Tag Archives: Conformity

Governor Hints At Local Business Tax Reform

On Friday, after skirting the topic in a major address to a business conference in Williamsburg, Governor Ralph Northam told a reporter that “he’s planning to ask the General Assembly to tackle business tax reform,” adding it would be “comprehensive.”

The reporter asked about it because of other comments made by Secretary of Finance Aubrey Layne and the President of the Virginia Economic Development Partnership, Stephen Moret.  Since his arrival in Virginia, Moret has from time to time mentioned local business taxes as a hindrance to economic recruitment and business start-ups. He did that again Friday in his own presentation to the Virginia Chamber of Commerce.

For more than a decade local business taxes, especially two of them, have been the focus of the Thomas Jefferson Institute for Public Policy, among others.  The taxes are generally despised by the business community, but local governments are highly attached to them, because they are a revenue source other than residential real estate taxes.

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To Get Useful Answers, Ask Correct Questions

It’s all in how you ask the question.

The Judy Ford Wason Center for Public Policy at Christopher Newport University has done a pre-General Assembly poll testing various issues that may dominate the 2019 session.  The headlines are driven by the favorable and unfavorable rankings (ask me about President Tariff Man this morning as I survey my portfolio) and the apparent openness of Virginians to ending restrictions on gambling.

The poll’s authors took a dive into the complex world of tax policy, as well, seeking to tease out how voters view various moves related to the windfall tax conformity revenue.  It could have been more useful.  To start the discussion, here is the question they used:

Q8: Virginia is expected to receive as much as $600 million in additional tax revenue as a result of the recent federal tax reform. There are several ideas about what to do with this additional money. I’m going to read two of them and I’d like you to tell me if you support it or oppose each one.

  1. Provide an across-the-board tax cut to all Virginians who pay state income taxes.
  2. Provide a fully refundable tax credit to low and moderate-income Virginians regardless of how much they pay in state income taxes.
  3. If only one of these options could be done, which one would you most prefer to see done, an across-the-board tax cut to all Virginians who pay state income taxes or a fully refundable tax credit to low and moderate-income Virginians regardless of how much they pay in state income taxes?

The results were ambivalent, with a healthy portion of voters liking either approach.  There were predictable partisan divides, with Republicans preferring the idea of a broad-based cut for all taxpayers and the Democrats leaning towards a tax credit targeted to the lower and middle income.  But 59 percent of Democrats were positive on Q1 and 49 percent of Republicans were positive on Q2.  Forced to choose by Question 3, the partisan divide appeared again.

The problem is those are not the choices, at least based on the discussions so far.

First, missing from the mix was the idea which may yet prevail, taking no steps to return the money.  A fair additional option to give the poll respondents would have been: “Retain the money to increase the state’s financial reserves and spend it on other pressing state priorities.”  Listing especially popular priorities would have pumped up the positives on that question.

That is the biggest and most important question:  does the General Assembly keep the money or give it back?  They didn’t ask it.

Second, nobody has proposed an across the board tax cut to all those who pay the income tax.  We at the Thomas Jefferson Institute have come closest to that, with a proposal to double the standard deduction that might reach 70 percent of taxpayers, and we may tout the Wason result as supporting our case.  But that is not a tax cut for everybody who pays, so they didn’t poll our idea.

Third, I doubt if more than a handful of people polled know what a “fully refundable” tax credit is (or a partially refundable one, for that matter).  It sure sounds nice; everybody loves a refund – the word by itself may inject a bit of question bias.  Which of course is why it has always been used to describe the Earned Income Tax Credit grant payments.

But imagine the answer to this question, which more accurately describes the proposal around the Earned Income Tax Credit: “Provide an annual cash payment to low- and moderate-income Virginians who do not owe any income tax but are still struggling to meet the needs of their families.”

There still would have been positive responses to that, but how many?  Would it have proven to be as popular a choice as a general tax cut?  More popular?  We will never know.   Will we hear repeatedly in the coming weeks that this or that idea has been “strongly supported in a poll”?  Probably.

To borrow a line used about modeling, all polls are wrong, but some polls are useful.  This poll unfortunately is not very useful because it left off the main choice – keep it or give it back – and didn’t really describe the two choices for giving it back getting the most attention.

