Youngkin Prevents Two Tax Increases, Will Still Sign Record State Budget

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After much political theater, the Virginia General Assembly and Governor Glenn Youngkin (R) have now compromised on a $188 billion state budget based simply on the revenue projected from current tax law, with neither tax hikes nor tax reductions.  Making those revenue projections slightly more optimistic eased the path.

With both sides backing off their desire to change the tax rules, it became clear there was less controversy over how to spend the state’s money in the new biennial budget from July 2024 to June 2026. The top shared priorities of legislators in both parties include education, public employee salaries and benefits, transportation, and capital improvements. Medicaid is also a huge budget growth driver which the Assembly really does not control.

The Democrats in the majority in both chambers will celebrate that the plan achieves the spending they included in the budget they passed in March. Youngkin will celebrate that it did so without either the sales tax or carbon tax provisions that budget included. His success looks even more impressive when you recall the two other major tax hikes Democrats approved and he vetoed, one to impose a massive payroll tax and the other to allow localities to hike the general sales tax.

With a slight hint of sour grapes, a budget summary from the House Appropriations Committee opens with: “The adoption of the digital economy modernization was not driven by a systematic look at Virginia’s tax structure.” That is a euphemism for the expansion of the state’s sales tax to digital transactions, which just a few weeks ago was deemed by Democrats to be vital to the Commonwealth’s future.

The idea is hardly dead. One provision in this final budget, which was not included in previous versions, directs a 12-member legislative study committee to revisit the digital tax. It is also directed to review “existing sales and use tax exemptions” and evaluate “efforts to increase the progressivity of the income tax.” The goal is a tax package with some actual consensus behind it to consider in 2025.

There is no effort in the document to rationalize the Democrats’ decision to abandon their push to return Virginia to the Regional Greenhouse Gas Initiative, which imposes a carbon tax on electricity. Presumably, as with the digital sales tax, including that was a deal killer and veto magnet for Governor Youngkin.

More telling is this. Democrats did not apply any of the additional “found” revenue used to balance the budget to cover the existing programs funded by RGGI tax money. Perhaps they are not as high among their priorities as they claim, bound to infuriate those enriched by RGGI dollars. RGGI has always been more about money than any climate concerns.

What remains in the budget is still a massive spending increase over previous years, fueled in large part by inflation and by the lingering residue of the federal pandemic spending explosion. Both the 2022 and 2023 General Assemblies approved bipartisan tax reductions, mainly by raising the standard deduction on the income tax. Tax revenue has continued to grow.

When the Assembly adopted a similar budget two years ago, it assumed general fund revenue (after the tax reductions) of just under $25 billion for Fiscal Year 2023. The projection for general funds in Fiscal Year 2026 is now $30.3 billion, a 22% increase in three years.

Despite that growth, the general fund (income and sales taxes) continues to be a shrinking percentage of the overall state budget. The non-general fund portion – federal funds, transportation taxes and fees, college tuition and fees – is now almost two-thirds of the total. All take additional dollars out of people’s pockets because of inflation, and all may continue to grow faster than even this budget assumes.

Perhaps by the time of next year’s budget amendments, and certainly in the 2-year budget developed after the 2025 election, the bottom line will be over $200 billion. And that budget summary document written by the Democrats on the money committee predicts “additional funding could be needed…to expand upon current initiatives and revamp the K-12 funding system.”

To their credit, Democrats have now laid out a legislative pathway to give all concerned a chance to be heard. Previous tax reviews have sputtered out and produced no changes, but this one might prove energetic. When major changes have happened, they result because somebody – usually a governor, but it can be legislators – has done the hard work of building consensus.

Some version of the digital sales tax expansion is in Virginia’s future, as more of the economy moves online. Many, but not all, other states have adopted some version of this tax. Most, however, have been careful about the taxes they have imposed on digital business transactions. What the Democrats were recently pushing was overly broad in its application, broad enough to raise concerns it would make Virginia uncompetitive.

It will be easier to convince Virginians to accept the new digital taxes if they are coupled with some level of income tax reduction, which is how Governor Youngkin sought to proceed in his original budget proposal. The Thomas Jefferson Institute’s top priority remains indexing the tax code to inflation, so that brackets and deductions automatically rise with the cost of living. That would check the box of making the tax more progressive.

