State Cap on Deductions Added To Tax Bill

The compromise income tax bill hailed for preventing a tax policy train wreck in Virginia includes one new provision not included in earlier bills, not mentioned in any of the Republican press releases and not yet included in any fiscal impact statements.  Democrats wanted it.

It is yet another departure from the new federal Tax Cuts and Jobs Act.  The bill maintains a formula to reduce or cap itemized deductions known as the Pease limit.  TCJA removed the Pease limit at the federal level but the substitute tax bill voted on in committee Friday restores it at the state level.  

Democrat Delegate Paul Krizek reported in his constituent newsletter that this creates a cap of $313,000 on Virginia deductions, “saving $80 million which can help fund some excellent programs like the Housing Trust Fund.”   The Pease limit is a bit more complicated than that, as seen in this Forbes article from two years ago.

Summary of the revenue impacts of the pending income tax compromise, with no reference to a restored cap on deductions. Source: Senate Republican Caucus

This is the only variation from conformity to TCJA that added revenue for the state, rather than subtracting it.  All the other variations from conformity in the pending bill lower taxes for people or businesses.

In a February 7 email to Delegate Vivian Watts, the senior Democrat on the House Finance Committee, the Department of Taxation estimated that keeping the Pease limit in Virginia’s tax rules increased state revenue $465 million over six years.  All of that would come from taxpayers with substantial itemized deductions on high-end incomes.  Charitable deductions would be among those limited.

It was previously reported that the tax policy changes being pushed by General Assembly Republicans counteract (“give back”) only half of the $4.5 billion six-year total increase in income tax collections caused by conformity.  Add this in, and the amount of tax relief is closer to 40 percent of the total additional collection, with more than 60 percent retained by the state treasury.

Looked at another way, more than 60 percent of the “tax increase” which has been the source of partisan bickering through much of 2018 and 2019 is surviving the General Assembly process.  What relief is coming is front loaded, with the largest element to be delivered in the form of a one-time check a month before the 2019 elections.

Following a short standoff between the Republicans in the House and Senate over competing approaches, the Senate approach has prevailed, with this late addition related to the Pease limit.  The bill is still to be voted on by the full House and Senate.

The surviving bill includes two elements benefiting most taxpayers.  The first is the one-time lump sum rebate of $110 per person or $220 per couple, proposed for payment in October of this year.  That is intended as compensation for the higher 2018 taxes imposed by conformity on tax returns now being filed with the state.

The second general element is a 50 percent increase in the standard deduction, the first for individuals since 1988 and the first for couples since 2005.  The increase, well below other amounts proposed in bills that failed, is not enough to compensate for inflation over the years.  The higher standard deduction reduces taxes by $360 million in the first year, but that covers an 18-month collection period.  The total benefit to taxpayers is lower in future years.

An earlier House version would have allowed individuals to split their election on tax deductions and use the federal standard deduction while continuing to itemize on their state returns.  That split election is not included in the bill which passed committee Friday.  Taxpayers will still need to file the same way on both forms.

A surviving element from the House bill allows Virginians who do itemize to deduct their entire local real estate and property tax bills.  On federal taxes, that deduction is now capped at $10,000. On Virginia taxes, the deduction will only be reduced if it bumps into the Pease limit. For some it will.

The final two elements of the compromise bill deal with variations from the federal law which produce lower state income taxes on large corporations.  Several other elements of the federal law producing higher state business taxes were not addressed, and the Assembly rejected proposals to trim the corporate income tax rate.  This is an indisputable corporate tax increase.

The political pronouncements Friday mentioned $1 billion in tax relief, but the benefits to average taxpayers included in that are limited to their share of the $420 million one-time rebate and the $360 million tax cut from the higher standard deduction.  For tax years 2020 and beyond the tax reductions are much lower.

To tally up the results, the good things are (1) Virginia does conform in time for a smooth filing season this spring, and conformity by itself provides great benefit to some taxpayers, (2) all taxpayers get a one-time rebate (with no relationship to how much additional state tax they paid, if any), and (3) the standard deduction increase is permanent.

On the negative side, (1) less than half of the higher tax revenue is counteracted, or “given back”, over the first several years, (2) Virginia’s effective corporate tax rate will rise and (3) the list of provisions where Virginia varies from full conformity has grown again, now including one that raised taxes rather than lowering them.

The bill does capture additional dollars in a “Taxpayer Relief Fund” but the language directs that once those one-time rebate checks go out, the balance and any additional balances generated from federal tax reform “shall be transferred to the Revenue Reserve Fund.”   Where the money goes from there is up to a future General Assembly.

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10 responses to “State Cap on Deductions Added To Tax Bill

  1. If you are not careful – you’re going to SCOOP the regular media!

  2. It will take me a while to digest, Steve, but basically Virginia decided to use TCJA as an excuse to redistribute wealth. They are taking money away from me as a NoVA borderline itemzier in the middle income bracket. Most of the debate was how to best dish out to other people, the money taken from people like me.

