First published today by the Thomas Jefferson Institute for Public Policy.
Do not be surprised if, by the time the next Virginia General Assembly elections roll around, the Democrats who are now complaining about the level of tax relief in the pending budget compromise switch positions, and campaign as champions of the deal.
The two key elements – a substantial increase in the standard deduction for income tax filers and a cut in sales and use tax on groceries for everybody – are ideas with long and bipartisan histories. Only the reluctance of previous governors and General Assemblies to part with the revenue stood in their way. Both are logical, populist reforms many Democrats had also championed in the past.
The Thomas Jefferson Institute has long been an advocate for a higher standard deduction, and the proposed 78% increase from $4,500 to $8,000 per person (up to $16,000 for a couple) falls just short of the recommended 100% increase. Remember, as recently as tax year 2018 it was only $3,000 (or $6,000 per couple) and raising it in 2019 was also a major recommendation of ours that was adopted.
This new amount will apply to this tax year. So in two steps over three years, the standard deduction has risen by $10,000 for a working couple. That 166% increase saves most of them $575 per year.
There is a catch: trigger language tied to revenue growth. Should the U.S. and Virginia go into recession, as many expect, and state taxes stagnate, the standard deduction could be reduced to just $15,000 per couple. Following a massive, multi-year expansion of tax revenue, it will be the growth rate starting this July 1 that sets the trigger.
Another catch: the sales tax reduction on unprepared foods and essential personal hygiene items will not go into effect until January 1, 2023.
The full General Assembly meets Wednesday, June 1, to vote on the budget compromise and on several other bills still in conference committees when the regular session adjourned. Any compromises on those – with some substantial issues involved – may not be revealed until Wednesday.
The bulk of the credit on this tax reform progress goes to Governor Glenn Youngkin (R), who promised to double the standard deduction in his campaign, made it a priority accepted by the House of Delegates in its version of the budget, and stuck with the idea through the long, stalemated negotiations with the tax-happy Senate of Virginia. (And the resistance came from some Republicans in the Senate, too.)
If the increase isn’t as large as it could have been, in large part that is because of the other tax changes Youngkin proposed and stuck with through the negotiations. Removing the sales tax on food and providing one-time cash rebates from the surplus were so popular after Youngkin proposed them, Democrat Ralph Northam put them in the proposed budget he introduced in December.
It appears the approach on the sales tax will be as Northam proposed and the Senate adopted, delayed by six months and only eliminating the state share of 1.5%. That leaves it up to localities to decide what to do with the 1% local sales tax on unprepared foods and might create an issue for the next round of local elections.
Absent from the scene though he is, Northam also deserves credit for the acceptance of his proposal to convert Virginia’s Earned Income Tax Credit (EITC) for the lowest income earners into a refundable tax credit. Instead of simply wiping out any lingering tax liability on their small salaries, the EITC now may provide a cash rebate. It will be coupled with the similar federal benefit.
This is an anti-poverty program with bipartisan roots of its own, dating back to Republican President Richard Nixon. (Fifty years? That’s about right for ideas to finally mature in Virginia.) It was not a priority of the Jefferson Institute because it really isn’t tax policy, but it is a valid approach to supplementing income. Only people who work get it (and as wages rise, its value decreases.)
The other major element of the deal, which had bipartisan and bicameral support through the 2022 process, is a major income tax subtraction for military retirement pay, starting at $10,000 for this year and rising to $40,000 in tax year 2025. It will be available only to those 55 and older.
Youngkin had also focused on fuel taxes, with two proposals. Tactically, they probably found themselves competing for wind in their sails and reduced each other’s chances of success. First, he offered (and the House approved) a one-year suspension of the most recent increases in the tax, and then he tried to get a 90-day suspension of the entire tax. Neither was adopted by the budget conference committee.
From an economic standpoint, either was of minor and short-term benefit. The standard deduction and sales tax changes should prove to be permanent. It is hard to imagine a future General Assembly reversing them.
The legislative process on the new budget, which takes effect July 1, has one more step. Youngkin can propose governor’s amendments to these bills, just as with other bills. Any final changes he proposes need simple majorities in both chambers to be adopted, still a challenge in the Democratic-controlled Senate, but he is likely to try that avenue.
For most Virginia tax filers using the standard deduction, and most do, the increased level will save them $201 each or $403 on a joint return. Eventually the state will adjust withholding tables so the benefit will accrue weekly, but for others it likely means smaller quarterly payments or a larger refund. Large portions of the wealthiest Virginians still itemize their deductions, and this provides no benefit there.
The resulting state budget, absent these tax revenues returned to the workforce, will still be setting records for spending and reserves held. The revenue grand total, general fund and non-general fund fee revenues, is about $166 billion over two years. After the tax changes, that is still a 17.5% increase over the same point two years ago, and almost a 41% increase over 2018’s $118 billion.