Even if this new legislative effort at consensus fails to produce a successful package of tax changes for the 2025 session, the issue will become a central debate in the 2025 election season. This is appropriate as voters should ultimately decide if taxes are too low, too high, or just right.

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Youngkin Budget 2.0 Meets Democrat Demands, Except Demand to Raise Taxes

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The fight that is about to occur at the Assembly’s reconvened session on Wednesday is entirely about taxes, not about spending.

An analysis of Governor Glenn Youngkin’s proposed compromise budget – done by the Democrats’ favorite financial bean counters, not by conservatives – confirms his budget comes extremely close to the spending levels Democrats approved at the end of the General Assembly.  The gap compared to the $188 billion overall budget is little more than a rounding error.

For K-12 education, the gap between the two budgets is a few hundred million dollars out of an overall education budget of $24 billion. As you review the list of detailed comparisons made by the Commonwealth Institute for Fiscal Analysis, item after item is the same as in the budget approved in March. That includes funding for healthy teacher and state employee raises the Democrats were so proud to include.

In other cases where the Democrats expanded spending, the Governor accepted 50-75% of what they approved. He pays for some capital projects with debt instead of cash and utilizes money from the Literary Fund for retirement premiums, both legal and common strategies used in the budget for decades. Governors of both parties have done those often.

On the other hand, while the General Assembly refused $1 billion in new discretionary spending sought by the Governor, he is seeking to restore just $230 million of it, mostly in education and economic development.

If Democrats refuse all or most of the Governor’s 242 proposed budget amendments, it will be because they want to hold the Virginia state government hostage to a potential shutdown for a tax increase.

The major tax hike the Democrats included in their budget and seek to restore is an expansion of the sales tax to digital goods and services, including purchases by Virginia businesses.

Even with that tax stripped out, and previous tax changes in 2022 and 2023, Youngkin’s budget 2.0 is 52% larger than the $123 billion overall budget Democrats approved four years ago when they had total control. The General Fund portion has grown 45% in just four years, from $44 to $64 billion. Yet the political left and its allies are exploding in rage that he is “slashing crucial funds” and “jeopardizing the future of our children.”

Faced with a budget based on a tax increase he opposed, the Governor had several options. He could have vetoed the budget entirely, forcing a special session to write a new one. He could have vetoed the sections that imposed the tax, likely to spark a test in court over the extent of his veto powers. He could have put all his proposals into a Governor’s Substitute, leaving the Assembly with just one vote to take on the whole package.

By offering his budget objections as a series of amendments, he took a path that makes it possible to adopt a budget on time.  This path also leaves the Governor the ability to review the results of the reconvened session before deciding whether to sign the budget or opt to issue a veto. The Governor’s approach retains flexibility for both him and the legislature.

While there is a dizzying total of 233 amendments, plus nine to House Bill 29 amending the budget for the current fiscal year, not all of them are likely to be equally important to the Governor. Some are technical changes or even corrections. Others are policy issues he cares about, but perhaps not so important that he will veto the budget just because they fail to pass.

One dilemma Democrats might create for him – one easy to predict – is to agree with the Governor and dump the digital sales tax but reject his attempt to remove language related to the Regional Greenhouse Gas Initiative. To rejoin RGGI means the related carbon tax on electricity is also restored.

And while Youngkin vetoed two bills that create the opportunity for additional local sales taxes for schools, following a referendum, both passed with enough votes to override that veto. If that override happens, complaints about the schools being underfunded become even more ludicrous, and a continued budget standoff is even more inexcusable.

Unfortunately, these budget standoffs have become so commonplace in Virginia that the public is bored with them, not paying attention, and the mainstream media coverage of the Assembly is a whisper of previous years. The assumption is somebody will blink, and disaster will be averted. To assume that this time would be a mistake. The atmosphere is pure poison compared to past disputes.

The liberal group that did the budget comparison, the Commonwealth Institute, is a good example. The numbers on their spreadsheet appear accurate, but the rhetoric accompanying it is pure partisan gamesmanship. In December, when Democrats were pushing income tax increases in committee, that group strongly attacked any attempt to raise or expand the sales tax as regressive, tougher on the poor. They were correct about its disparate impact. Now they claim it was a good idea all along.

