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Senate considers major overhaul to state tax code


The State Journal

CHARLESTON, W.Va. — While Gov. Jim Justice and members of the Legislature ponder how to best address a looming budget deficit that could top $450 million, members of a special committee in the Senate are exploring a complete overhaul of the state’s tax code.

State Senate President Mitch Carmichael, R-Jackson, set up the Select Committee on Tax Reform to look at data and collect evidence to support ground-up changes to the way taxes are levied and collected in the Mountain State.

Sen. Robert Karnes, R-Upshur, chairman of the select committee, said members are looking for a “pro-growth tax code.” Their intention is to abolish West Virginia’s personal and corporate income tax structure and replace income taxes with a broad-based consumption tax on most goods and services bought and sold in the state.

“The state’s that don’t tax income tend to grow between 50 percent to 150 percent more than states that tax income, on average,” said Karnes. “West Virginia grew 2.1 percent in the past 25 years.”

Seven states — Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming — have no state income tax for their residents. Residents of New Hampshire and Tennessee also do not pay income tax, though they do pay taxes on dividends and income from investments.

Proponents of doing away with income taxes say lack of a state income tax encourages growth and discourages people from leaving their states for those with less friendly tax codes. But opponents argue states without an income tax are forced to balance their budgets in other ways, usually on the backs of the poor.

Karnes, Carmichael and 16 other senators have introduced a bill, Senate Bill 335, with proposed changes to the state tax code. The biggest changes proposed by the bill are phasing out the personal income tax and corporate income tax over the next several years and replacing them with a broad consumption tax of up to 8 percent. The consumption tax would be similar to a sales tax, but would apply to most goods and services.

“The Legislature finds that all vendors, purchasers and other persons, regardless of their means, benefit from the availability of goods and services in the marketplaces of this state and from the use of goods and services in this state,” the text of the bill explains. “The Legislature further finds that the functions of state government foster and protect those marketplaces and uses, and as a result, all vendors, purchasers and other persons who avail themselves of those benefits should provide financial support for those functions of state government through a broad-based tax in the form of a general consumption tax on the selling, purchasing and using of goods and services in this state.”

According to the text of the bill, “In the free enterprise system, the best judge of a purchaser’s ability to pay for the purchase of goods and services is the purchaser, and, thus a broad-based consumption tax is firmly based on that principle of sound and fair taxation. The Legislature further finds that such a tax may readily be structured to enhance the economic competitiveness of the state’s economy among the economies of other states and nations.”

The proposal does contain several exemptions from the consumption tax, including school textbooks, government purchases, churches and some nonprofits and charities, prescription drugs and medical equipment, health care services, day care and sales for fundraisers. Food stamps and WIC benefits also would be exempt because they are federal programs, which cannot be taxed.

Some lawmakers like consumption taxes over other forms of taxation because everyone has to buy things sometimes.

Karnes said committee members aren’t yet sure what the overall effect of the proposed legislation would be on the state’s revenue or budget.

“In order to get a fiscal note, you have to get a bill in,” he said. But Karnes said lawmakers are shooting for a tax proposal that is at least revenue-neutral, and said they may end up with one that brings in more revenue than the current tax structure.

Karnes said committee members hope to know within a few weeks what kind of financial impact could be expected from the legislation.

Reactions to the idea of eliminating West Virginia’s income tax have been mixed.

“I think it’s an idea worth pursuing,” said Senate Finance Committee Chairman Mike Hall, R-Putnam.

But, he said, “It will require a solid fiscal note, which is currently in the process of being obtained.”

If a broad consumption tax would bring in the revenue needed to balance future state budgets without a personal or corporate income tax, Hall said he was willing to consider the overhaul.

Justice also has said he would like to do away with the personal income tax. But with the Mountain State’s current financial crisis, Justice isn’t sure now is the time.

“I want to eradicate the state income tax. That was my idea, not their idea,” Justice said. “But how we go about doing that is going to take a lot more concentration on the development on my side.”

Justice and Republican leaders in the Senate and House of Delegates have vastly different ideas on how best to balance the state’s budget. Justice has proposed modest budget cuts coupled with an increase in fees, wholesale taxes and a half-percent increase in the state sales tax, while Republican leadership wants to balance the budget without any tax increases if possible.

