House, Senate Tax Policy Shootout Starts

The Best Friends of the Taxpayer Face Off

The numbers to remember as the Virginia House of Delegates and State Senate start voting on income tax conformity bills, perhaps beginning tomorrow, have nothing to do with the hundreds of millions of dollars on the table or the millions of taxpayers waiting to file returns.

The key numbers are 32 and 80.

With an emergency clause on one of the two House bills, scheduled for debate Thursday, and on the only Senate bill that came out of committee today, a full 80 percent of the members of either chamber need to vote yes or they fail.  

The Republicans do not have 32 votes in the Senate or 80 votes in the House.  As the GOP tax bills passed out of committee Monday and today, Democrats complained about the closed process and the policy.  They voted no or abstained.  Secretary of Finance Aubrey Layne, speaking on behalf of Democratic Governor Ralph Northam, expressed no official positions on the bills, but will have to give some signal to his own team.

Only with an emergency clause, which means the bill takes effect immediately upon the Governor’s signature, can the state conform to the 2017 federal Tax Cuts and Jobs Act in time for it to apply to 2018 state taxes.  Only with an emergency clause can any tax policy change be retroactive to tax year 2018.

The substitute versions for House Bills 2355 (adopting conformity) and 2529 (addressing tax policy) are on second reading in the House tomorrow.  The new substitute for Senate Bill 1372 combines elements of both House bills into one.

Conformity to the new federal regime was the one and only non-debatable provision for the Governor, a drum he’s been beating since August.  The votes to kill it, or at least further delay it, rest on his side of the aisle now.   That may give the Republicans some comfort as they contemplate the next phase of this game.

But the policy bills they have passed, so different on many decisions, are likely to decrease that comfort as taxpayers find out how they might fare.  The only constituency likely to be happy with both bills, oddly enough, are the huge international and multinational companies seeking a state exemption for so-called GILTI, a form of income from overseas operations now subject a new federal tax.

That’s it – the only taxpayers getting what they asked for in both bills are large foreign-owned or multinational operations. The Senate even made the GILTI tax break retroactive to 2018, the only retroactive provision period.  No other element of the Senate and House bills matches up, although they claim $980 and $950 million of “tax reform” respectively over two years, which represents most (but not all) the $1.2 billion in so-called “windfall revenue.”

Both packages do increase the standard deduction, the House by 33 percent and the Senate by 50 percent, but only for tax year 2019 and beyond.  For tax year 2018, the return everybody is about to file with the state, the standard deduction remains $3,000 for an individual and $6,000 for a couple.  Secretary Layne had said a standard deduction increase for 2018 was possible, without too much administrative cost, but neither chamber took that up.

The Senate’s proposal for addressing 2018’s windfall is that every taxpayer get a special, one-time refund later this year (closer to the election) of $110 for an individual or $220 for a couple.  Everybody gets the flat amount, without regard to income or the specific impact of TCJA on them.  It will disburse an estimated $420 million.  Only people who do not owe any tax will be denied the special refund.

That is likely to be a sore point with Democrats, because those low-income workers with no tax liability are exactly the people the Democrats wanted to see get a grant under an expanded Earned Income Tax Credit.  The Senate bill instead creates a sort of one-time EITC grant for everybody else.

The House, however, is only including a vague promise of future tax reform based on the hundreds of millions of TCJA conformity revenue coming in for tax year 2018.  The same bill that adopts conformity sets up a special fund to receive and hold the excess revenue.  As the bill left committee, it called on the Department of Taxation (read, the Governor) to suggest by August 1 future tax reform provisions.

What the House bill does do, and the Senate bill does not, is allow Virginia taxpayers to split their decision on itemized deductions starting in 2019.  They can take the federal standard amount but itemize on their state returns.  For many people that counteracts the negative impact of the decision to conform to the new federal rules, and their subsequent decision to take the new higher federal standard deduction.

The bills also differ on their treatment of the new $10,000 cap on local tax deductions included in the new federal rules.  The House would disregard it, letting taxpayers deduct any amount of real estate or personal property taxes above $10,000.  The Senate would place a new cap, not $10,000 but $20,000, on any state deduction for local taxes.

Neither bill adjusts the corporate income tax downward, as the federal tax bill did, or indexes future tax rules to adjust for future inflation, another standard feature of federal taxes.  Both of those steps were suggested by the Thomas Jefferson Institute for Public Policy in a plan widely endorsed by business and conservative groups.

Legislators reported they heard zero support from business leaders for cutting the corporate income tax, even though those receipts will grow rapidly under conformity in the out years unless the rate is cut.  The House also ignored pleading from some large businesses for restoration of full deduction for interest, now limited at the federal level. In yet another variation, the Senate did provide a partial restoration of that deduction, 20 percent instead of 100 percent.

Don’t get too attached to any of these provisions.  The two approaches are so far apart on so many points a conference committee seems inevitable, unless they negotiate quickly behind the scenes, and a total train wreck remains possible.  The Governor’s point of view is going to have to factor in at some point, and his EITC grant proposal is far from dead.  With a $200 million per year estimated price tag, it could easily be the poker chip he takes from the table at the end.