December 8, 2021
Tax Proposals Would Reduce Resources for Education, Transportation, and Other Priorities
When the state invests in social goods that benefit all of us like schools, health care, and the environment, our communities and families thrive. However, without sufficient public resources to fully fund public services over the long term, state policymakers will be unable to fully advance equity and opportunity in Virginia.
The incoming Youngkin administration and state lawmakers have proposed several major tax proposals to reduce taxes for individuals and businesses. These include one-time tax rebates, dramatically increasing the state standard deduction, eliminating the state and local sales tax on groceries, and pausing the recent increase to the fuels tax. While some of these policy ideas may have merit individually, enacting them without ways to backfill those resources would threaten the overall fiscal stability for the commonwealth and the well-being of our communities. To date, the incoming administration has not identified any measures to replace these revenues.
New analysis from the Institute on Taxation and Economic Policy (ITEP) shows that the incoming administration’s plan would reduce state and local revenues by about $2.9 billion at least—more than 3.5 times the combined annual General Fund budgets of the state’s Department of Health, Department of Behavioral Health and Developmental Services, and Department of Social Services, and more than 5.5 times the annual General Fund budget of the Virginia Community College System. ITEP was unable to model some elements of the proposals that would reduce revenues even further, such as a business tax “holiday” and a mechanism that would freeze local property tax revenues (subject to ballot measure).
RECENT TAX PROPOSALS WOULD REDUCE RESOURCES FOR EDUCATION, TRANSPORTATION, AND MORE
|(cost in millions)||GF unrestricted||GF K-12||Transportation||Localities|
|Double standard deduction||$681|
|Eliminate sales tax on groceries||$227||$114||$227|
|Pause recent gas tax increase||$268|
Much of the plan would reduce the state’s General Fund, which is the portion of the state budget over which lawmakers have the most discretion and which primarily goes toward funding K-12 and higher education and health and social services. In addition, revenues related to the state and local sales tax on groceries are currently directed to K-12 education (40% of grocery tax revenues), transportation (20%), and localities (40%). The gas tax revenues are dedicated to transportation funding, including highway construction and maintenance and public transit.
Due to the impacts of the pandemic, six-year state transportation revenues were $1.8 billion below pre-COVID estimates (as of October 2021). Maintaining the recent fuel tax changes would allow the state to restore funding to planned transportation projects across the state as the economy recovers, while a one-time reduction in the gas tax would worsen and prolong those spending cuts.
Some of the proposed changes would shift costs onto localities in Virginia, which have limited revenue authority. Eliminating the sales tax on groceries would require localities to generate an additional $227 million of local revenues or enact steep budget cuts. Faced with these budget pressures, localities could choose to increase reliance on other regressive revenue sources, which ask more of those with less. Fines and fees are one example, which are already assessed at the highest per capita levels in the areas of Virginia that have the highest shares of Black residents and residents with incomes below the poverty line.
While it appears the state will have additional revenues available in the 2022-2024 two-year budget, the overall state fiscal picture remains highly uncertain over the next few years. For example, depending on the actions of the next federal Congress, another round of federal budget cuts could be enacted (such as the federal “budget sequestration” that occurred after The Great Recession), which would have an outsized negative impact on the Virginia economy and state revenues. Volatility in global markets and “nonwithholding” tax collections, which are closely tied to investment income gains, could also decline unexpectedly in the near future. Enacting permanent state tax changes based on short-term revenue increases would increase the likelihood of substantial budget cuts in the coming years.
To reduce costs for people and families in Virginia without risking the state’s fiscal situation or ability to invest in thriving communities, a better path forward should include offsetting revenue or creating sustainable future pension savings. In addition, state lawmakers could better target these measures to families in Virginia with low to moderate incomes.
Responsible steps to strengthen Virginia’s budget
- Virginia’s individual income tax resembles a flat tax, because most taxpayers are in the same tax bracket. The top rate of 5.75% begins at taxable incomes above $17,000, which means millionaires are in the same tax bracket as millions of Virginians with low and moderate incomes. Adding new brackets that apply to tax filers with the highest incomes would generate new revenues and make the state tax code more progressive, where people pay a higher tax rate as their ability to pay increases.
- Households with higher incomes tend to save more of their income or spend on untaxed services, and so pay a lower share of their income on sales taxes. Modernizing Virginia’s sales tax to apply to services and digital products would cover a broader, more balanced mix of consumer spending and create a more sustainable, less regressive revenue stream.
- The state could make a large one-time deposit to offset future teacher and state employment pension and other retiree benefit costs, such as those related to the Virginia Retirement System. Doing so would produce ongoing savings for the state and localities while also helping to reduce or maintain required contribution amounts for those programs.
More targeted options to help Virginia families
Although the sales tax on groceries and fuels taxes are regressive taxes, they also are paid by high-income and high-wealth households. Those in the highest 1% of the state income distribution (average income of $1.9 million) would save $317 on average per year from eliminating the sales tax on groceries, while those with incomes between $45,000 and $76,000 would only save $118 on average per year. Sales and fuel taxes are also partly “exported,” meaning they are paid by non-residents who may be traveling through the state, which makes sure that these individuals pay for a portion of state or local services they use (such as maintenance on roads they are driving on). In other words, some of the benefit of eliminating or reducing sales and fuels taxes would flow to out-of-state residents.
Policymakers should consider the following options, which would be better targeted to helping Virginia families:
- The 2020 transportation package partly offset increased gas taxes by reducing vehicle registration fees, which directs savings to Virginia residents. A further reduction of the registration fee could be a more targeted approach to lowering costs for Virginia drivers.
- Virginia currently has a state Earned Income Tax Credit (EITC) that matches up to 20% of a family’s federal EITC. Many working families with low incomes do not get the full amount of the tax credit because the state EITC is “nonrefundable.” Making the state EITC fully or partially refundable would help lift incomes for these families.
- Over the past six months, families across the U.S. have received monthly Child Tax Credit (CTC) payments to help them afford basics like groceries and child care. Some states have enacted state CTCs. If Virginia enacted a state CTC, the state could create a more targeted means of helping families.
As state policymakers debate tax proposals in the coming session, they should take the long view. While strong revenue growth is expected in the next two years, these are not guaranteed into the future indefinitely. The General Assembly must proceed cautiously, without shifting costs and budget cuts onto localities or neglecting to come up with ongoing measures to offset these provisions over the long term.
Budget & Revenue, Economic Opportunity, Education