The Virginia General Assembly will face a fast start to a short session when it returns to Richmond to tackle the most perilous of issues in an election year: the balance between tax relief and government spending.
A simmering debate over state tax policy finally reached a boil Friday, as Republican leaders in the House of Delegates proposed a plan that targets tax relief for what they call middle-class Virginians — two-income families making between $125,000 and $150,000 — while offering some help to lower-income earners.
The proposal was a challenge to Gov. Ralph Northam, who has proposed to use $1.2 billion in additional state tax revenues from federal tax reforms to help low-income working households and pay for widely sought investments such as improving water quality in the Chesapeake Bay and expanding access to broadband networks in parts of rural Virginia that lack it.
The timing requires immediate attention if the legislature has any hope of making major tax policy changes available to taxpayers who soon will file state returns for 2018. The assembly also needs immediate clarity to determine how much money it has to spend on its priorities in the state’s two-year budget.
“Until we resolve the tax policy issues, we will be unable to produce a budget,” House Appropriations Chairman Chris Jones, R-Suffolk, said during a press conference call Friday led by House Speaker Kirk Cox, R-Colonial Heights.
Jones had called publicly for a special session on tax policy last year in response to the Tax Cuts and Jobs Act, which President Donald Trump signed in December 2017, but the opportunity was lost in the bitter aftermath of the pitched political battle over Medicaid expansion last spring.
The General Assembly has been in special session ever since, but it hasn’t elected judges or filled a long-vacant seat on the State Corporation Commission, much less tackled comprehensive tax reforms.
“They’re already in special session — we could have done this in November,” Secretary of Finance Aubrey Layne said Saturday.
Del. Richard “Dickie” Bell, R-Staunton, tried to jump-start the debate in September, when he filed a bill that would allow Virginia taxpayers to continue itemizing deductions on their state returns even if they claim the fattened standard deduction on their federal taxes.
The same proposal is the linchpin of the tax plan unveiled by Cox and other House Republican leaders on Friday. It includes an emergency clause so that tax policy changes could benefit taxpayers who will file state returns this spring for their 2018 taxes.
“It was filed September 17 in hopes that it might be part of the Republican conversation, but was never part of any conversation on tax reform by the caucus,” said Bell, who said he will not run for re-election after this year.
Now, with political control of both assembly chambers at stake in next November’s election, legislators will grapple with a choice of whether to spend an unintended state income tax windfall from Trump’s tax bill or give it back to taxpayers.
“I want to give some back and invest some,” said Del. Mark Sickles, D-Fairfax, second-ranking Democrat on the Republican-controlled Appropriations Committee.
Senate Republican leaders haven’t shown their hand on how they want to play the game, but they generally insist on protecting middle- to upper-income taxpayers who could pay more in state taxes because of the federal law.
“That’s the crux of the session,” said Sen. Ryan McDougle, R-Hanover, chairman of the Senate Republican Caucus. “Virginians will not take advantage of the federal tax reforms unless we make some changes. I think we need to return that money to Virginians and let them spend it.”
But McDougle and other legislators who represent rural areas also want their constituents to have an opportunity to get their share of economic growth through access to high-speed broadband communications networks, especially in light of state incentives for big companies such as Amazon and Micron Technologies to locate or expand operations in Northern Virginia.
In a pre-Christmas spree of budget announcements, Northam proposed a five-year, $250 million investment in broadband — beginning with $50 million in the fiscal year that begins July 1. He would pay for it with “limited-time” money from increased state income taxes under new federal tax provisions for individuals that will expire after 2024.
Senate Republicans support the spending priority, but not necessarily the source of money to pay for it.
“You can make some decisions on priorities with current resources, as well,” said McDougle, a member of the Senate Finance Committee. “It doesn’t have to be new money.”
Democrats back the governor’s proposal to give about $216 million from the temporary federal tax provisions to low-income taxpayers who qualify for the earned income tax credit, but whose state tax liability isn’t large enough to use the entire amount.
They also think Northam’s proposal to give teachers an additional 2 percent raise — on top of the 3 percent increase they are due to receive in July under the current budget — represents a crucial investment in K-12 education that would be financed by recurring tax revenues that have been growing robustly.
“He would return the money to where the impact is the greatest,” said Del. Vivian Watts, D-Fairfax.
However, Watts is preparing legislation that would raise the state standard deductions to offset the effect of the new federal cap on deducting state and local taxes. It’s a big issue for homeowners in Northern Virginia, where property values and taxes are high, but it’s also part of the House Republican tax plan unveiled on Friday as both parties prepare for suburban political warfare.
“It’s going to be your suburban voter,” said House Appropriations staff director Robert Vaughn.
