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July 31, 2012

Despite ‘Surplus,’ Virginia’s Revenue System Can’t Pull Its Weight

While the news of a budget “surplus” is certainly positive, it is important not to let the notion of a budgetary “surplus” distract us from the real and serious problems we have with our revenue system in our state, problems that run much deeper than just the impact of the Great Recession.

Remember, news of a “surplus” this year doesn’t tell us what we did to achieve that budget “surplus.” Virginia cut funding in a wide array of arrays and continued to use budget gimmicks to keep the books in balance.

When we look closely, Virginia has serious structural problems in the way we raise the resources we need to provide for public services in our state and invest in our future.

  • Virginia has grappled with budget shortfalls in 10 of the last 12 years. Reliance on deep cuts, one time budget balancing tools, and gimmicks got us through the worst of the recession, but the structural problems still exist and will resurface.
  • Since the onset of the recession in 2007, state personal income has increased roughly three times as fast as state general fund revenues. But state general fund revenue as a share of personal income has fallen. Had the share remained constant, Virginia would have nearly $3.9 billion more in general fund resources to invest over the next two years.
  • Costly tax breaks, like lowering taxes for certain industries or giving a special break to people who buy certain products, cost Virginia billions of dollars each year. They are baked into the tax code but are not subject to the same regular scrutiny or evaluation as other types of state spending.
  • Fully taking into account Virginia’s growing population and the rising cost of providing key services, current investment in our economic building blocks like education, health care, and transportation, falls about $4.8 billion short compared to pre-recession levels.

Virginia’s largest sources of general fund revenue – the individual income tax, the corporate income tax, and the sales and use tax – are insufficient because they are outdated, narrow, and inadequate in the context of Virginia’s modern economy. As a result, they fail to produce enough money to adequately invest in core public programs and services that build the economy.

State Income Tax
Virginia’s basic income tax structure has not been touched since 1987; a quarter of a century ago. Since then, however, the income distribution has shifted, with income growth heavily concentrated among higher income households. Yet we’ve done nothing to adjust for that reality. Prior to 1987, we adjusted the basic structure to account for this change on average every 3 to 4 years.

Corporate Income Tax
Over 60 percent of Virginia corporations paid no corporate income tax in 2008, though it is likely many of them had taxable profits. In addition, a growing share of total income taxes are paid by individuals and a shrinking share are paid by corporations because the tax code has fallen behind key changes in business models and practices as well as the creation of numerous special tax breaks.

Sales & Use Tax
Sales tax revenue as a share of total general fund revenue has steadily fallen since 1977, largely driven by changes in what Virginians are buying and how they are buying it. The marked shift in consumption from goods to services and the rise of Internet shopping mean that less and less of what people buy is even subject to taxation under current law in Virginia.

When it comes to raising revenue to fund the core functions of our public structures, Virginia is frozen in time. What we need is a 21st century revenue system for a 21st century economy. We cannot afford to continue demonizing taxes or pretending that if we ignore them, we can reach our potential as a state or as a community. Planning for the future by modernizing Virginia’s revenue system will help the Commonwealth maintain its competitive edge and maximize future prosperity.

Read more in our latest analysis about Virginia’s outdated tax structure, Frozen in Time.

The Commonwealth Institute

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