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.

Those Who Work, Those Who Don’t

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After the 2016 election results we are struggling to understand what hit us. One common view is that Democrats have become tone deaf to the working class, advancing policies that cater to other key constituencies of the party but failing to do much about bettering the economic lives of those in the middle and lower middle. Why, we ask, did Wisconsin, Michigan and Pennsylvania forsake Hillary Clinton in favor of a bombastic outsider who made huge promises, but apparently hasn’t a clue how to govern to deliver on them?

Several thoughtful books can help us find the answer. The best of these is Those Who Work, Those Who Don’t, a sociological study written by Jennifer Sherman in 2009. Sherman sought out a small town in rural America where industry and jobs had been decimated and widespread poverty made the normal social pecking order collapse. This should sound familiar in West Virginia. She wanted to learn what factors provided status and capital in a community where economic distinctions were no longer possible. What she learned is an eye-opener.

Sherman’s town is located in the rural Northern California forest area. She gave it the fictitious name Golden Valley. Golden Valley’s economy was wrecked by the environmental decision to protect the spotted owl at the expense of local industry. All logging activity and most sawmilling in the area ceased and many layoffs occurred. Golden Valley residents viewed this economic devastation as the handiwork of bi-coastal liberals who cared nothing about working class people. But they also recognized that Rebublicans cater to big corporate interests and were not concerned about their plight either.

In Golden Valley nearly everyone was poor. In the absence of economic wealth and distinctions, moral capital was the source of self-esteem and community standing. Those who had moral capital were often able to exchange it for economic capital in the form of job opportunities and assistance from other community members in time of need.

There were two main sources of moral capital. The first was connection to work. Work ethics were highly valued. Those who had a steady full time job were at the top of the hierarchy, followed by those with part time jobs, those on unemployment compensation, and those with a work-related disability. Receiving state or federal benefits because of unemployment or disability was not a negative because these benefits had a connection to past work. Even those who worked to support their families by hunting, cutting wood for fuel or gardening had moral capital from these activities.

Those who did not work, but instead received government welfare assistance, had negative moral capital and lost standing in the community. This effect was felt powerfully by those in that category. Many drove forty miles to the nearest town to use food stamps for fear that they would be recognized by their neighbors. At the bottom were those who were addicted to drugs or abused alcohol, and those who survived through illegal activity. These people were shunned as having no work ethic and were effectively shut out of job opportunities.

The second source of moral capital was “family values.” A person high on the family values scale was usually in a stable marriage, and was a parent or foster parent. But as in most poor communities the traditional family didn’t exist. Children were often raised by grandparents, distant relatives or complete strangers. An individual or couple could gain moral capital if they provided a safe home for any child in the community who needed one. Parents in Golden Valley did not behave as middle class parents frequently do by planning for and becoming involved in the child’s future. Instead parents gained self-esteem and community standing merely by sheltering children in an environment free from abuse that allowed them to develop in their own manner and direction.

What can those interested in regaining the votes of working class people learn from all this?

  • Working class people value hard work, so policies that are designed to provide jobs will be supported by working class voters;
  • working class people are not lazy, do not want public assistance, and will mostly avoid using even well-intentioned benefits that do not somehow recognize recipients as having been connected to the working economy;
  • working class people believe that their moral values of hard work and family are the true American values. Republican rhetoric about morality and values resonates with them;
  • guns, particularly those associated with hunting and providing food, are a strong tradition in rural America and are sometimes essential for family survival; and
  • working class people will reward politicians and political parties that speak to them in a sympathetic, understanding manner and couple this with policies that attempt to deal with the hardships in their lives.

Working class people do not vote against their “interests” when they vote for the Republican agenda, even if that agenda worsens their economic plight. In fact, it is condescending to suggest this. Instead they vote in line with their values. It’s just that Republicans have been more successful addressing those values. But there is nothing inevitable about working class support for the Republican agenda. A progressive agenda that seeks to level the economic playing field through tax reform and job creation can reverse this trend.

Hillbilly Elegy

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Hillbilly Elegy, by J.D. Vance, has received a lot of attention recently. It is the story of a young man with Appalachian roots whose immediate family moved to Middletown, Ohio. The family was rife with domestic violence, divorce, drug abuse and stress. It was also full of love. Vance eventually succeeded beyond the wildest dreams of his “hillbilly” friends and family, graduating from Yale law school, landing a well-paying job, and having a loving stable marriage.

The book is a canvas upon which you can paint your own conclusions. The Wall Street Journal lauded it for demonstrating how folks can overcome social and economic liabilities through mentoring and a large dose of personal responsibility. Vance does attribute much of his success to his grandparents who guided and protected him. But he also acknowledges that government programs, such as Pell grants and low-interest student loans, were important. Vance says that while the social problems and destructive behaviors of the working class cannot be solved by government alone, government policies can act like a thumb on the scale in favor of the working poor.

But another force took over later. At Ohio State, where Vance attended as an undergraduate, and at Yale he was the beneficiary of connections. Connections helped him get into an Ivy League law school; connections helped him get interviewed and hired by a prestigious law firm. He realized that using connections is how the upper middle class and very wealthy routinely succeed. Lack of connections is a big reason why the poor and working class cannot flourish with the same regularity.

In the current debates about economic growth and tax policy, we often hear arguments that suggest a person’s economic status is a measure of his or her virtue. As Robert Reich put it in his book Reason, “If you’re rich you must somehow deserve it. If you’re poor, you deserve that, too.” But many of the super-wealthy inherited their wealth and added nothing to society to get it. Think Paris Hilton. More to Vance’s experience, Reich notes that the false connection between wealth and virtue fails to recognize that

the rich were lucky to be born into families that gave them access to excellent primary and secondary schools, talented teachers and tutors, summer “enrichment” programs, prestigious universities, and all the contacts and connections that come from wealthy parents and classmates and membership in exclusive clubs.

So our current unequal society is not “the way it was meant to be” or some market-driven judgment on which of us are worthy of financial reward. Instead it is structured from the beginning to favor those who are already wealthy, in many cases through nothing but the luck to be born to the right parents.

This inequality is not inevitable. J.D. Vance noted that within two generations after his hillbilly family moved to Middletown, Ohio and got good jobs with Armco Steel “they had caught up to the native population in terms of income and poverty level.” Thoughtful and effective government policies can provide the needed thumb on the scale in favor of the working class to create jobs, income and a hopeful future. The cultural change and the connections will follow.