Those same voters are likely to be the lion’s share of the estimated 600,000 taxpayers whom Republicans expect to pay higher state taxes because they could no longer itemize if, under current Virginia law, they choose to claim the standard deduction on their federal returns, which doubled under the new tax law.
Vaughn predicts those voters will discover their higher state tax liability around February, as they are preparing tax returns for 2018.
“I think that’s when you’re going to hear the racket,” he said.
Decoupling the option of itemizing deductions from conformity with other provisions of the federal tax law is the linchpin of the House Republican tax plan. The legislation will be carried by House Republican Caucus Chairman Tim Hugo, R-Fairfax, one of two GOP delegates remaining in Northern Virginia after a Democratic electoral wave in 2017.
Hugo says the legislation would prevent “a hidden tax increase” that Northam’s budget would use to help lower-income earners and pay for new spending initiatives.
“Our proposal keeps more money in the pockets of Virginians without costing the state one penny,” he said Friday.
However, Layne said House Republicans have significantly underestimated the amount of lost state revenue under their plan, which also would increase the state standard deduction by $1,000 for individual taxpayers and $2,000 for couples.
House Republicans say their plan would reduce state revenues by $441 million in the next fiscal year, almost all of the additional money expected from the tax law’s temporary provisions for individual taxpayers, but the finance secretary says the true cost to the state could be “a couple hundred million dollars” higher than Republicans estimate.
Critics say the plan also would defeat the purpose of conforming state and federal tax definitions by requiring Virginia to create its own system for taxpayers to itemize deductions instead of relying on the IRS to define and police them.
“What do you itemize and who’s going to check up on it?” asked Watts, a member of the House Finance Committee.
The lower-income earners who would benefit under Northam’s proposed budget also make up a growing chunk of the population in suburban districts — more than 23,000 in Chesterfield County and 26,000 in Henrico County — said Michael Cassidy, president and CEO of the Commonwealth Institute for Fiscal Analysis, a liberal policy organization that favors a “refund” of the full earned income tax credit due to those who are eligible.
“It ain’t your grandpa’s suburbs anymore,” Cassidy said. “There are a lot of working-class people trying to make ends meet in these suburban districts, which are also swing districts.”
The legislative outlook is further complicated by a competing proposal, introduced in the House by Del. Chris Peace, R-Hanover, that would double the state’s standard deductions and drop its corporate income tax rate by a percentage point over two years.
Those proposals — which Layne estimated would cost $440 million and $160 million a year, respectively — echo a plan pushed by the Thomas Jefferson Institute, a conservative policy outfit that sponsored a poll which found taxpayers strongly in favor of the state returning the money instead of spending it.
“Hugo’s approach is to try to make everybody whole and go back to where we were before the Tax Cuts and Jobs Act,” said Steve Haner, a former state Republican party official who is a senior fellow at the institute. “Our goal is tax reform.”
“It would give broader tax cuts to millions of people, as opposed to a few hundred thousand,” Haner said.
But trying to address comprehensive tax reforms in a short legislative session “would be folly,” said Jones, the House Appropriations chairman.
The assembly’s failure to address tax policy in special session last year “may have been a wasted opportunity to address Virginia’s tax code,” said Nicole Riley, Virginia director of the National Federation of Independent Business.
The NFIB, with 6,000 small-business members in Virginia, prefers doubling the standard deductions as a simpler way to return additional tax revenues to taxpayers, but its biggest concern is immediate conformity between the state and federal tax codes to ensure that the federal law’s business provisions are enacted here.
“We want to see conformity to the federal changes,” said Riley, citing provisions that allow businesses to write off more capital expenses and lowering the tax rate on pass-through income.
House Finance Chairman Lee Ware, R-Powhatan, acknowledged that the House plan falls short of comprehensive tax reforms, but he called it “a good step in tax policy.”
However, Layne said it’s not likely to help taxpayers on their 2018 state returns because the legislation comes too late to enact many of the provisions, particularly for itemizing deductions by taxpayers who take the federal standard deduction.
“There’s no way we can get that done this year,” he said.
Instead, House Republicans propose a one-time deduction that taxpayers could use next year in preparing their 2019 returns — months after the legislative elections.
Jones has not given up hope that the General Assembly and governor could negotiate an agreement that could take effect on an emergency basis, which would require approval by 80 percent of each chamber’s representatives. They would have to act within the first two weeks after the legislature convenes Wednesday.
“We need the governor to come to the table,” he said.
But Haner, who has been involved in General Assembly sessions for more than 30 years, cautioned that “getting an emergency bill passed would require a lot more consensus than anyone expects.”