West Virginia’s Governor Justice and top lawmakers have expressed support for eliminating or reducing the state’s income tax during the upcoming legislative session.
The personal income tax is the state’s largest source of tax revenue, providing the state with $1.95 billion in FY 2020, which accounts for 43 percent of the state’s general revenue fund.
The personal income tax is usually the fairest source of revenue collected by state and local governments. A well-designed income tax can ensure that wealthier taxpayers pay their fair share, allow for lower rates on low- and middle-income families, and provide a counterweight to less balanced taxes.
For the most part, West Virginia’s personal income tax meets these standards. West Virginia’s personal income tax is progressive, meaning that it is structured such that higher-income residents pay a larger share of their income in personal income taxes compared to low- and middle-income residents.
While the alleged economic benefits of eliminating the income tax are questionable at best (and will be explored more in a follow-up post), one certainty is that eliminating the income tax would dramatically alter the distribution of state and local tax systems in ways that are detrimental to lower-income families.
States without income taxes are not necessarily “low tax” states for everyone. The trade-offs required to make not having an income tax possible often result in higher taxes overall, particularly for low- and middle-income families. Public services such as schools and roads must be paid for somehow, and in states without income taxes this typically means higher sales taxes, excise taxes, and property taxes, all of which tend to fall more heavily on lower income families.
As a result, the bottom 20 percent of households pay an average overall state and local tax rate of 11.2 percent of their incomes in the states with no income taxes. In comparison, those households pay an average overall state and local income tax rate of 10.2 percent in the states with the highest income tax rates. In other words, low-income households pay more in taxes in states without an income tax than they do even in the states with the highest income taxes.
The opposite is true for high-income families. Without exception, the lowest state and local tax rates in the nation for high-income taxpayers are found in the states that do not levy personal income taxes. On average, states with the highest top tax rates collect 9.8 percent of their wealthiest residents’ incomes in taxes. In the states without personal income taxes, the effective tax rate for this group is less than one-third of that level, or 2.6 percent of income.
Simply eliminating the income tax would provide a huge windfall for West Virginia’s wealthiest residents, with relatively little benefit for the rest of the state. The wealthiest 1 percent in West Virginia, those making more than $413,000 per year, would see an average tax cut of more than $36,000 — more than 43 times greater than the tax cut middle-income West Virginians would receive. Of the total $1.9 billion tax cut, over 70 percent of the savings would go to the wealthiest 20 percent of taxpayers in West Virginia.
Fully eliminating the income tax would be fiscally disastrous without some form of replacement revenue, which in most states with no or very low income taxes, comes in the form of a high sales tax. But, as mentioned above, because the sales tax falls most heavily on low- and middle-income families, the savings from eliminating the income tax can be completely offset by increases in the sales tax, resulting in an overall tax increase for all but the most wealthy.
For example, if West Virginia were to replace just half of the revenue lost from eliminating the income tax with an increase to the sales tax, the sales tax would have to increase from its current rate of 6 percent to 10.3 percent, which would give the state the highest state sales tax rate in the country, by far. The current highest state sales tax is California’s at 7.25 percent.
The rate would be even higher when local sales taxes are included. 58 municipalities in West Virginia have a local sales tax of 1 percent. For those cities, the combined state and local sales tax rate would be 11.3 percent. That is nearly 2 percentage points higher than the state with the current highest combined state and local sales tax rate, Tennessee, at 9.5 percent.
Raising the sales tax to 10.3 percent would replace half of the revenue lost from eliminating the income tax, but it would also mean that 60 percent of West Virginians would see an overall tax increase. Only the wealthiest 40 percent of West Virginians would receive an overall tax cut with the income tax eliminated and the sales tax increased. The wealthiest 1 percent of West Virginians would get an average tax cut of over $33,000. The poorest 20 percent of West Virginians would see average tax increase of almost $200.
And even with a 10.3 percent sales tax, and a net tax increase on 60 percent of West Virginians, the state would still be facing a revenue loss of nearly $1 billion.
States without the income tax almost always require higher sales and excise taxes to fund public services, putting the responsibility of paying for those services on low-income families. The benefits of eliminating the income tax are almost entirely enjoyed by the wealthy, while costs are shared by all, as eliminating the tax would undermine the investments in education, infrastructure, and other public services that are funded with income taxes.
