July 20, 2023
The Impact of Recent Tax Choices and Proposals
Tax changes in Virginia during the 2022 session
In 2022, the Virginia General Assembly approved a two-year budget (fiscal years 2023 and 2024) with $3.7 billion in tax cuts, including improving the state Earned Income Tax Credit, one-time nonrefundable tax rebates, alterations to the state standard deduction, as well as elimination of the state portion of the sales tax on food and hygiene products.
Improving the state Earned Income Tax Credit
The 2022-2024 budget created, for the first time, an option for a refundable Earned Income Tax Credit (EITC) in Virginia, with a refundable EITC equal to 15% of the federal EITC. Previously, the state only offered a nonrefundable EITC up to 20% of the federal EITC. However, since the benefit was nonrefundable — meaning that the credit amount can only count towards income tax liability and may not exceed it — many of the working low-income families who qualified for the credit were unable to access the full benefit due to having low or no income tax liabilities. With the new refundable EITC option, qualified working families were able to see more cash back this tax season. In Virginia, people with less pay a greater share of their incomes in state and local taxes than those with the highest incomes, so this particular choice was a step toward flipping Virginia’s upside-down tax code.
In Virginia, people with less pay a greater share of their incomes in state and local taxes than those with the highest incomes, so improving Virginia’s Earned Income Tax Credit was a step toward flipping Virginia’s upside-down tax code.
Increasing the state standard deduction
The largest tax change in the budget was the large increase in the standard deduction, impacting any filer who chooses to take the standard deduction rather than itemize. The state standard deduction was increased from $4,500 to $8,000 for single filers and $9,000 to $16,000 for married filers filing jointly, almost doubling the standard deduction for Virginia filers. This is the second time the standard deduction was increased in recent years. In 2019, the state standard deduction increased from $3,000 to $4,500 for single filers and from $6,000 to $9,000 for married filers.
A larger standard deduction helps filers reduce their taxable income. However, increasing the standard deduction can also leave out lower-income families who have smaller taxable incomes. Improving the state EITC at the same time as increasing the standard deduction made sure Virginians with the lowest incomes were not left out of the tax package.
The standard deduction change has a $1.6 billion impact for the 2023 and 2024 budget years. This reduction in revenues, as well as the impact of the cut on future revenues, could have negative impacts on the ability to invest in key services, such as education and health care.
One-time nonrefundable tax rebates
The budget included one-time, nonrefundable tax rebates of up to $250 per individual or up to $500 for married filers. This program had a large budget impact, costing about $1 billion in state revenues, but was a one-time measure causing less concern for future funding. The rebates were nonrefundable, meaning many lower-income families were excluded or received little benefit, as their rebate could not exceed their income tax liability.
Eliminating the state sales tax on food and hygiene products
The 2022-2024 budget eliminated the 1.5% state sales tax on grocery and hygiene products. Sales taxes impact families with low and moderate incomes the most — they pay higher proportions of their incomes on sales taxes since they spend larger proportions of their incomes on consumer goods, such as food. However, resources raised through the Virginia grocery sales tax were dedicated to K-12 education and transportation. Eliminating the sales tax means a choice between providing general funds instead – leaving less of those flexible dollars for other priorities – or less money being available for our schools and transportation system.
Tax proposals in Virginia in 2023
On the heels of the substantial $3.7 billion tax package, the governor’s and House’s budgets proposed an additional $1 billion in tax cuts for fiscal years 2023 and 2024, which included reducing the corporate income tax rate, further increasing the standard deduction, and reducing the top income tax rate. Most of these cuts will benefit people with high incomes and profitable corporations. With no budget negotiated yet, the cuts are still on the table.
Corporate and business tax cuts
Both the governor and the House proposed a flat reduction in the corporate income tax rate from 6% to 5%. This cut would largely benefit a small subset of high-income corporations. The less than half a percent of corporations in the state reporting over $10 million in taxable income are responsible for two-thirds of corporate income tax paid in the state. This proposal would cost $362.1 million in revenues this budget cycle and $682.4 million in the next. The Senate rejects this tax cut, freeing up $362 million in revenues to use elsewhere in their budget, including significant investments in education.
The governor and House also proposed establishing a state Qualified Business Income (QBI) deduction, which would allow a tax deduction on business income passed through to personal income tax. The proposed deduction is set up to be half of the 20% federal QBI deduction. This policy primarily benefits high-income individuals. In 2020, though they only made up a quarter of QBI deduction claims, households making $200,000 or more claimed 70% of the federal benefit. This proposal would reduce revenues by $162.1 million this budget cycle and $225.6 million in the next. The Senate also rejected this tax cut, freeing up $162.1 million in revenues to invest elsewhere in their budget.
Personal income tax top rate reduction
The governor and House included a proposal to reduce the top personal income tax rate from 5.75% to 5.5%. Virginia’s top income tax rate kicks in at taxable income over $17,000. The average Virginia teacher making just over $62,000 shares the same top tax bracket with someone with over one million dollars in income. However, since a millionaire has more income over $17,000, they stand to benefit more from a top rate reduction. High-income households stand to gain large tax cuts, while families with low and moderate incomes will see very little. This would come at large costs to state revenues, with $333.3 million lost this budget cycle and $1.467 billion lost in the next. The Senate rejected this tax cut as well, freeing up $333.3 million in revenues to use elsewhere in their budget.
Most tax cuts being considered in 2023 will benefit people with high incomes and profitable corporations.
Increasing the state standard deduction
The governor’s and House’s budgets proposed to further increase the state standard deduction to $9,000 for single filers and $18,000 for married filers filing jointly, fully doubling the standard deduction from its 2019 base. While increasing the standard deduction can reduce taxes for many low- and moderate-income filers, it also leaves out many lower-income families with already low income tax liabilities. In the budget passed in 2022, the increase in standard deduction was paired with improving the state Earned Income Tax Credit, making sure that low-income families remained part of the tax conversation. The further increase to standard deduction would cost $94.9 million in revenues this budget cycle, and $402.4 million in the next.
Considerations to further improve EITC
While lawmakers paired the increase to the standard deduction with an improvement to the EITC in 2022, current budget proposals do not include further improvement, leaving families with low incomes out of tax conversations. A legislative proposal (House Bill 1653) would have allowed families to claim a refundable state EITC up to 20% of the federal credit, which would put another few hundred dollars in the pockets of families who need it most. While the bill did not pass, lawmakers and media have previously suggested that it could still be considered in budget negotiations. Increasing EITC refundability to 20% would cost just $36.5 million in this budget cycle.
Budget & Revenue, Economic Opportunity