I do commend the CNU center for releasing the full text, cross-tabs and demographics of their sample.  Absent those, nobody should believe any poll result featured in the media or in campaign materials.

The Push for EITC Cash Grants Accelerates

A useful EITC example from the Commonwealth Institute’s website. Whether anybody “earns” a credit is debatable, but that claim will appeal to those who benefit.

With the 2019 General Assembly now a handful of weeks away, the main advocacy group for a new cash welfare entitlement in Virginia is ramping up its efforts with various appeals, perhaps testing themes for later use.

On Wednesday on its website the Commonwealth Institute for Fiscal Analysis was arguing that the state Earned Income Tax Credit (EITC) should be converted to a “refundable” cash grant because of how it would help “communities of color,” who pay a larger percentage of their income in state and local taxes.

A few weeks back, the focus was on how “veterans and their families deserve full credit.”  And, of course, they have broken down their data by legislative district, conflating the number of people who claim the EITC already with the number who would benefit from their idea.  Not everybody who now claims the state EITC would qualify for a grant.

The first to advocate for converting the tax credit into a cash payment was Governor Ralph Northam, who mentioned it last summer as his favored use for the windfall state income tax dollars generated by conformity.  It has nothing to do with that windfall.  In order to benefit from this idea, you already must be paying zero state income tax.

In recognition of that, the argument now is people need to get the balance returned in cash because they are still paying sales, excise and other taxes, just not income taxes.  It’s not good enough to zero out their income tax, advocates claim.

As previously explored, the Earned Income Tax Credit is a program with conservative credentials and has succeeded in improving the finances of low-income working families.  At the federal level, if your income and family size qualify you for a credit which is larger than your tax bill, the difference is sent to you in cash.  To call it a “refund” is political fiction, because it is not cash you paid in taxes to start with.  It just comes at the same time the rest of us are getting refunds.

The federal version has grown into a major income transfer program, about $60 billion annually, and as always with these programs the push to expand them is constant.  A Democratic House of Representatives will be more attentive.

In an earlier tax reform effort, Virginia added its own version of the program, allowing a credit against state taxes equal to 20 percent of the federal EITC.  But Virginia did not take the second step of paying cash grants from state revenue to people who had larger credits than tax bills.  That is what Northam and the Commonwealth Institute are talking about doing now.

The cost impact is about $250 million, based on an earlier legislative proposal which failed, but a full analysis is lacking.  The cost to taxpayers – and it is a cost to taxpayers, not a refund and not tax reform – will need to be more carefully spelled out when a bill finally appears.  Advocates have developed a calculator for individuals and for some the grants would be substantial.

While this proposal is not tax reform, but instead is a way to share the windfall revenue with low-income working families, the idea is not incompatible with tax reform.  It would be possible to couple it with an increase in the standard deduction or some other change in personal income taxes that actually aligns with to the conformity windfall.  It is only a question of how much revenue with which the legislature is willing to part (for some, the answer is none).

The proposal to expand the standard deduction would reach far more Virginians – more in “communities of color,” more veterans, more in every legislative district – than would turning EITC into a cash grant.  The problem for some on the left is they would not all be poor or working-class and might even be well-off.

What they would not be is the same people.  As noted before, to qualify for the cash grant Northam and the Commonwealth Institute are talking about, you already must be paying zero state income tax.  If the EITC credit has already wiped out your state tax bill, an additional standard deduction is of no value.

But there is this, which should appeal to the Commonwealth Institute:  The additional standard deduction would add to the number of people who pay zero income tax.  An EITC cash grant would go to those already paying zero but would not grow their ranks.

And this:  The additional standard deduction would stay with you as your income grew.  EITC – whether a credit or both a credit and grant — shrinks as your income grows, and that is what people really want, growing income.

If the General Assembly must choose, it should choose tax reform and increase the standard deduction.  If its willing to do both, well, this is why the legislative process is great theater.  It cannot be predicted.

Confusion, Silence Will Earn Business Higher Taxes

State revenue impacts of conformity to federal business tax changes without a corresponding cut in tax rates. Source: Department of Taxation

“I’m not going to get into it unless anybody wants me to.”

So said Kristin Collins, policy development director for the Virginia Department of Taxation, as she neared the end of her November 19 slide presentation on federal tax conformity and its impact on Virginia state taxes.  The final handful of slides focused on the business tax issues, and not one member of the legislative panel asked her to get into them.

