Virginia legislators went through a painful budget process during the 2002 General Assembly. Huge budget deficits could amount to $3.8 billion by 2004 according to the governor’s final projections. Virginia is broke, and it is time for the state to correct the serious problems in our tax code that have landed us in this mess. The following changes should be part of any plan suggested by the current Tax Commission and enacted by the General Assembly.

Bring justice to the state income tax

Tax rates and brackets

The two lowest brackets of the current income tax have not been adjusted since 1926. The first $3,000 of a person’s income is taxed at the rate of 2 percent. The next $3,000 to $5,000 is taxed at 3 percent. Between $5,000 and $17,000 is taxed at 5 percent, and anything over $17,000 is taxed at 5.75 percent. That is the lowest top-bracket rate of any neighboring state that has a personal income tax.

These collapsed rates give Virginia an income tax structure which is essentially a flat tax. All but the poorest families make over $17,000 per year, so most of us are taxed at the same rate, whether we make $20,000 per year or $200,000. The brackets and rates should be adjusted to distribute the tax burden more fairly.

Tax deductions and exemptions

Currently, these are set so low that families with very low incomes carry a heavy tax burden. A study by the Center for Budget and Policy Priorities noted that in 2001, Virginia levied the 4th highest income tax of any state ($483) on a single-parent family of three making $17,661 a year. A two-parent family of four making $22,630 a year pays $591 in state taxes, the fifth highest state tax burden in the country on families in this low-income category.

A married couple currently gets a standard deduction of $5,000 if they file jointly or $2,500 apiece if they file separately. A single person gets a standard deduction of $3,000. A study commission appointed by the General Assembly in 2000 recommended new standard deductions of $7,000 for married couples filing jointly and $3,500 for single and married persons filing either separate or combined returns. This would also eliminate the marriage penalty of the current standard deductions. The study commission also reported: “With regard to personal exemptions, we have determined that exemptions of $2,500 each . . . in concert with the increased standard deductions, accomplish the goal of removing poverty-level income from the base for most taxpayers.”

The same commission recommended eliminating the special deductions currently given to people age 62 to 64 ($6,000) and age 65 or over ($12,000.) Lower income seniors would still qualify for the new standard deductions and exemptions, but those in the higher income brackets would be taxed.

Refundable earned income tax credit (EITC)

An EITC set at 20 percent of the federal tax credit would lift most low-income families in Virginia out of poverty. The standards for eligibility would gradually phase out at $30,000 of yearly income. Currently families that make even one dollar above the federal poverty line do not qualify for Virginia’s Low-Income Tax Credit. Under a refundable Earned Income Tax Credit, working families would receive a refund check if the size of their tax credit exceeds that of their tax bill.

Eliminate unfair exemptions in the sales tax and corporate income tax

Sales tax exemptions

In Virginia, 31 percent of state and local tax revenue comes from the sales tax. The problem is, we continue to tax sales of things like food, for which low-income people must spend a disproportionate part of their wages. At the same time, we give sales tax exemptions to a whole host of services, most of which benefit consumers with more disposable income.

The sales tax in itself is regressive, which means that it gathers more money from poor people, in proportion to their income, than it does from the wealthy. It works like this: someone making $16,000 per year pays the same sales tax as someone making $250,000 per year. The latter doesn’t even notice because it is such a small percentage of their total income. The former, who may not have enough to cover basic bills and necessities, misses every penny.

Virginia’s sales tax is made even more regressive by taxing basic necessities, like food. In contrast, luxuries such as amusement parks and symphony tickets go untaxed. Nothing is wrong with having fun, but isn’t an N’Sync concert more appropriate to tax than a loaf of bread?

A commission appointed to examine Virginia’s tax structure by the General Assembly reported in December of 2000 that the state probably lost several billion dollars in uncollected revenue in 1999 due to all the sales and use tax exemptions included in our tax code. They also reported that approximately $146 million would be recovered by extending the sales tax to personal services, amusements and repair services alone.