And the same press release points to a grand total of $174 million in discrepancies between the Governor’s proposal and the approved Assembly budget (this was before they had done their spreadsheet.) While both the Governor’s proposal and the Assembly proposal represent major spending increases over the current budget, the slight disparities in his plan are presented as “harmful cuts.” A budget fully $25 billion larger in just a single two-year cycle, and $65 billion larger than four years ago, is dismissed as riddled by “cuts.”

Nothing is cut. The Democrats just want to raise taxes to spend more. That will be why Virginia employee pay and retirement checks and state services are threatened after July 1, should reason not override partisanship this week.

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Virginia’s Paid Family and Medical Leave Act Deserves a Veto 

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Sitting on Governor Youngkin’s desk is a paid family and medical leave bill that would provide eight weeks of paid leave per year for most employees in the Commonwealth. The program would pay employees 80 percent of their weekly salary up to an amount equal to 80 percent of the regional average salary for their qualified leave. Interestingly, teachers, state employees, and constitutional officers are not covered under this program — presumably, these employees already have paid leave benefits and the General Assembly did not want to tax their allies.

The arguments against mandatory paid family and medical leave policies are well known. First, mandated paid leave increases leave usage — thus harming firm productivity, particularly in smaller businesses where absent employees have a far greater negative impact. Second, studies show that mandated leave has a negative impact on female workers, who are more likely to use time off to care for children or aging parents, especially if that leave is paid. This fact is surely considered during hiring and promotion considerations. Third, mandated paid leave limits the ability of employees to choose wages or other benefits they may value more than paid leave. In fact, the taxes used to cover paid leave are an employment tax that reduces employment and puts downward pressure on wages.

In addition to these practical concerns about implementing a mandatory paid leave program, the bill passed in Virginia is far worse than most such bills. The bill on Governor Youngkin’s desk will require a new 250-person agency, that would initially collect a .66 percent tax on employment divided between employees and employers. While the tax is technically divided, economic studies show that employers typically pass on the “incidence” of their portion of the tax to employees through lower wages over time.

It is also important to note that the Virginia bill will tax all wages up to the Social Security Wage Cap which is $168,600. Thus high-wage workers will pay $1,113 per year, while low-income workers ($30,000 per year) will pay $200 per year with very little difference in benefits. By comparison, several states cap the taxable wage at half the Social Security cap. Additionally, most of the 13 states with mandatory leave have a lower tax-to-benefit ratio and the ones that use private insurance to operate their program have far greater benefits at much lower costs without having to fund a massive government agency.

The taxes collected under this new paid leave program would be used to pay an estimated $1.4 billion into a “Family and Medical Leave Trust Fund” needed to cover first-year leave benefits and the $33 million needed to pay for the annual cost of reviewing claims and doling out the new leave benefits. This, it turns out, is a difficult process. In Oregon, where they have a similar program it takes months for employees to get their leave reimbursements, putting employees at great risk. Because it will take two years to set up this massive new agency, the bill authorizes a loan of $100 million to cover start-up costs to be paid back by 2032 (the bill estimates that they will borrow $70 million next year, and $30 million the following year).

According to the official fiscal impact statement for this bill, by 2030 (just four years after it is created), this program will begin paying out more in benefits ($1.834 billion) than it collects in tax revenue ($1.686 billion) — meaning the trust fund will have an annual deficit of over $148 million in 2030 ($181.5 million if you add in annual operating costs). Using conservative estimates, without added taxes, this means the trust fund would run actual deficits by 2038. Of course, the legislation requires the trust fund to be fully funded at 140 percent of the prior year’s expenditures, meaning those who wrote this bill knew that taxes would need to be raised to meet its obligations. In short, the .66 percent tax in the bill is the camel under the tent that legislatures know is not nearly enough to fund this program over the long term. Within five years, taxes will have to grow to 1 percent, and within ten years to 1.25 percent of payroll.

Of course, the above assumes the benefits under this act remain the same. This is not likely. The original bill provided 12 weeks of paid leave, a month more than is included in the final version sitting on the Governor’s desk. As with most entitlements, supporters often pass a lower benefit bill knowing that once the program is in place, they can grow it over time. The intent of the authors is clear, 12 weeks of paid leave per year is their goal.