With all the focus and political discussion swirling around individual income taxes and conformity, the business tax issues have received little notice.  In the projections on the state’s revenue windfall the higher business taxes produced by conformity play a big role.  In 2023 and 2024, the later years in the state’s projection, higher business taxes account for over 40 percent of the new revenue, according to an outside consultant’s study.

Collins was presenting to the Joint Subcommittee to Evaluate Tax Preferences, the closest thing Virginia has to a permanent tax commission in its legislative body.  Many key players on the money committees belong.   The chair, Delegate Lee Ware of Powhatan,  who also chairs House Finance, intends to call the joint panel together again for a deeper discussion and perhaps some decisions before the General Assembly starts in January.

A group I’m working with has already recommended on the individual side that Virginia increase its standard deduction, and on the corporate side we think Virginia should start to cut the corporate income tax rate, from 6 percent now down to 5.5 percent for this tax year and 5 percent for next tax year.  The full Thomas Jefferson Institute paper on our proposal is now available.

The business community needs to get its act together and decide what it wants, or it’s going to get the full effect of these business tax increases.  Unincorporated businesses – S corporations, pass-throughs, partnerships – do very well under conformity but incorporated businesses get hit.  The cut in the corporate income tax rate we propose effectively short-circuits that tax increase in general but does not return the benefit directly to the companies hit with the highest new taxes.

Some in the business community would prefer to leave the tax rates intact but instead get the General Assembly to restore the corporate deductions targeted by Congress.  They would have Virginia refuse to conform to those certain aspects of the federal system, which does target the corrective action directly to those facing higher taxes.

Our proposal is full conformity but rate cuts aimed at all corporate taxpayers.  It represents general tax reform, not maintenance of the status quo.

A short list of changed business provisions create the big tax hike, and they are spelled out in the Tax Department chart above.  You can see that several grow in impact over time, and a major change in the treatment of research and development expenses doesn’t even kick in for three years.   Unlike some of the new individual tax provisions, these changes have no sunset date.

What is wrong with that chart – and potentially misleading – is it includes provisions for both unincorporated and incorporated businesses.  The two changes producing lower taxes are mainly for the entities exempt from the corporate income tax, and most of those raising taxes are for corporations.  It also fails to detail one of the more controversial changes dealing with repatriated international earnings.

That provision, which goes by the wonderful acronym GILTI, is already the subject of a lobbying effort by some Virginia corporate taxpayers, who note some other states (Tax-achusetts included) have already elected to allow that deduction despite the federal action. It stands for Global Intangible Low-taxed Income, and the IRS guidance runs to 150 plus pages.  The argument over whether and how to tax intangible income (royalties on patents and copyrights for example) is an old one.

The Section 199 deduction also known as the domestic production activities deduction (DPAD) has been a source of contention in Virginia before, because when Congress expanded it Virginia balked at going along in full.  Its purpose was to lower the effective tax rate on manufacturers, and by lowering the tax rate for everybody by 40 percent Congress largely addressed that problem.  It then killed Section 199. (Virginia should do the same:  accept the change and lower its rates!)

The largest cash impact comes from new limits on the deduction for interest expenses, and here Congress also had reasons for its move.  Why subsidize excessive debt?  Apparently there is also a push on in Virginia to keep that deduction in place on Virginia corporate returns.

The limits on amortization of research and development expenses have a delayed impact, but eventually a large one.  That’s another one where Virginia could stay the course, maintain the old rules, but at the cost of a lost opportunity to lower overall rates.

The business community has some decisions to make, and it may be a handful of companies who have a developed presence at the General Assembly who get to make them.  Long-term considerations and discussion of overall economic policy tend to get ignored when lobbyists can angle for their own client’s advantage. That game is now afoot.

Just Give It Back and Here’s How

Senate Finance Committee chart separates the impact of business-related conformity provisions on individuals and corporations, key information for designing a response. TCJA = Tax Cuts and Jobs Act

A joke making the rounds Wednesday had Governor Ralph Northam agreeing that Virginians did deserve a return of the windfall tax increase flowing to the state due to conformity, but we’d have to take it as Amazon Prime memberships.  Don’t expect laughter if the 2019 General Assembly votes out a massive multi-year incentive package for a super-wealthy corporation and refuses a simple and broad-based tax reform proposal for almost everybody else.

