Tax Reform: Replacing Income & Sales Taxes with a General Consumption Tax WV Senate Select Committee on Tax Reform, 17 February 2017 presented by Ted Boettner, Executive Director West Virginia Center on Budget and Policy www.wvpolicy.org @WVCBP tboettner@wvpolicy.org @WVPolicywonk

Who Pays Taxes in West Virginia? West Virginia state and local taxes as a share of non-elderly family income, 2015 Source: Institute on Taxation and Economic Policy, Who Pays?, West Virginia 2015

Personal income tax is based on ability to pay Sales tax is regressive, falling harder on low and middle income families Sales taxes as a share of family income Personal income taxes as a share of family income Source: Institute on Taxation and Economic Policy, Who Pays?, West Virginia 2015

Senate Bill 335: Initial Analysis No fiscal note. Revenue neutral? Implementation of new consumption tax would likely take longer than 3-4 months. The legislation is highly regressive and would further exacerbate growing income and wealth inequality and could reduce consumer spending – which would hurt our state’s economy. Real-world experience and academic evidence show cutting income tax is not a surefire way to boost economic growth. There is no academic consensus that replacing income taxes with a sales tax boosts economic growth. Most states that have cut income taxes since 2012 are underperforming compared to the national average (e.g. Kansas). Important to note a bill passed out of the House in Kansas yesterday (HB 2178) to rollback Gov. Brownback’s tax cuts. Also, Alaska lawmakers (w/ bipartisan support) and governor are trying to restore an income tax.

Senate Bill 335: Initial Analysis Higher sales tax could hurt in-state businesses as residents shift purchases to neighboring states or the internet. Also, levying more business-to-business sales taxes could lead to vertical integration (hire staff internally to avoid tax). Over the long-run, sales taxes grow slower than income taxes – so this most likely means more budget gaps in the future and more fiscal instability. Business paid $500 million in sales taxes and $400 million in income taxes in FY 2015. SB 335 could increase taxes on businesses. West Virginia would have highest grocery tax in the nation. Only border state with a grocery tax is VA (2%). Is there an exemption for new home purchases and private university tuition? What would happen to local sales taxes? What about federal deduction?

New General Consumption Tax (Revenue Neutral) Elimination of personal/corporate income tax and sales & use tax Less than $19k (Lowest 20%) $19K-$33K (Second 20%) $33K-$51K (Middle 20%) $51K-$84K (Next 20%) $84K-$159K (Next 15%) $159K-$353k (Next 4%) $353K or more (Top 1%) $11,000 $26,000 $40,000 $66,000 $110,000 $212,000 $778,000 +$500 +$946 +$1,071 +$355 -$1,804 -$6,087 -$27,755 80% of households get tax increase Richest 20% get tax break 60% households get tax increase Richest 40% of Households get tax break All West Virginians, 2017 Income Levels Source: Institute on Taxation and Economic Policy, February 2017 *Severance tax reduction is not included

The sales tax exempts a large share of income at the top Compared with a broad-based income tax, a flat sales tax allows a 50% deduction for the average high-income household Average = 80% Note: Low-income people spend more than they earn because the receive tax credits And other cash transfers, gifts from family member and friends, and borrowing Source: Consumer Expenditure Survey, U.S. Bureau of Labor Statistics, August, 2016

Biggest income tax cutting states not seeing job boom Total nonfarm job growth since the tax cuts took effect Source: Bureau of Labor Statistics, Current Employment Statistics (January 2016 seasonally adjusted), and the U.S. Bureau of Economic Analysis, 3nd Quarter of 2016. Note: Effective dates for tax cuts are January 2012 for Maine, January 2013 for Kansas, June 2013 for Ohio and Wisconsin (retroactive to January 2013), and January 2014 for North Carolina.  

Biggest income tax cutting states not seeing income growth boom Total personal income growth since the tax cuts took effect Source: Bureau of Labor Statistics, Current Employment Statistics (January 2016 seasonally adjusted), and the U.S. Bureau of Economic Analysis, 3nd Quarter of 2016. Note: Effective dates for tax cuts are January 2012 for Maine, January 2013 for Kansas, June 2013 for Ohio and Wisconsin (retroactive to January 2013), and January 2014 for North Carolina.  

North Carolina underperformed most of its neighboring states Total private sector job growth since North Carolina tax cuts took effect Source: U.S. Bureau of Labor Statistics, Current Employment Statistics, January 2017 (seasonally-adjusted)

Kansas cut taxes on the wealthy, raised them on low-income people Impact of Kansas Tax Changes Between 2012 and 2015 Source: Institute on Taxation and Economic Policy – 2015 Income Levels Note: Included personal income tax cuts, cigarette tax increases from $0.79 to $1.29, and sales tax increase from 5.7% to 6.5%

What’s the Matter with Kansas? Lower tax revenues, education spending, and cash reserves Kansas Credit Rating Downgraded 3 Times Source: Arizona Center for Economic Progress

