Virginia taxpayers will save almost $600 million over two years as a result of the increase in the state standard deduction, a step proposed last year by the Thomas Jefferson Institute for Public Policy. That is a fresh estimate released November 21 as the Senate Finance Committee heard an after-action report on the 2019 tax conformity issue.
It is not a huge dent in the almost $10 billion the state collects in individual income taxes over two years but can be viewed as a tax reform glass half full. Further tax reform does not seem to be high on the General Assembly’s 2020 agenda, but it should be. Virginia has a long history of complacency and inertia on tax policy, changing only when forced.
The higher standard deduction was made possible by a windfall of state tax revenue created by conforming to changes in federal income tax rules in 2018. The General Assembly could have kept the entire windfall for spending initiatives. The Jefferson Institute led a campaign pressing for corresponding state tax reforms. The fresh data is now reducing the estimated size of that windfall going forward, but additional tax reform is still possible.
The 2019 tax reform legislation created a Taxpayer Relief Fund that is intended to hold any additional revenue in the windfall generated by conforming to the new federal rules and not returned to taxpayers, keeping the excess funds segregated and available for additional tax reform. That was something else recommended by the Jefferson Institute and adopted.
The state is now projecting that the various changes made in 2019 are eliminating most of the revenue windfall created by the federal changes, in part because it now estimates much lower income from that windfall than it first projected. After $431 million in one-time refunds this fall, the first deposit into the Taxpayer Relief Fund will be just $24 million, with an estimated $5 million more to be deposited in 2020.
However, using the state’s new and conservative projections, made without much transparency, there are potential Taxpayer Relief Fund deposits of $165 million in 2021 and $183 million in 2022. Those sums create potential for minor tweaks to reduce state income taxes, and again a higher standard deduction or some other help on the low end should be the focus. The 2020 General Assembly should leave the Taxpayer Relief Fund in place and use it as intended.
This year’s increase in the standard deduction provided the most generous tax reform, saving a Virginia couple $173 per year. Because the vast majority of households now take the standard deduction, that amounts to $360 million in tax relief for this year and $236 million more next year. It should have been higher.
Virginia’s standard deduction of $6,000 for a married couple had been unchanged (and eroded in value by inflation) for decades. The Jefferson Institute recommended that Virginia double it, to $12,000 per couple, but the 2019 General Assembly only went halfway and raised it to $9,000. The standard deduction is a portion of income exempt from the personal income tax.
Even at $9,000, Virginia’s standard deduction is substantially below the tax-free income allowed at the federal level or in surrounding states. Because the Internal Revenue Service adjusts its provisions for annual inflation, the 2020 federal standard deduction goes up to $24,800 for a married couple. That means Virginia taxes $15,800 in income which is not taxed at the federal level, a major burden on lower income families, who often owe zero federal income tax. Matching the federal amount would save that couple up to another $900.
The Jefferson Institute recommended that Virginia also start indexing its tax provisions to inflation. A failure to do that in effect creates small annual tax increases. But that was not adopted in the 2019 state tax legislation. It remains a good idea, another good way to expend the Taxpayer Relief Fund going forward.
Increasing the state standard deduction was right in line with the new federal policy, but there were four other tax changes which reversed the federal policies and put Virginia out of conformity. The new committee presentation also provided the latest impact estimates for them, three tax cuts and one tax hike.
Two major business tax deductions, taken away by the federal law but restored by the General Assembly, saved corporate taxpayers about $11 million this year and will save them almost $48 million over the next two years. The largest allows an interest deduction in Virginia which was disallowed at the federal level.
For those individual taxpayer who still itemize their deductions, Virginia will also ignore the new federal $10,000 cap on state and local tax deductions. Allowing Virginians to deduct all state and local taxes saves them (and costs the state) $97 million over the next two years. This was a nod toward the regions with the highest housing tax amounts, but some taxpayers everywhere will benefit.
The three tax cuts other than the standard deduction saved taxpayers another $145 million over two years, but their benefit will be far smaller than the $181 million in revenue collected by a Virginia-specific wealth tax also created in the legislation.
Congress eliminated a federal wealth tax provision which limited the deductions allowed to high income taxpayers, but effective with this year the state put it back in place for state returns only. The rule is known as the Pease Limitation. To trigger the limitation the taxpayer needs income of about $325,000 or more, and as income grows, the deductions allowed shrink.
Even that high trigger will capture enough Virginia taxpayers that Virginia expects to collect $108 million off the Pease Limitation this year and another $73 million next year. It takes back about one-third of the total savings from the higher standard deduction.
With its low standard deduction, Virginia taxes low income workers more heavily than its neighbor states, and with the Pease Limitation back in place it puts an additional burden on its richer citizens. Neither makes Virginia more competitive or attractive.
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