Give it back.

In the past few days the General Assembly’s key money committees have discussed what to do about the gush of new revenue the state will garner when it conforms to this year’s new federal tax regime.  They should give it back.

After wrestling with different approaches over the last few months and consulting stakeholders, the public policy group I’m affiliated with, the Thomas Jefferson Institute, has settled on two basic steps that have always been on the options short-list.

1) For individual taxpayers, the state should double its standard deduction to $6,000 for individuals and $12,000 for couples.   That removes up to $6,000 from the taxable income of an estimated 2.8 million Virginia tax returns, the vast majority of Virginia taxpayers.

2) For Virginia’s incorporated businesses, the corporate income tax rate should be cut from 6 percent currently to 5.5 percent for 2018 and 5.0 percent for 2019.

Both steps should be retroactive to tax year 2018 so they would reduce the taxes you compute for the state in a few months.

Both steps are first steps, because all indications are the state tax increases created by the federal tax changes will accelerate in future, by the state’s own estimates.  Even a standard deduction of $12,000 is too low for a family and should rise more.

Neither step squeezes the state budget.  The amount of “windfall” revenue returned by these changes is still lower than the estimated new revenue conformity creates.  On an individual basis there will still be winners and losers, but the current state budget is not among the losers.  No spending need be cut.

The drumbeat on this issue started by multiple posts on Bacon’s Rebellion has spread, sparking only a few comments at a recent House Appropriations Committee meeting and a  presentation in front of the Senate Finance Committee Thursday.  The tone of the Senate meeting, which I did not attend, may be reflected in this Richmond Times-Dispatch account where any effort to prevent the tax increase is framed as a loss of state revenue.

The Senate Finance staff produced the slide used above which slices the conformity revenue projection a new and useful way.  It separates the business tax impacts into two measures, those that show up on individual returns because the business is not incorporated and those that show up on corporate returns.  With that split you can see that the state impact of conformity is immediately quite positive to pass-through businesses and immediately a substantial tax increase on corporations.

The way the Northam Administration had packaged the same data implied the impact on business in the first year was minimal.  Not so.

That extra $157 million hit to corporations in the first year represents about a 17 percent increase over the base projection for corporate income taxes and (don’t you love it when a plan comes together?) we propose a 17 percent cut in the rate.

The idea of increasing the standard deduction for individuals must also have great appeal, because the Senate is considering a temporary substitute – a tax credit that would have a similar impact for taxpayers (perhaps not as substantial) but would not be a permanent change in the rules.  What Virginia needs, and what taxpayers should demand, is a permanent change.  The idea that Virginia would continue to stand on its ridiculously low standard deduction deeper into the 21st Century is troubling.

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Conformity: Option on Deductions Saves $370M

Allowing a split choice on deduction methods provides 87,000 taxpayers with a tax cut and reduces the conformity tax hit for 456,000. Source: Secretary of Finance.

If Virginia were to allow its taxpayers to keep taking itemized deductions at the state level, even though they take the new higher federal standard deduction, almost 550,000 more would be expected to itemize at the state level, Secretary of Finance Aubrey Layne told state legislators Thursday.

Almost 90,000 would be people who were not claiming itemized deductions before.

That idea is popular with some legislators, many of them House of Delegates Republicans, who are hearing from taxpayers who face a difficult choice.  Under current Virginia law, which would remain in place if Virginia simply adopted straight conformity with the new federal rules, the decision on standard deduction vs. itemized must be the same on both state and federal returns.

When Layne reported on an earlier projection that Virginia would gain $532 million in new individual income tax revenue during 2019, and $3 billion over six years, much of that would come from that situation.  More than 600,000 Virginia taxpayers were expected to switch from itemized to standard deductions, lowering their federal tax but increasing their state tax.

Along with the number of returns that might split their method, he also estimated the amount of tax dollars involved as $370 million.  That estimate was for 2020, and its not clear what the more immediate impact would be.  Layne presented that as lost revenue for the state but turn the coin over and it’s a tax cut for those families.

Why does this matter?  It puts a price tag on that proposal being discussed in some circles, and that price tag is less than the estimated revenue gain from conformity.  The idea could be implemented without blowing a big hole in the state’s already-adopted budget – a big point in its favor.  The budget was written with no conformity tax gains included.

