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Deadlocked Again on Taxes vs. Spending

By Stephen D. Haner and published by the Thomas Jefferson Institute for Public Policy and shared here by previous agreement.  

We have seen this before in Virginia and here we go again: the classic conflict between tax cuts for the many versus more government spending for a few.

The Republican-dominated House of Delegates has passed a series of broad tax reductions, while the Democratic-dominated Virginia Senate has killed its versions of the same bills.  Last Sunday the Senate then produced a budget proposal about $1 billion richer in funds for education, mental health services and other poll-tested priorities.

Killing the tax bills creates even more revenue to spend in future years, billions more.

The 2023 Virginia General Assembly tax debate is just another revival of an old political show. Last year it ended well for new Governor Glenn Youngkin (R) and for those hoping to pay less in state taxes.  This year is not guaranteed to see the same outcome, not unless there is a late push to engage public attention as the House and Senate seek compromise.

The long list of tax cuts which passed the House should also be whittled down to the essentials, which might make it easier to build that public support.

It is a long list of proposals, perhaps too long. The Senate killed a proposed increase in the standard deduction, a reduction of the corporate income tax rate from 6 to 5 percent, a reduction in the top personal income tax rate from 5.75 to 5.5 percent, and a state version of a popular business deduction available at the federal level.

The Senate even rejected (so far) a highly popular proposal to expand a major tax break for military retirees.  Last year bipartisan majorities in both houses supported creating the big tax subtraction but allowed it only for those age 55 or older.  The House has now voted to eliminate the minimum age, but the Senate didn’t even have a bill on that issue.

What of all that is essential?  The most important tax measure the 2023 General Assembly should pass is not even under consideration.  The recent spate of serious inflation has provide the best opportunity in 50 years to index Virginia’s tax code.  The tax brackets, subtractions and deductions should all be adjusted for inflation and then set to rise gradually with future inflation.

The Thomas Jefferson Institute inserted a single question on the issue in a recent Mason-Dixon Polling and Strategy survey, and the idea was universally applauded by Democrats, Republicans and Independents.  Support was strongest among Democrats (70 percent).  Everybody grasps the impact of inflation now, even the younger folks who missed the last wave in the 1970s.

But Youngkin didn’t propose it and probably the most comprehensive bill on the topic was introduced by a House Democrat.  It never came up for a vote, not even in committee. Unless indexing reappears out of the budget talks, inflation will continue to produce revenue windfalls for government and higher taxes for people.

In the absence of indexing, Youngkin’s effort to add another $2,000 to a couple’s standard deduction becomes the highest priority in his package.  The other high priority item the Assembly really should adopt in any compromise is the qualified business income deduction, only of benefit to businesses which are not incorporated.

Little has been done to promote the package beyond talking points on Virginia’s anemic economic performance and population loss, with the premise being that lower corporate and individual tax burdens will turn things around.  Go to the public website for the Virginia Chamber of Commerce and look up its legislative priority list and you find a vague endorsement of “tax reform to better position the Commonwealth for economic growth and investment” with no mention of the corporate rate cut or qualified business income deduction.

From the outset, the only way to sell a major corporate income tax reduction was a compelling argument it would improve economic outcomes coupled with a strong show of support from the business community.  The window is closing on that.  There might be value in trimming the top rate from 6 to 5.75 or even 5.5 percent just so Virginia’s economic marketers could advertise a rate “less than 6 percent.”

There may also be value in arguing that the top rate for corporations should mirror the top rate for individuals. So much business activity now is in non-incorporated entities.  Gig workers and many small businesses are taxed under the individual tax rules.  That is why the other high priority item is the qualified business income deduction based on a similar federal provision.

The qualified business income deduction at the federal level was created in the 2017 Tax Cuts and Jobs Act to level the playing field between incorporated and unincorporated businesses. At the federal level it creates an additional deduction equal to 20 percent of the business net income and Youngkin’s proposal would grant a 10 percent deduction on the state return.

Only businesses organized as sole proprietorships, S-corporations or partnerships (and some trusts) can claim it.  While many of these are small, it can include large companies.  But they are large companies not organized as C corporations.

As the fiscal impact statement on the bill reports, only Iowa, Colorado, Idaho and North Dakota also recognize the qualified business income deduction for state taxes.  If competitive positioning is your goal, Virginia should make every effort to adopt this pro-business provision that is not recognized in most direct competitor states that also have income taxes. For once, let’s lead.

But again, that argument has not been pushed in any public messaging, either from political leaders or from the various business groups that might benefit.  If squeaky wheels get grease, silent wheels just rotate around the shaft.

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