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Signs Virginia Will Keep Tax Reform Windfall

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As of right now all the signs indicate that the Virginia General Assembly and the Northam Administration are going to allow the federal tax reform to generate additional tax revenue for the Commonwealth. Some of what the Congress gave back will flow not to Virginia taxpayers, but to the state treasury.
What are those signs? None of them are totally clear but the circumstantial case is strong.
There are no plans for any special session later in 2018 to amend Virginia’s tax code in response to the federal changes. I have confirmed that with the chairmen of both the House and Senate committees, but of course that could change.
In a recent talk at Christopher Newport University, Senator Frank Wagner, R-Virginia Beach, was gushing to the crowd over all of the extra revenue expected in Virginia – some of which is already baked into the state budget just adopted.
Secretary of Finance Aubrey Layne a couple of months ago, talking to the Senate Finance committee, left me with a strong impression that the administration would be slow to amend Virginia’s tax code and forego any windfall. His next big chance to address the General Assembly in public comes in August when the money committees hold the joint meeting on the closeout of fiscal year 2018.
By then the state may have received the consultant report it has commissioned detailing the state revenue impact of the various federal provisions. A very important sign will be whether that data is widely disseminated or held close as governor’s working papers.
Another sign: The Commonwealth Institute for Fiscal Analysis, possibly reflecting the attitude of key General Assembly Democrats, has come out in favor of full conformity because it believes the net result will be hundreds of millions of dollars in new revenue for the state from higher income taxpayers and from corporations. Unless Virginia changes its tax rates or makes other adjustments that will be correct, except not everybody paying more will be rich.
The strongest indication is the state’s own fiscal stress. The new budget total is about 12.5 percent higher than its 2016 counterpart but the increase in the general fund was only five percent, somewhat anemic for a time of economic growth. Virginia is very dependent – too heavily dependent – on the personal and corporate income taxes to make its base budget. It won’t want to part with income tax dollars.
Virginia was under pressure before expanding Medicaid and the risk that adds that the federal government won’t continue its 90 percent match on the expansion far into the future. Virginia’s reserves remain too low even in the new budget.
Finally, nobody is pushing the alternative, at least not publicly. It’s dead quiet. The average taxpayer won’t feel the impact until early 2019. Nobody is demanding the General Assembly adjust Virginia’s tax rates, standard deductions or filing thresholds to lower taxes on individuals. Nobody is warning that much of the business tax benefits will be wiped away if Virginia moves conformity forward but leaves the corporate tax rate at 6 percent.
The contrast with 1986 is striking. As the GOP director of communications and research and the main liaison with GOP legislators, I helped organize efforts pushing Governor Gerald Baliles to give back any windfall. It was just a year after the transportation taxes had gone up in a special session. Of course, we were the minority in those days and had lots of freedom to stir the pot.
Baliles responded by cutting taxes the way he wanted to, which shifted the tax burden up on higher incomes. But it was a tax cut with some sound policy behind it.
A demand for revenue neutrality is one possible goal to advocate this time around. Another more challenging goal – shared by some legislators – would be to take the opportunity created by this revenue cushion to make some basic changes, tax reforms that would make Virginia more productive and competitive. We are deeply mired in complacency and mediocrity right now while many other states – North Carolina comes to mind – are being aggressive.
Tax Year 2018 is basically half over – two of four quarterly payments have been made and most employees have seen half of their paychecks for the year. The individual amounts being withheld are based on the prior tables. The law already says that if you take the federal standard deduction you must take the state standard deduction, so that windfall happens even if the 2019 General Assembly sits on its hands and leaves conformity fixed at 2017.
An earlier state estimate was that 600,000 individual or combined returns would switch from itemized to standard deduction. That probably means an extra $5,000 to $10,000 in Virginia taxable income for them – meaning higher taxes up to $575. Assume half that and the state looks to collect another $170 million. People who have enjoyed a regular state refund may be in for a surprise when they have to actually write a check next May 1.
It would certainly be an option for Virginia to simply do nothing, but I do expect the General Assembly will make some adjustments in response to the federal changes. That decision could still come at a fall special session or more likely it will be an emergency bill in 2019, passed in time to determine the actual taxes paid for 2018. My prediction: selective conformity, with several exceptions that pad the state’s income and some individual tax rate adjustments to lower taxes on low income workers.
The 2017 federal legislation is very different than the 1986 legislation. The 1986 law was tax simplification and the 2017 bill makes the tax code – especially for business taxpayers – impressively more complex. Having never prepared a corporate return I won’t claim to understand them and I’m very dependent on the Tax Foundation’s reports.
But on behalf of Newport News Shipbuilding I became very familiar with the domestic production activities deduction, Section 199 – and under full conformity that large deduction goes away, increasing taxable income for a large percentage of businesses.
As a small business myself, I’ve dealt with the expensing rules, Section 179, and that is an area where I predict the administration will be tempted to de-conform and be less generous than the new IRS rules.
Will Virginia allow that new 20 percent deduction for certain pass through income? Now that I’ve seen how narrowly that is going to be applied, it is less important – but it is still important to any taxpayer having to add that back into their Virginia taxable income.
The foreign source income rules mystify me, old and new. Do not ask me about GILTI (Global Low-Taxed Intangible Income). Virginia’s current deduction for Subpart F foreign income is tied to a specific IRC section number, and I’m told the new law added or amended several other sections that could become state-taxable now. Virginia may also see a short term bump from all the repatriated foreign profits.
Each and every proposed variation from the new federal system should be examined by the business community and if need be challenged as a tax increase. If Virginia taxes more and more things that the IRS and other states do not tax, it will degrade our competitive position. I hope that is the goal for the folks in this room – a better competitive position for Virginia.
(This column first ran in Bacon’s Rebellion on June 21, 2018).

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