What is lost in this current debate is that just two years ago, Virginia implemented a provision to allow for private insurance to cover wages during family and medical leave. This was a reasonable approach to build on the large number of employers who already provide paid leave to their employees privately. The law made it easier to expand such leave benefits to small and medium businesses through an insurance instrument, without a massive new government agency and risky new government trust fund. Last year, AFLAC was the first company to be approved as a seller of this new insurance instrument.

This was the right approach, as most employees already have paid leave options as reported recently by the Cato Institute. Because these programs are not mandated “one size fits all” benefits, they are tailored to the needs of individual employers with their employees as a part of broader benefits packages. The danger of mandated paid family and medical leave is that it will limit flexibility and harm small employers who can not afford to have employees take extended leave. Worse yet, many large businesses may opt to end their more generous private leave plans because of the complexity of getting their plans approved as an alternative to the government-mandated program.

Governor Youngkin should veto this bill — and allow the private market to continue to close the gap in paid leave benefits through private insurance and employer-employee benefit negotiations. The Democrat’s dystopian view of employers as unwilling or unable to help accommodate the needs of their employees without the heavy hand of government is backward thinking.

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Governor Youngkin uses his veto pen to protect farmers and lower-skilled workers 

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There is a near-universal consensus among economists that increases in the minimum wage harm low-skilled workers the most. Originally designed to mimic racially discriminatory laws elsewhere, the minimum wage continues to be a means of picking certain classes and geographic locations over others. For example, the minimum wage benefits the high-cost-of-living areas in the Northeast over the lower-cost-of-living areas in the South. It also benefits the more educated over the less educated, and as I have noted before in the Jefferson Journal, increases in the minimum wage benefits the healthy over the handicapped. Governor Youngkin’s understanding of the dangers of government intervention in wages is best summarized in the Governor’s defense of his veto of HB1 and SB1 — which would have raised the minimum wage to $15 per hour. In his veto explanation, the Governor notesThe free market for salaries and wages works. It operates dynamically, responding to the nuances of varying economic conditions and regional differences. This wage mandate imperils market freedom and economic competitiveness.” Acknowledging the regional differences in impact, the Governor noted“Implementing a $15-per-hour wage mandate may not impact Northern Virginia, where economic conditions create a higher cost of living, but this approach is detrimental for small businesses across the rest of Virginia, especially in Southwest and Southside. A one-size-fits-all mandate ignores the vast economic and geographic differences and undermines the ability to adapt to regional cost-of-living differences and market dynamics.” Even without the Governor’s signature, Virginia’s minimum wage was set to be indexed to the consumer price index beginning in October of 2024. This will keep the earning power of the current minimum wage intact going forward — which is a much more reasonable approach and will prevent a wage shock that will surely have an immediate negative impact on Virginia’s most vulnerable workers. The Governor also vetoed a companion bill, HB157, that would have removed the long-standing exemption from the minimum wage for migrant and farm labor. Governor Youngkin clearly understands the truism written on many bumper stickers that “farmland lost, is farmland lost forever,” when he wrote in his veto explanation“The agricultural sector has thin margins, and this bill will significantly affect the industry. The data from the USDA Census of Agriculture and the Weldon Cooper Center for Public Policy further emphasize the importance of supporting our agriculture industry. The loss of five thousand farms and nearly five hundred thousand acres of farmland in the last five years has dramatically altered our economy and communities.” It is refreshing to have a Governor who understands and can articulate important economic principles so clearly. We applaud Governor Youngkin for his bold use of the veto in defense of those the General Assembly foolishly put at risk when they passed these bills. We are thankful for the Governor’s clear desire to see the Commonwealth move forward with continued job growth, a strong economy, and healthy farming communities.
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The Sausage Factory Produces a Digital Sales Tax with Little Explanation or Debate

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The Virginia General Assembly has now jumped into the brave new world of taxing the digital economy, but the sales tax provisions it adopted in the budget conference report Saturday are not the same ones that appeared in earlier budget versions. The cabal of tax raisers in the secret final negotiation got creative.

