At a recent Senate Finance Committee retreat, state legislators had a preview of economic and revenue projections and other significant issues expected to be debated in the 2019 General Assembly session.
A vice-president of Moody’s Analytics said that Virginia’s economy continues to perform well due to increased federal spending coupled with federal tax cuts. However, he likened the performance to a sugar high and said that indicators are starting to point toward a recession in the next two years because of increased interest rates and increased import/export tariffs. He cautioned that rising lending could exacerbate a recession. He also noted that Virginia’s budget was well positioned for a recession because we have bolstered our Rainy Day Fund.
Next, we examined the state budget. Nearly 70 percent of Virginia’s general fund revenue comes from income taxes. Traditionally, Virginia has been a “conforming” state, meaning that the Virginia’s definition of adjusted gross income is identical to the federal definition and taxpayers and accountants do not have to use two different sets of rules to figure out taxes. However, the tax bill passed by Congress in early 2018 significantly rewrote what constitutes income and limited deductions. Most significantly, Congress and President Trump limited the deductibility of real estate taxes and state and local income taxes to a total of $10,000 (aka “SALT”).
While most Virginians will see a combined net decrease or no change in their combined federal and state tax liability, many taxpayers who save on federal taxes, might end up paying more on their state taxes due to the limitation on SALT because Virginia historically requires taxpayers to claim the same deductions on their state income tax returns as on their federal returns. If Virginia continues to conform consistent with our traditional policy, the Commonwealth will see additional revenue of about $600 million per year.
New state revenue is desperately needed. Virginia is still not funding K-12 education at the levels reached pre-2009 and preschool funding is still marginal. Our higher education funding is about half of the state goal. Our safety net funding for services like subsidized childcare, temporary assistance for needy families and mental health care is abysmal. Notwithstanding these needs, I suspect some legislators will propose a broad tax cut even though most Virginians’ combined tax liability will be about break even.
Governor Northam has also proposed to use part of the new revenue to fund a focused tax cut for low-income, working Virginians by making the Virginia Earned Income Tax Credit (EITC) refundable. Today, if a taxpayer claims the EITC and their refund exceeds their tax liability, they receive a federal refund, but no state refund. Refundability would benefit about 15,700 taxpayers here in the 36th District and 90,000 taxpayers in Fairfax, Prince William and Stafford counties.
Even though low- and moderate-income taxpayers make up half of Virginia taxpayers, they are projected to receive only six percent of the benefit from federal tax cuts. This would also help to restore some fairness to Virginia’s income tax which is basically a flat tax today.
Also, earlier this year, the U.S. Supreme Court decided the Wayfair case, reversed longstanding precedent and held that states can now tax internet sales. Many online retailers, such as Amazon, were already paying sales taxes because they already had a physical presence in Virginia (distribution or data centers). The additional revenue from taxing internet sales will be about $124.7 million off $2.9 billion in sales activity, but after mandatory allocations for secondary education and transportation, the net additional revenue to the General Fund is projected to be only about $58 million per year.
While state revenues have come in around $555 million over original forecasts, expenses are also higher. Specifically, forecasted Medicaid spending was off by $469 million along with about $200 million in other obligations such as Hurricane Florence expenditures, opiate epidemic-driven, public safety expenditures, mental health expenses and the projected Amazon investments which will consumer much of the higher revenues.
The 2019 session is likely to be a very significant session for tax policy and spending decisions. If you have any feedback, please email me at email@example.com.
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