Also, the price tag Layne announced (probably working with that new tax model the state has developed) is a bit lower than the revenue loss/tax cut value on the other big idea.  Previously Layne had estimated that if the legislature doubles the state’s standard deduction (to $6,000 per person or $12,000 per couple) that would cost (or save) $440 million.  He repeated that number Thursday in an interview with Bacon’s Rebellion.

The information is in a slide that Layne prepared for the monthly meeting of the Senate Finance Committee, but according to the Richmond Times-Dispatch the committee didn’t want to take up the topic today.  The newspaper story, at least the first iteration, seemed to characterize the $370 million as the state revenue impact if the state doesn’t conform to any of the federal changes.

That number would be far more complicated.  A failure to conform at all would involve a state-specific addition or subtraction on more than 20 individual and 30 business provisions and would remove from Virginia returns many highly positive changes – changes taxpayers would be furious to find they lost on their state returns.  Layne confirmed that his number was just focused on the proposal to let people split their decision the deduction method.

Layne also reproduced some pages of the forms that Minnesota taxpayers will use to accomplish just that, to back out all the various federal changes when they prepare their state returns.  That is a nightmare that no Virginia leader is promoting for here, but it is a very possible outcome if the General Assembly fails to act in early 2019 after having failed to act through all of 2018.  Conformity will require a positive vote by a super majority in both chambers to be retroactive for tax year 2018.

In his un-given presentation Layne continued to discourage the General Assembly from doing anything to remove the conformity tax bite for tax year 2018.  He argued against both proposals circulating, to double the standard deduction or allow the option state itemized deductions.

“Such responses will not only impact taxpayers whose state taxes were increased as a result of the (Tax Cuts and Jobs Act) but will also impact taxpayers whose tax liability did not change as a result of the TCJA,” Layne said.  That is correct. For tens of thousands of Virginians, they would not be revenue neutral removal of “conformity tax” but would be real tax cuts.

Virginia Should Double Its Standard Deduction

In 1987, as part of its response to the conformity issues created by President Reagan’s tax cut, the Virginia General Assembly increased the standard deduction available to Virginia taxpayers to $3,000 for an individual and $5,000 for a couple. At some point since the joint filing amount went up to $6,000 to eliminate any marriage penalty.

Faced with a similar problem in 2019, that’s what the Virginia General Assembly should do as a start:  Increase the state standard deduction.  Double the amount of income a Virginia couple can shield from tax under that method, with no itemized deductions necessary.

Virginia also allows personal exemptions to provide a bit more tax-free income.  The personal exemption is now $930 each.  A couple with one child gets $6,000 in standard deductions and $2,790 in personal exemptions for a total of $8,790 pre-tax income.  Compare that to where surrounding states are on that score and to the new federal standard deduction of $24,000.  Even if Virginia doubles the standard deduction, its only a step in the right direction, as you can see below.

Taxable Income Threshold
Couple Plus One Child
Virginia Current $8,790
Virginia Proposed $14,790
Maryland $13,600
District of Columbia $24,000
North Carolina $17,500
South Carolina $24,000
West Virginia $6,000
Tennessee No Income Tax
Federal Taxes $24,000

I’ve been drawn to this idea from the start but when I saw that surrounding states (except West Virginia) were already there, this suddenly struck me as imperative.

It would be only a good first step toward preventing the personal income tax increases which will result when Virginia conforms to the new federal tax rules and definitions.  The idea is further explored in a briefing paper published today by the Thomas Jefferson Institute for Public Policy.  It is neither creative nor comprehensive tax reform, but creative and comprehensive make people nervous and will take time so let’s start with something simple and familiar we can do quickly.

It is better than doing nothing, which is what the Virginia Society of Certified Public Accountants is recommending.  It wants to adopt conformity and let the revenue accumulate, hoping later next year some consensus on reform will emerge.  Hope is no substitute for cash.  This is a very attractive idea that might get consensus now and could be adopted in the same bill that accepts conformity.

It is also a better approach than breaking conformity and allowing Virginia taxpayers to itemize on their state taxes while taking the standard deduction at the federal level.  The whole idea behind federal tax reform – and many surrounding states clearly agree – is to move people away from deductions driving their economic behavior.