There is no academic consensus that income tax cuts boost economic growth Donald Bruce and John Deskins, “Can State Tax Policies Be Used to Promote Entrepreneurial Activity?,” Small Business Economics , 2012. “[S]tates with more progressive personal income tax structures and states that have more aggressive corporate income taxes through the imposition of a combined reporting requirement both tend to have slightly higher entrepreneurship rates. The composition of state tax portfolios is not found to be a significant determinant of state entrepreneurship.” “Using a framework that in prior research generated significant, negative, and robust effects of taxes on growth, we find that neither tax revenues nor top income tax rates bear stable relations to economic growth or employment across states and over time” Source: West Virginia Center on Budget and Policy and Center on Budget and Policy Priorities

Are West Virginians fleeing to states without income taxes? Florida? Between 1993 and 2015, 403,821 households left W.Va. and 392,313 moved into W.Va. 97.2% of departing households were replaced by new arrivals 84% of households moving from WV to FL were replaced by new arrivals from FL Source: Internal Revenue Service, Statistic of Income (SOI) – Migration data 1993-2015

States with highest income tax rates experiencing faster economic growth Per capita real GDP growth from 2005 to 2015 (chained 2009 dollars) None of the five saw the economic growth that was claimed, and in North Carolina the modest growth that did occurs was concentrated to urban areas of Charlotte and Raleigh leaving the rest of the state behind. The nine states with the highest top income tax rates also have more Fortune 500 companies, higher median incomes, and a smaller share of residents without health insurance. Source: U.S. Bureau of Economic Analysis (Does not include District of Columbia)

Personal income tax is a more sustainable source of revenue than sales tax Personal income and sales and use tax revenue growth in W.Va. Before phase out of grocery tax Source: WV State Budget Office, Executive Budget FY1988-FY2018

Shifting from income to sales tax would increase business taxes in W Shifting from income to sales tax would increase business taxes in W.Va. According to COST, businesses pay 42% of state/local sales taxes $3.9 Billion FY 2015 Source: Ernest & Young, FY 2015 COST Report on State and Local Business Taxes  

West Virginia would have highest statewide grocery tax in the nation if SB 335 is enacted States that currently apply a sales tax to groceries Source: Federation of Tax Administrators Note: State allows a rebate or income tax credit to compensate poor households. Also, there are places in Alabama were tax on groceries reaches 10%.

The income tax reform West Virginia needs to grow its economy Scale back income tax exemptions – Every taxpayer regardless of income receives a $2,000 exemption for each dependent. Phase it out between $150,000-$200,000, and eliminate it for those over $200,000, and it would increase revenue by an estimated $10 million. Modernize rates and brackets - West Virginia’s personal income tax schedule has not changed since 1987, when the state’s top personal income rate was reduced to 6.5 percent from 13. Since then more middle-income households into higher tax rates. A 3% surcharge on income over $200,000 would yield $96 million. Create a refundable WV Earned Income Tax Credit (EITC) – 26 states have a state EITC modeled after the federal EITC, which is the most successful anti-poverty poverty program in the nation. A 15% WV EITC would provide an average tax credit of $332 to over 155,000 families in West Virginia and help boost labor force participation, reduce poverty, and led to better health and education outcomes.

State Revenue Impact (including taxes paid by non-residents) Eliminate personal income tax, corporate income tax, sales and use tax; Create general consumption tax to reach a revenue neutral proposal All West Virginians, 2017 income levels 2017 Income Group Lowest 20% Second 20% Middle 20% Fourth 20% Next 15% Next 4% Top 1% State Tax Change Income Less Than $19,000 – $33,000 – $51,000 – $84,000 – $159,000 – $353,000 – Range $19,000 $33,000 $51,000 $84,000 $159,000 $353,000 Or More Average Income in Group $ 11,000 $ 26,000 $ 40,000 $ 66,000 $ 110,000 $ 212,000 $ 778,000 Combined Impact Eliminate personal income tax, corporate income tax, sales and use tax; Tax Change as a % of Income 4.7% 3.7% 2.7% 0.5% –1.6% –2.9% –3.6% — Average Tax Change +500 +946 +1,071 +355 –1,804 –6,087 –27,755 Individual Components   State Revenue Impact (including taxes paid by non-residents) TAXES CREATED Create a general consumption tax 8.6% 8.1% 7.4% 5.8% 4.4% 2.8% 1.6% +3,272,500,000 +906 +2,094 +2,943 +3,808 +4,850 +6,000 +12,826 Share of Total Change 6% 14% 19% 25% 24% 8% 4% TAXES ELIMINATED Sales and use tax elimination -3.3% -3.1% -2.7% -2.1% -1.7% -1.1% -0.6% –1,272,000,000 –351 –798 –1,089 –1,408 –1,864 –2,333 –4,926 Personal income tax elimination –0.5% –1.4% –2.0% –3.1% –4.3% –4.6% –1,877,500,000 –53 –784 –2,045 –4,790 –9,754 –35,654 1% 3% 7% 34% 18% 17% % Receiving Tax Cut 20% 52% 73% 90% 98% 100% 99% Corporate income tax elimination –0.0% –0.1% –123,000,000 –2 –5 –9 –18 –33 –134 –855 21% SOURCE: Institute on Taxation and Economic Policy, February 2017