As the final budget negotiations began, the House of Delegates and Senate budgets differed on the key point of whether to exempt businesses from paying sales and use taxes on a host of digital services and goods. By extending the tax to business transactions, the Senate proposed to collect about $1 billion more for its spending plans.

The tax amendment both bodies approved Saturday agreed with the Senate position of extending the tax onto business transactions but did not include the full list of digital services that will now be taxable for individuals. The business taxpayers will only have to pay on “software application services.”

If this budget provision survives and becomes law effective July 1, beginning in 2025 individuals will also have to pay on “computer-related services, web hosting and design, data storage, and streaming services.” Those are on top of the various digital products that more closely parallel traditional tangible goods, such as a downloaded movie or book.

The final draft adds very consequential language about how to tax bundled transactions of both goods and services, paragraphs that appeared in no version during the regular Assembly process. And it loops in Virginia’s existing sales tax on communication services, which was the state’s first foray into taxing services when approved more than a decade ago.

Both are complicated provisions, substantive changes in tax policy, that were sprung on outsiders as a surprise when the conference report was revealed late Thursday. In the 48 hours before the vote, no full analysis emerged. During the brief floor debates, neither issue was a topic. The infamous law of unintended consequences will be in full play.

The new code section on bundled services can be found in the text at §58.1-603.3. Then the bundled transaction language is applied to the communications sales tax at §58.1-650. If a different tax rate would normally apply to different parts of the transaction, the higher of the two rates could be imposed on all of it.

For the average taxpayer, these details will be gibberish. They will simply pay more tax on scores or hundreds of annual purchases, and in most cases will never notice the sales tax buried on the bill. But for Virginia’s business community, the details will matter, and the coming process to develop guidelines at the Virginia Department of Taxation will be fraught with peril.

Only a half dozen or so other states already tax digital products and services, and their rules on how to treat business-to-business transactions vary widely.

Republican Governor Glenn Youngkin is strongly opposed to what just happened, and the sales tax base expansion is the main reason 14 Senate Republicans and 37 House Republicans voted nay on the conference report Saturday. Youngkin is correct in his assertion that once it is fully in effect, it costs taxpayers about $1.5 billion per year. It also increases the cost impact on taxpayers of the bills on his desk allowing an additional 1% sales tax bite for local school capital projects.

But by burying the issue in the budget, something Youngkin did to himself, he complicated his ability to simply veto the budget item outright. There have been legal arguments in the past over gubernatorial vetoes of budget language, and now such a veto would have to be accompanied by a detailed list of major spending reductions.

To repeat a line from two months ago: “The dilemma the governor will face in the final budget showdown in March is obvious to everybody who has a cursory understanding of how the budget process works.”

In the brief floor debates, Republicans did point out that the sales tax is regressive, in that it takes a larger chunk out of the incomes of lower- and middle-income taxpayers. In recent years Democrats have postured that they want to make Virginia’s tax code less onerous to the poor, but the 2024 session will make our tax code more onerous. To steal a song line, a pocketful of mumbles, such are promises.

More telling was a colloquy Saturday between Delegate Lee Ware, R-Powhatan, and Delegate Vivian Watts, D-Fairfax. Ware has been chair of the House Finance Committee, Watts is now.  Ware’s questions illustrated how that committee has totally lost its authority and the big spenders of the House Appropriations and Senate Finance committees have grabbed all that power.

Until just a few years ago, the power to tax and spend were centered in different committees, at least on the House side. And even on the Senate side, the rules worked to keep taxing and spending bills separate. A standing rule specifically required that any bill on revenue issues had to clear committee and the full floor vote first — in effect deciding the revenue amounts before the spenders got their hands on it.

A line appeared on every session calendar, designating a deadline for “Committees responsible for revenue bills to complete work by midnight,” in advance of the budget bills. That line is now gone from the calendar and the spending foxes are in total command of the taxpaying chickens.  The separate revenue process is also undermined by this growing practice of embedding tax bills into the introduced budget.

Legislators are not ones to surrender power, as all the failed 2024 campaign finance reform efforts proved once again. The passage of this massive tax policy revision within the budget bill, with the final language only appearing in the final hours, cements the future practice. It is one more reason Virginia is increasingly considered less and less a stable, reliable place to do business.

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