Finally, this is a better idea than giving low income workers grants through the Earned Income Tax Credit system.  The grants come once a year and you must apply.  They reduce to nothing on a sliding scale.   This is a clear-cut tax reduction of $345 ($6,000 x 5.75%) for almost every family taking the standard deduction.  With withholding tables adjusted, the money shows up in every paycheck.

Many in the political class remains focused on spending the windfall money.  This takes away about $440 million of that possible spending, according to the Department of Taxation’s modeling.  This is an accidental tax increase, a windfall not approved by the General Assembly or (despite some of the rhetoric) caused by the Governor.  Any tax increase has economic consequences as people lose spendable income, so if you can reduce that impact there is economic benefit.

People with a pile of itemized deductions, which would usually be people who also have high incomes, taxes, interest payments and charitable giving, didn’t take the standard deduction before and will not do so going forward. This idea does nothing for them.  This also does nothing to address the corporate income tax increases which are coming.

VA CPAs Say Conform, Hold Tax Funds for Later

The Virginia Society of Certified Public Accountants (VSCPA) Monday called on the 2019 Virginia General Assembly to conform Virginia tax with recent federal changes, to track and sequester the hundreds of millions of dollars in higher taxes thus generated and to hold those funds for a future tax reform effort.

Nobody knows these issues better than the people who prepare tax returns, and the CPAs cite continued uncertainty over the full impact of the federal changes, especially with several issues still awaiting guidance from the U.S. Internal Revenue Service.  The society’s position is detailed in a white paper.  It offers no firm advice on what policy changes should eventually be adopted.

“VSCPA leadership and the VSCPA Tax Advisory Committee considered and discussed numerous policy options in an effort to make a recommendation, considering extensive input from VSCPA members and tax professionals, and determined that there was no member consensus on any single policy prescription,” Vice President Emily Walker wrote in an accompanying news release.

The VSCPA has enhanced its clout on this issue by hiring former Senate Finance Committee Chairman Walter Stosch as an outside lobbyist.  Stosch’s message to conform in full and then hold the money for later decisions is likely to carry greatest weight with his former colleagues in the Senate.

On the same day the CPA’s position was announced the first piece of proposed conformity legislation was filed, a House bill seeking to allow one major deviation from conformity.  It would allow Virginians to take the standard deduction on their federal returns but still itemize deductions on their state returns.  The deductions they can take will be under the new federal rules, however.

In previous Republican-generated statements pledging to allow Virginians to keep state itemized deductions while taking the federal standard deduction, the question of which deductions – new or old — has not been addressed.  The new federal law places limits on state and local tax deductions, eliminates the moving expense deduction, and make many other changes.

Delegate Richard Bell (R-Staunton) is not on either the House Finance or Appropriations Committees and it is likely other bills will emerge, probably many of them, before the session starts in January.  To apply retroactively to tax year 2018 any bill will have to pass with 80 percent super-majorities in both chambers, requiring a bipartisan consensus.  A bill changing policy for tax year 2019 needs just the usual majorities plus the Governor’s signature.

Secretary of Finance Aubrey Layne was back discussing the issue before the House Appropriations Committee Monday, at the end of his regular presentation on the state’s finances.  A CPA himself, he probably helped influence that society position paper.  The Northam Administration is resisting efforts to make immediate tax policy changes in response to conformity but has not ruled out a tax reform effort next year.

That approach has its own challenges.  By the administration’s own estimates, conformity with no policy changes produces almost $600 million in additional revenue for tax year 2018 from individuals and businesses.  To hold the funds in reserve for a future tax policy debate would require great discipline on the part of the elected leaders.  And if done in special session next year that debate would take place during the run-up to what is likely to be a bitter primary and election season for both House and Senate.

Layne has access to the revenue model produced for the state by Chainbridge Solutions LLC and added a data tidbit yesterday:  While some people will see a tax increase if Virginia adopts full conformity, others will see a tax increase if the state does not.  The individual tax hike from non-conformity is more than $181 million.  That’s far less than the other way around but demonstrates the complexity of all this.

Speaking of complexity, an effort to explain this in easier-to-understand language led to the production of another white paper, this one mainly written by me and distributed Monday.  You can find it on the Thomas Jefferson Institute website here.