid volatility in our budgeting.

But for many Republicans, particularly a Senate faction led by Robert Karnes (R, Upshur), tax “reform” meant radical reductions to the personal income tax, the largest single source of state revenue. Karnes and his crowd actually think that cutting income tax for wealthy “job creators” will raise revenues.  By allowing these people to keep more of what they make, reasons Karnes, they will leap into action, juicing up business and the economy. This widely debunked nonsense was exposed most recently by the Kansas experience where substantial income tax cuts put the state’s economy into the toilet.

Karnes and the Senate Republicans labored under a false belief that also afflicted House Republicans. It can be reduced to a simple equation: tax = bad. In an environment where we needed more revenue to avoid harmful cuts, only the House Republicans were willing to put their toe into the water to find new revenue sources. Even then, House Republicans wanted to add new items upon which to levy sales taxes rather than raise the tax rate itself, presumably so they could then claim they didn’t raise taxes. They rejected a Senate bill because it “amounted to a tax increase.” The conservative Tax Foundation, which followed the situation in West Virginia closely, said “It would almost be easier to enumerate the taxes the legislature didn’t consider as possible solutions to the budget shortfall over the past few months.”

West Virginia has well-documented problems. On just about any measure of successful governance we are last in the country or very close to it: per capita income, workforce participation rate, educational attainment, health indicators and obesity, opioid addiction. You name it. Governor Justice’s initial proposed budget recognized that important spending on education and social programs had to be retained in order to ensure that we did not become a failed state. But later he seemed to lose his head by aligning himself with Senate Republicans and their income tax cuts, presumably on the theory that even a bad idea is better than no idea. In the end he lost respect from everyone, even members of his own party.

The best summary of the cuts our FY 2018 budget will make versus the spending from FY 2017 (which itself involved cuts from prior years) has been provided by the West Virginia Center on Budget and Policy.   The budget cuts $7.5 million from colleges and universities and $2.5 million from community and technical colleges. Public broadcasting was cut nearly $1 million, the line item for the Division of Culture and History was cut 14%, and the West Virginia Commission on Women, the Division of Educational Performance and the Tobacco Education Program were all completely defunded.

We need some new thinking and new leadership who recognize that good government is expensive and that we cannot cut our way to prosperity. If West Virginia is determined to elect Republicans to majority roles in the House of Delegates and Senate, these public servants need to rise above squabbling among themselves, reject the latest fashion in right-wing economic theory, and a find a way to grow revenues over the long haul. Yes, that might mean even raising taxes, which West Virginians would welcome if we applied the revenue toward solving some of our many problems.

 

The West Virginia Budget Crisis

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Remember the large budget deficit that confronted West Virginia lawmakers at the start of the legislative session? One estimate in November 2016 was that in FY 2018 (beginning July 1, 2017) we would generate only $4.055 billion in revenue, roughly $500 million short of anticipated spending. That brought many legislators to Charleston for the general session prepared to strip spending down to a bare minimum and force the state “to live within its means.” Fortunately, those views softened when confronted by political reality.

Now projected FY 2018 revenues are about $40 million better than first predicted due to an improving coal market and a $33 million transfer from general revenues to the Workers Compensation Fund that won’t be made. But the remainder of the budget shortfall hasn’t disappeared. How the shortfall will be closed is the subject of a House and Senate conference committee meeting today. So far, the fiscal and political stress created by the shortfall has caused Governor Justice and quite a few legislators to behave as if any idea – even a demonstrably bad one – is better than nothing.

June 12 is the sixteenth day of a special session devoted to this project. The extension to allow the conference committee to meet expires on June 13 and if a solution is not reached immediately the tax reform effort may be abandoned entirely. The two opposing camps are the Governor and Senate Republicans — who want to reduce income taxes — and nearly the entire House who want to raise sales tax rates and coverage without reducing income taxes.

Neither approach is progressive. Sales taxes hurt lower and middle income citizens who have no choice but to spend almost all of their income on taxed items. Because income taxes are generally paid more heavily by wealthier citizens, the proposed income tax reductions coupled with the sales tax increases would result in an overall tax decrease for the wealthy but an overall tax increase for lower and middle income taxpayers. According to the West Virginia Center on Budget and Policy, the plan lowers taxes on the top 20% of West Virginia households and increases taxes on the remaining 80 percent of households.

Nevertheless, a sales tax increase seems likely to be in any budget deal. But it is uncertain what the new rate will be. The conference committee is now considering an increase from 6% to 6.5%. Whatever higher rate is chosen, it would be applied to previously untaxed items such as telecommunications services, digital goods, electronic data processing services and health fitness memberships. The 6.5% rate is projected to raise $96 million in FY 2018 and $106 million in FY 2019.

Beyond that, the thinking of the Governor and the Senate Republicans has come unmoored. They want to reduce income taxes by 7% in FY 2018 and in similar amounts staged over coming years. What should trigger these further reductions has been the difficult issue. Senate Republicans have only agreed to this “modest” series of reductions in income tax because opposition to their original proposal was fierce. An income tax reduction is the brain child of Sen. Robert Karnes (R, Upshur), a conservative ideologue, who headed the Senate Select Subcommittee on Tax Reform. You may wonder how a reduction in income tax collections will close the budget gap?

You’ve heard the Republicans’ answer before – tax cuts will lead to more growth and job creation, which will lead to higher tax collections. The problem is this theory has never worked. While there may be some small growth benefit in tax cuts, it never amounts to as much as the tax revenue lost. This played out painfully over a decade in Kansas, which finally abandoned its tax cutting regime by adopting tax increases passed by a Republican legislature over the veto of Republican governor Brownback.

But it is Governor Justice who has gone the furthest into fantasyland. After properly opposing massive spending cuts that would have rendered West Virginia a shell, Justice has gone over to the income tax views of the Senate Republicans in order to get a deal. He defends their position because “just think of how far they’ve come” from their original proposal to cut income taxes 30%. In other words, we should all support a bad proposal because it is not insane like the first one.

Governor Justice has engaged in what can only be described as weak and illogical explanations for his positions. He acknowledges that increasing sales taxes may swamp any benefit low and moderate income taxpayers would get from a reduced income tax. But then referring to that reduction he asks why we wouldn’t want to “give money back to the guy mowing the grass?” When pressed he has further supported the reduced income tax idea by suggesting it would be “a great move for our image and a great move to potentially bring people to our state.” Don’t bother looking for any hard numbers.

Governor Justice also has urged the adoption of a tiered coal severance tax that would generate less tax revenue when coal prices are low and increased revenue when they are high. The net impact would be a $49.9 million reduction in severance tax collections for FY 2018. This proposal is either the result of strong coal industry lobbying or faulty thinking, or perhaps both. Surely other industries in the state with greater economic impact than coal, such as healthcare, would benefit from favored tax treatment. This is just one more example of pandering to extractive industries that do not represent our future.

So in the end, how does Governor Justice believe the budget gap will be closed? He predicts an additional $100 million in tax collections from economic growth that will result from the tiered coal severance tax and his $2.8 billion infrastructure spending plan. This guesswork, called “dynamic scoring,” is so speculative it would make Donald Trump blush. There are easily a hundred ways that this tax revenue could fail to materialize even if the infrastructure plan is pursued. This is why state budgeting based on estimates of economic growth is considered unsound.

Governor Justice once appeared to be the sensible, stable player in the budget and revenue battles. Now he seems to be the chief inmate in the asylum.

 

 

 

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

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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

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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?

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

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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.

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.