Brace yourself. Virginia is about to start talking about taxes. Not raising them, but whether to keep to keep a windfall of revenues from taxes that got raised without anyone actually voting for them. Gov. Ralph Northam, a Democrat, is already proposing ways to spend some of that money. Republican Speaker of the House Kirk Cox is already calling this “Northam’s middle class tax increase.”
Before the politics get too out of hand, let’s take a more cold-eyed view of what’s happening. First of all, this is not “Northam’s middle class tax increase.” It’s a tax increase for some people, to be sure, but the parentage of it is accidental. When Congress passed its tax bill last December, it lowered taxes for most taxpayers — but not all. We can argue another day about who benefited most from those tax cuts, but here’s what we need to know today. According to an analysis by a consulting firm hired by the state, 10.2 percent of Virginia tax returns will actually see their federal taxes increase. That’s money going to the federal treasury, not the state one, but here’s how that plays out.
The new federal tax law means that 25.7 percent of Virginia tax returns will see their state taxes increase as well. The precise reasons why a federal tax cut winds up becoming a state tax increase may require an accountant to explain, but the layman’s version goes like this: The federal tax law changes deductions and what can be itemized. Because state taxes are based on how you filled out your federal tax form that sets off a series of calculations that don’t always work to a taxpayer’s advantage on their state taxes. The very short version: The two tax systems are now out of whack.
Who are the people who will be paying more state and federal taxes as a result of these changes? There are some in every income bracket, according to the analysis by Chainbridge Software. Those in lower income brackets see the biggest percentage increases in their state taxes; those in higher income brackets see the biggest increases in dollar terms.
Some of those 25.7 percent of those returns will still see their overall taxes go down, but most will not. In all, 16.5 percent of Virginia tax returns will see an overall increase on their combined state and federal taxes. That’s 606,561 returns in all. On average, those taxpayers will wind up paying an additional $1,937 in combined state and federal taxes. It’s safe to say that this will come as quite a surprise to those Virginians. Some people making under $25,000 a year will wind up paying $934 more; some making over $1 million a year will wind up paying $210,445 in additional taxes. In all, the Virginia treasury expects an additional $594 million in tax revenues in 2019 as a result of the federal tax changes, growing to $611 million in 2020 and on up to $950.6 million extra in 2024.
This is what Republicans call “Northam’s middle class tax increase,” which seems an inaccurate and unfair term — although Northam isn’t exactly proposing to reverse it, either. Not surprisingly, Democrats and Republicans have different views on the subject. House Republicans are expected to present a plan in coming weeks to address this inadvertent tax increase. Northam, meanwhile, has gotten out in front by presenting a plan for a tax refund for some taxpayers. You’d think a tax refund would be something Republicans would like, except this one isn’t. Northam’s proposal is aimed at the Virginians who take the earned income tax credit, which is generally described as aimed at low-income taxpayers, although that “low-income” definition seems a somewhat loaded term. The highest income bracket eligible for the credit is up to $49,194 for a single person with three children or $54,884 for a couple with three children. You can decide whether that qualifies as “low income.” In 2015, some 633,000 Virginia households filed for the federal earned income tax credit, according to The Commonwealth Institute for Fiscal Analysis; another 150,000 qualified but didn’t file.
Here’s the short version of how Northam’s proposal would work: Suppose someone owned the state $800 in taxes but qualified for a $1,000 credit under the earned income tax credit. Today, that means they’d pay no taxes because the credit more than covers the tax liability. Under Northam’s proposal, that person would get the $200 difference in the form of a refund. That’s expected to cost about $250 million, or 42 percent of the state’s windfall from the tax changes.
Republicans see this as redistribution of the wealth from taxpayers in higher income brackets. “If you haven’t earned it, you shouldn’t get the additional money,” says Del. Chris Jones, R-Suffolk, and the chairman of the House Appropriations Committee. State Secretary of Finance Aubrey Layne argues that this is exactly what the earned income tax credit was created for. It was first proposed by Milton Friedman — “one of the godfathers of modern Republican economic thought,” according to Politico — and enacted under a Republican president, Gerald Ford. The idea was that lower-income taxpayers are hit by a lot of regressive taxes — such as the sales tax. The earned income tax credit was created as a way to mitigate that; Republicans initially billed it as conservative alternative to public assistance. This isn’t welfare; by law, you have to be working to qualify for the credit. In pushing his earned income tax credit plan, Northam is effectively embracing what was once a Republican argument. Here’s the curious thing: You can certainly view this as a redistribution of the wealth from upper-income taxpayers to lower-income ones. Or you can view it as a redistribution of the wealth from Democratic localities to Republican ones. That’s because the people most likely to file for the earned income tax credit are in rural Virginia, especially Southwest and Southside Virginia, the two most Republican parts of the state. The people least likely to file for it are in Northern Virginia, one of the most Democratic parts of the state. This creates an unusual political dynamic. Layne pitches this as an economic development plan for rural Virginia, on the theory that those who get a refund check will spend it and help the local economy.
The debate we’re about to get will be a test of whose narrative prevails: Are Democrats enabling a tax increase on some taxpayers simply by doing nothing and letting the tax changes take effect? Or are Republicans standing in the way of a tax refund that would disproportionately benefit many of their rural constituents? The irony, of course, is that both views are correct.