VIRGINIA Democrats, led by Gov. Ralph Northam, are preparing to do what Democrats were born to do: raise taxes and spend other people’s money. The opportunity arises thanks to the simplification reforms in last year’s federal tax-cut legislation. This makes the current opportunity to tax and spend especially appealing because state Democrats can use the changing and complex relationship between state and federal tax codes as a cover to ding middle-class Virginians.
Supporters say the state income tax increase Northam proposes will mainly affect “the wealthy.” That’s accurate only if your definition of wealthy extends to, say, a married couple of twenty-something public schoolteachers who just bought their first house. Assuming a net income of about $80,000 for our two young educators, a back-of-the-envelope calculation of their state income tax liability suggests it would balloon by at least $700 under the Northam plan.
The state’s windfall, estimated at $594 million, arises because federal tax reforms last year almost doubled the standard deduction—up to $24,000 for married couples filing joint returns. This produced at least two benefits for taxpayers: (1) For most, it lowered tax liability, especially when combined with rate cuts; and (2) For millions of taxpayers, it eliminated the tiresome, time-consuming task of listing and documenting itemized deductions, such as mortgage interest, charitable donations and real estate taxes. A win-win, as they say.
But because the Virginia tax code only allows filers who itemize on their federal returns to do so on their state filing, many middle-class workers, like our aspiring teachers, face a big tax shock next year. That’s because taxpayers with less than $24,000 in deductions have zero incentive to itemize on their federal return. To do so would cost them both time and money.
Let’s say our teachers have $19,000 in itemized deductions, not an unreasonable assumption if they have a house, a mortgage and outstanding student loans. They won’t itemize on the federal forms because their deductions are $5,000 below the automatic federal standard deduction.
Before the federal reforms were enacted, the couple would have been able to deduct the $19,000 on state taxes as well. But under current Virginia law, because the couple took the standard deduction on their federal return, they are required to do so on their state return as well.
Virginia’s standard deduction is $6,000 for a married couple (and $3,000 for an individual), so our teachers’ taxable Virginia income will be $13,000 higher than if they were still able to itemize. That translates into about $750 in additional state income taxes. Some middle-class Virginians could see their state tax bill increase by more than $1,000. Wealthier taxpayers would, for the most part, be unaffected.
Northam has proposed using about half of the state’s anticipated $594 million revenue windfall from federal tax reforms to expand Virginia’s earned-income credit, in a way that would allow low-income workers to receive a check from the state if their credit exceeds their state tax liability. For example, a worker who qualifies for a $1,000 credit, but owes only $800 in state income taxes, would receive a $200 payment from Virginia. We support this idea. Earned income credits are an effective method for shifting funds from the government to workers. The earned income credit payments tend to only partially offset payroll taxes deducted from workers’ wages.
We do not, however, believe that middle-class taxpayers should be forced to fund this credit, as Northam’s plan would require. Nor do we believe the state should use the rest of the money to expand its already expansive budget. Instead, the governor should work with both parties in the General Assembly to enact revenue-neutral tax reform that both simplifies the tax code and rewards work, personal initiative and private investment.
If comprehensive reform proves too much for our leaders right now, the simplest short-term solution might be to raise the state’s standard deduction to a level that minimizes harm to Virginia taxpayers. With $594 million to work with, that shouldn’t be too hard to accomplish.