Last week, the House swiftly passed an income tax reduction plan (HB 4892) that could lead to large budget deficits while giving most of the tax cuts to high-income West Virginians. While the bill is convoluted and vague, it is apparent it will have large fiscal ramifications for the state on top of eventually eliminating the state’s progressive personal income tax – the single largest source of revenue for the state budget.
Similar to a bill last year, this bill creates a Personal Income Tax Reduction Fund (the fund) to trigger reductions in the state’s personal income tax rate schedule. According to the bill, this fund would receive up to $3 million annually (beginning in 2021) from online internet sales tax collections (think Amazon/Netflix), 25% of General Revenue Fund Surpluses (this would amount to $9 million in both FY18 and FY19), and an undetermined amount from lottery and excess lottery funds beginning in 2020 that appears likely to be in the tens of millions based on the fiscal note. The fund can also receive appropriations from the legislature.
It is unclear how much revenue would flow into the fund annually but it’s apparent that it would redirect some lottery funds and that this would impact programs funded by the state’s lottery commission, such as the PROMISE scholarship, Medicaid, infrastructure, veteran services, and debt service on bonds, to name a few. This is especially concerning since the state is projecting declines in lottery funds of $50 million annually after fiscal year 2021 (see graph below).
Once the fund reaches “an amount equal to or exceeding 2.5 times the total net reduction in personal income tax revenue collections that would have been received in that fiscal year if the income tax rates for that fiscal year had been reduced by 0.25 percent” it triggers a reduction in the state’s personal income tax rates for each bracket of 0.25%. The rates would decrease by 0.25% every time the trigger is met. The fiscal note does not estimate the loss of revenue associated with the income tax rate reduction of 0.25% for each bracket or for any further reductions of 0.25% in the tax rates if they triggers are met. According to analysis from the Institute for Taxation and Economic Policy, the revenue loss from a 0.25% reduction in each of the five personal income tax rates (see table below) would be $102 million, a reduction of 0.50% would be $204 million, a reduction of 0.75% would be $306 million, and a reduction of 1% would be $408 million.
While the fund may have enough revenue to cover the drop in General Revenue tax collections that would result from the triggered reductions in the personal income tax brackets for the first year, over time it would not. That’s because the cost of the tax cuts is ongoing year to year, but the fund only replaces all or some of the revenue lost in one particular year when the trigger is met. It is unclear if the entire fund balance is deposited in the General Revenue fund when the trigger is met, but it would seem reasonable to assume any unused funds beyond filling the budget hole created by the income tax reduction would be carried over every year.
For example, the table below provides an illustrative example how the bill will lead to large revenue losses over time. While there are no estimates for how much lottery or surplus revenue from the general revenue fund will flow into the fund, the table below shows what the impact would be if $75 million per year flowed into the fund each year and the trigger for reducing income tax rate was $255 million or 2.5 times what the revenue loss would be if income tax rates were reduced by 0.25%. Each yellow row highlights when a income tax rate reduction of 0.25% would take place based on the fund reaching $255 million. As is evident from the table, by year five there will be a funding gap or revenue loss to the general revenue fund of $102 million and over time the revenue loss would grow to over $500 million by year 18.
If the amount of lottery funds diverted into the fund is small, say a couple of million per year, which might be the case, than the fund would build up slowly over time assuming no additional deposits. This means if it takes 15 to 20 years to reach the $255 trigger in tax reductions, than the fund would be just parking money into a fund over a long period of time.
Cutting Each Income Tax Rate Mostly Benefits High-Income West Virginians
Currently, West Virginia’s personal income tax rates starts at three percent on income under $10,000 and tops out at 6.5% on income over $65,000, as shown in the table below. Because West Virginia has a progressive income tax structure, as income increases so does the rate at which it is taxed. The state’s tax rates are also marginal. For example, if your taxable income is $250,000 (after any deductions, credits, or exclusions) this does not mean that all of your income will be taxed at the top rate of 6.5 percent. Your first $10,000 is taxed at three percent, the next $15,000 at four percent, and so on. Only the last $190,000 is taxed at the top tax rate of 6.5 percent.
The table below shows the current marginal tax rates and what the rates would be according to HB 4892 for a reduction of 0.25% and 1%. A tax filer with $50,000 in taxable income would see a tax reduction of $125 under a reduction of 0.25% for each tax income tax bracket and reduction of $500 if the rates are reduced by 1%. Meanwhile, for someone with a taxable income of $250,000 the tax reduction would be $625 and $2,500 respectively. This means that the reduced rates in this way gives a larger tax cut to those with higher incomes (Note that this is taxable income, which is lower than total income.)
While the table shows the impact of a 0.25% and 1% reduction on two tax filers based on taxable income, the graph below shows the impact of cutting personal income tax rates by income group in West Virginia. According to the Institute on Taxation and Economic Policy, a 1% reduction in each personal income tax rate would give a West Virginian with an income between $38,000 and $59,000 an average tax cut of $235 compared to $6,027 for someone in the top 1 percent with an income of above $478,000. This means someone in the top 1 percent would receive on average a tax cut that is 26 times as large as someone in the middle 20 percent. This is because wealthier West Virginians benefit the most from each rate reduction, especially the top marginal tax rate that drops from 6.5% to 5.5%.
In fact, nearly 2 out of every 3 dollars of the estimated $408 million in tax cuts from reducing each of the income tax rates by 1 percentage point go to the top 20 percent of income earners that make over $96,000. Meanwhile, the majority of West Virginians in the bottom 80 percent only receive 38 percent of the total tax cuts.
HB 4892 is a poorly designed tax cut that will not only lead to large revenue losses but will also further exacerbate the state’s already large projected budget deficits over the next several years. West Virginia is currently running a budget deficit of over $10 million in the current fiscal year and our state faces significant funding shortages in our schools, colleges, health and human services, and other areas. If lawmakers want to cut taxes they need to start from the bottom up, not the top down, and the cuts need to be fiscally sound and balanced.
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