“I think there’s a way to get rid of the state income tax,” Justice said. “I think there’s a genuine pathway to doing that. But, along the pathway we have got to find a way to do it to where it doesn’t hurt our people in getting there.”

House Speaker Tim Armstead, R-Kanawha, is so far taking a more modest approach to tax reform. While Armstead favors removing many of the current exemptions from the state sales tax to broaden the state’s tax base, the House may not be ready to do away with income taxes just yet.

Ted Boettner, executive director of the left-of-center West Virginia Center on Budget & Policy, said eliminating the state income tax would be a mistake.

“Efforts to gut the income tax and replace it with a higher sales tax would dramatically shift tax responsibility onto low- and moderate-income West Virginians, while giving a huge tax break to wealthier West Virginians,” Boettner said. “Such a move would not only exacerbate growing income equality and destabilize our state’s revenue system, compelling evidence shows it would likely backfire and lead to large budget cuts.”

Unlike progressive taxes like an income tax — where tax rates go up as income levels rise — sales and consumption taxes are considered regressive because poor people end up bearing more of the burden than rich people. Even though they may be paying the same tax rate, poor people have to spend a larger percentage of their incomes on goods and services than rich people do, Boettner said.

Garrett Ballengee, executive director of the conservative Cardinal Institute for West Virginia Policy, said he couldn’t comment specifically on the Senate tax reform bill. But he generally favors consumption taxes over income taxes.

“I think that taxation predicated on consumption is a more desirable way to raise revenue than that raised through income taxation,” Ballengee said. “There are only two inputs into the creation of economic growth/output — a generally agreed-upon proxy for human well-being, flourishing, etc., — capital and labor. As a result, it’s a good idea to minimize any distortions or disincentives to either of those inputs, which, by definition, an income tax does. Plus, there is a rather compelling theory in tax policy/theory that an income tax penalizes those for what they contribute to society, while a consumption tax penalizes those for what they take out.”

“However,” Ballengee warned, “there is no denying that a wholesale change from an income-tax based revenue stream to a consumption-tax based revenue stream is disruptive. For that reason, I believe that a phase-in period should utilized and should probably be in the range of 3-5 years for the transition to occur smoothly.”

To partly make up for the regressive nature of a consumption tax, Karnes said members of the tax reform committee are looking at an earned income tax credit or its equivalent, which could provide a refund to working families who make less than a certain amount of money. Karnes said the committee also may consider some kind of credit for seniors or others on fixed incomes.

Karnes also doesn’t buy the argument that raising and broadening a consumption tax would cost people more.

He estimated that the average family spends about 2 1/2 percent of its income for income taxes. Even if they’re paying more for consumption taxes, without an income tax they may well end up saving money, he said.

Karnes said a family may currently be paying about $850 in income taxes. Even if they end up paying $350 more a year for consumption taxes, “We’re talking possibly another $500 going back in the pockets of the working poor,” he said.

But what does the lack of an income tax look like in the real world? Boettner said Alaska might be a good example.

Like West Virginia, Alaska’s state budget has historically relied heavily on severance taxes for revenue. And, like West Virginia, Alaska suffered massive deficits when those severance taxes dropped off.

Alaska and West Virginia are among six states that include Texas, North Dakota, Wyoming and Oklahoma whose budgets have relied heavily on severance taxes. All are currently struggling to balance their budgets.

According to the U.S. Energy Information Administration, “Alaska’s severance tax revenue has fallen further and faster than other states because its tax is based on the operators’ net income rather than on the value or volume of oil extracted. In 2015, when average net incomes after operating and capital expenses were near zero, the state derived practically no revenue from this tax, versus more than $5 billion in 2012.

“Based on 2014 data, severance taxes accounted for about 72 percent of the state’s tax revenue,” a 2016 Energy Information Administration report said.

Most states that have no income tax for their residents never had one. But Alaska abolished its state income tax in 1980.

“Alaska is the only state to ever abolish its income tax,” Boettner said. “Now, with bipartisan support, they want to reinstate their income tax.”

Alaska recently introduced a bill to do just that, Boettner said.

But Karnes said unlike West Virginia, Alaska has no state sales tax. He said Alaska lawmakers would be better off to institute a sales tax than bringing back the income tax if they need more revenue.

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