    • The bill gives you $172.50 on your standard deduction as partial compensation. I at least pushed to give you $345. 🙂 No question it could have been done.

      • Any prognostication about the future — as in, any chance this can of worms will be reopened in the near term if the Dems gain the ability to do so?

        • Next year it will be harder to itemize at the Federal level, because for 2019 the TCJA will eliminate a lot of medical itemized deductions (by requiring a 10% of income threshhold from current 7.5%). So presumably that puts more Virginians in the paying-more-state-income-tax category.

    • As I think you pointed out in an earlier post, that is the point of progressive tax system–folks with higher incomes pay higher rates than those with lower incomes. Be that as it may, I don’t think that applies here. As I understand Steve’s explanation, the additional revenue realized by the state as a result of TCJA, after the one-time refunds next fall, is not being “redistributed” as the Governor proposed, but will be deposited into the Revenue Reserve Fund. I assume that means it will not be available for this year’s GA to spend.

  3. OF course, we’re now into our second week of doing taxes with the software that reflects the current tax code.

    Any major changes now – and we’ll have to wait until the software gets updated, not to mention amending all returns already completed.

    By the way, we are not seeing great refunds Federal or State – it’s very
    much a mixed bag with some folks seeing tax increases.

    The folks who have kids are doing well with EITC and the child tax credit – the folks with other non-kid dependents not as much.

    On top of this, there is talk of the Feds making changes also – known as Tax extenders…

    ” Opinion: Costly tax extenders would extend taxpayer confusion
    By The Concord Coalition on Feb 8, 2019 at 10:40 a.m.
    As if filing federal tax returns weren’t already confusing enough, some lawmakers are considering retroactive changes in the tax code that would apply to 2018. This means some taxpayers may need to delay preparing and submitting their returns — and perhaps will even be forced to file revised tax returns later.

    The changes under discussion include the possible renewal of “tax extenders,” which are short-term provisions that benefit certain individuals, businesses and industries.

    Rather than making them a permanent part of the tax code, however, Congress has renewed many extenders year after year so that they appear less expensive. Despite efforts by supporters last year to get them renewed for 2018, however, Congress did not do so.

    According to an estimate by the Committee for a Responsible Federal Budget, renewing more than 20 tax extenders that expired in late 2017 would cost about $10 billion a year — or $80 billion to make them permanent.

    The Concord Coalition has long questioned the use of tax extenders, and expressed concern again late last year that they might be deficit-financed. Extenders have many other critics as well who say the provisions are costly, unfair and ineffective in achieving their stated goals.

    The cost to the government of borrowing more money to retroactively extend certain tax breaks — or even quickly adding new ones, as some on Capitol Hill are suggesting — should give lawmakers pause.

    In a reminder of the nation’s alarming fiscal situation, the Congressional Budget Office released projections last week showing that deficits would increase by $11.6 trillion over the next 10 years — despite a strong economy.

    so the point of this is that these Federal Tax extenders will reduce taxable income – which is what Virginia uses at the start of it’s calculations.

    If the Feds do extend AND Virginia makes changes – it’s not going to be certain what happens to Virginia revenues.

  4. Looks like Maryland is directionally doing the same thing as Virginia. When I get a chance I will try to do comparisons of Va. to MD, PA, NC, NJ state taxes for a few income scenarios.

  5. Well, 40% of a loaf is better than no loaf at all.

    Under the circumstances, that’s pretty good. The difficulty for anyone pushing for lower taxes is that the issues are so impenetrably complex that no one can understand them. One reason that Steve is getting so many scoops on the tax issue, I suspect, is that he is the only person who had made the sustained, brain-numbing effort to understand the details. If the issue can’t be summarized in a sound bite, it won’t play on the evening news, and the public won’t get exercised about it.

  6. Folks talk about corruption and “rigged systems” and one need look no further than the tax code – both Federal and Virginia and folks would be shocked to see the sheer number of subtractions, deductions and credits in the Virginia code.

    However, the folks that these things are aimed at – know full well about them and use them. You wonder why Virginia has many more wineries now than before?

    The average taxpayer schmuck .. just wants to get his/her taxes done and get it out of the way – but there’s a whole other class of folks who “know” the credits, deductions, and subtractions – usually by hiring a professional who knows every little nook and cranny in the code that can be exploited.

    The same thing has been true about MedicAid of all things… for a long time, a substantial number of people did not know they were actually eligible for Medicaid – until recently when volunteer activist types have been helping people who are qualified , get those benefits – and it has resulted in a significant underestimation of the forecasts… has become known as the “woodwork” effect.

    The same thing could happen for the Virginia Tax code if the average person actually hired a tax professional (a GOOD ONE)… to find and exploit every benefit they can.

    Instead.. most folks justs pay up and move on….

    And there is one fundamental difference between the Feds and the State. If the Feds underestimate the forecasts – it’s no big deal – it just gets added to the deficit/debt but if Virginia screws up on the forecast – there is real pain because the budget must be balanced.

    Software, however, is getting better and better at helping ordinary people “discover” what they actually do qualify for…

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