Corporate tax exemptions and expenditures

Virginia has no way to measure how much revenue it loses yearly in corporate welfare, since there are no laws which require state agencies and other bodies to disclose, measure or report how much they give away. As a first step, the Governor could authorize a report on tax expenditures — the money the state does not collect — due to corporate tax breaks, and make a judgment about whether the people of Virginia benefit by receiving quality jobs in return.

Corporate income tax

Finally, at 6.0 percent our corporate income tax rate is simply too low. Virginia ranks 42nd in the nation in the amount of revenue received from a tax on corporate income. Rates for our neighboring states include Maryland at 7.0 percent, North Carolina at 6.9 percent, and West Virginia at 9.0 percent. Virginia could raise the rate to 7.0 percent and still remain comfortably below the national median of 7.5 percent.

Six percent of the state income tax should be returned to local governments

Localities in trouble

Education and transportation needs go unmet in many Virginia cities and counties, not to mention other services such as public health departments, mental health boards and local jails. Why? Because economic growth over the past decade has followed new channels, moving away from property and tangible products and toward the growing service industries.

Local governments obtain most of their revenue from property taxes on real estate. Their finances follow the fortunes of the state’s old economy, while the state gets most of its revenue from the new economy via the tax on individual income. From 1995 to 1999, the median growth in local tax revenue was only 5.7 percent, while the growth in state revenue from the income tax averaged 9.8 percent

Add to that the host of unfunded mandates, new social and environmental issues and rapid population growth in certain areas of the state, and localities find themselves with more and more to do while having less and less money to do it. What can be done to even the playing field?

Share the wealth

One solution proposed by a number of state legislators, along with the Virginia Municipal League (VML) and the Virginia Association of Counties (VACo), would be for the state to share a percentage of its income tax revenue with local governments. In December of 2000 a study committee appointed by the General Assembly suggested, “at least six (6) percent of the state’s annual net individual income tax collections be dedicated for return to Virginia’s localities.”

The membership of VML and VACo have proposed a formula for dividing up the money which seems fair to rural, urban and suburban counties. Fifty percent would be based on the total state income tax paid by taxpayers filing returns in each jurisdiction; 40 percent would be based on where wages were earned (i.e., each localities’ relative share of the total statewide wages earned according to federal BLS statistics); and finally, 10 percent would be divided equally among all 135 cities and counties.

New legislation along these lines was proposed in 2002 by Delegate Joe May, Delegate James Almond and Senator Mary Margaret Whipple, but all three bills were continued over to 2003 for action, which means they are dead for the time being. Estimates for fiscal year 2002 indicate that around $500 million would have been sent back to localities had the bills passed.

Weed out inefficiency in our state budgets

Current service estimates

Virginia needs an objective body that will keep track of what the state is currently bringing in and paying out. This is crucial to understanding the current budget situation and how to prepare for the future. This evaluation should be publicly reported twice each year.

Accurate financial projections

We arrived at the current budget mess by inaccurate and politically motivated estimates of future state income and spending needs. Virginia needs an objective analysis of revenue and expenditures from five to 10 years into the future. These projections should include estimates based on harsh, moderate and good economic conditions. They should show the cost of maintaining existing services as well as the cost of meeting new or currently unmet service needs.

Who pays?

Virginia should figure out which income groups are paying what in current taxes and evaluate the fairness of those respective tax burdens. In order to set up a fair tax system, we have to know whether poor people get hit with a higher tax bill in proportion to their income than rich people. Since we rely so much on the sales tax, it is likely we will find that poor Virginians pay more than their fair share.

Accountability

Finally, any changes to the tax code should be enacted only after public debate. And to make sure we don’t find ourselves in the same mess in 25 years, the basic orientation for all legislators should include a dedication to good tax policy.

Perhaps 2001 was not the best year for tax reform, since the General Assembly had so little revenue to work with. But the Virginia Organizing Project, along with many others, believes that a comprehensive package of tax reforms must be enacted soon in order to address the serious needs across the Commonwealth. Virginia must fix the state’s tax structure for individual income, cut enormous exemptions in the sales tax and the corporate income tax and be more generous in its support for local governments.