Competing Approaches to Tax Relief for Virginians

As the General Assembly considers tax bills, it is important to compare the different options and the burden they place on poor working Virginians. As part of Governor Kaine’s recommended budget amendments, he proposed the Working Virginians Tax Cut. This proposal would raise the state’s filing threshold and “no-tax floor” so that individuals making less than $12,000 and married couples with an income of less than $24,000, would not have to pay taxes or file a return beginning Jan. 1, 2008. This updated no-tax floor would change current tax law in which individuals with income less than $7,000 and married couples making less than $14,000 a year do not have to file.

Senator Stosch introduced Senate Bill 778 that would enact the Governor’s package as proposed. Likewise, Delegate Cline’s House Bill 3022 would have done the same. However, when the House Finance Subcommittee took up HB 3022 on Monday, Jan. 29, 2007, an amended version in the form of a substitute was passed. The substitute took a different approach to tax relief and watered down the original proposal, providing less tax relief for low-income Virginians.

Governor’s Proposal/ SB 778

Amended HB 3022“No-Tax Floor”/Filing Threshold ChangesIndividual Increases from $7,000 to $12,000Increases from $7,000 to $10,210MarriedIncreases from $14,000 to $24,000Increases from $14,000 to $20,420Personal Exemption ChangesNo changeIncreases from $900 to $930

The Governor’s Proposal and Senate Bill 778 are steps in the right direction to provide needed tax relief for low-income Virginians. These proposals each raise the filing threshold/no-tax floor to be above the federal poverty line. This allows the relief to address not only the “poor” as defined by the federal poverty line, but also the “near poor” (those living just above the federal poverty line).

The House bill, however, halts the relief at the federal poverty line. It then provides a token increase to the personal exemption for all taxpayers – including the wealthiest. By doing so, HB 3022 spends millions in tax revenue for a small benefit of no real value to taxpayers: less than 14 percent of taxpayers would see a tax reduction of more than $5 and less than one percent would see one of more than $10.

This change comes at a steep price for low-income workers who can be helped by the Governor’s proposal and SB 778. The House Bill reduces the tax cut for the poorest Virginians (those making less than $19,000 a year) by 73 percent and on the next poorest income group (those making less than $33,000 a year) by 55 percent.

Background

As part of his recommended budget amendments, Governor Kaine proposed the Working Virginians Tax Cut. According to the Governor (using data from the 2004 tax year), this change would mean that 176,000 working Virginians who now have to file the paperwork to prove that they owe no taxes would no longer have to file. In addition, it is estimated that another 147,000 working Virginians would no longer have to pay any state income taxes. Thus, slightly less than 10 percent of all returns will be eliminated. The revenue impact of this proposal is modest. Estimates are that it will reduce revenues by $13.8 million in 2008, $27.4 million in 2009, and $24.9 million in 2010.

The Working Virginians Tax Cut will help address some of the unfairness in the state’s tax system. The increase means the state’s no-tax floor would reach above the current federal poverty guidelines for individuals and families of four. As noted in the Governor’s budget speech, Virginia has a reputation for being a low tax state. However, low-income Virginians pay a disproportionate share of state and local taxes. According to the Institute on Taxation and Economic Policy, the poorest 20 percent of Virginia households (those earning less than $16,000 per year in 2002) paid 9 percent of their income on state income, sales, excise and property taxes. The richest 1 percent of households paid only 4.8 percent.

This proposal is the latest of a number of efforts on the part of Virginia to reduce the burden of incomes taxes on the poor. It takes the approach of increasing the filing threshold and also increases Virginia’s no-tax floor, which is a targeted approach to providing tax relief.

Filing Thresholds Are Important, But Only Part of the Picture

A filing threshold establishes the minimum income for which a return must be filed. Many states require families to file a state income tax return if they are also required to file a federal income tax return. For example, the current filing threshold for federal income taxes is $8,450 for single taxpayers and $16,950 for married taxpayers. Virginia’s current filing thresholds are lower than that ($7,000 for individuals and $14,000 for couples filing jointly). This proposal would raise the Virginia filing threshold to be above the federal one.

The filing threshold, however, is different from the income tax threshold which is the income level at which someone begins to owe state income tax. A state’s income tax threshold is affected by two broad factors: provisions applicable to most or all that are designed to exempt some amount of income from taxation, and provisions specifically targeted to provide low-income tax relief. Income taxes generally are not imposed on total income. Virginia allows nearly every taxpayer some subtractions from income, most often through personal and dependent exemptions and/or standard deduction, before tax liability is calculated. The size of these exemptions, deductions and credits affects the income level at which families begin to owe tax.

No-Tax Floors: A Targeted Way to Provide Low-Income Tax Relief

This proposal is not just a filing threshold change, it is also a “no-tax floor,” or an income amount below which no taxes are owed. This is because the way the different bills under consideration by the General Assembly would implement the increase is in a section of the tax code that lays out the standards under which no tax is levied and no return is required to be filed. No-tax floor provisions supersede all other provisions of the income tax for taxpayers whose incomes fall below the specified level. So, a family who would otherwise owe income taxes but whose income falls below the floor would face no income tax liability.

A no-tax floor keeps the cost of income tax relief down by exclusively targeting families with income below a specified level. This proposal would set the Virginia floor high enough to eliminate income taxes on all families who fall below the federal poverty level, which is $10,210 for an individual and $20,650 for a family of four.

There are some areas of concern with this approach, however. First, the way the proposal is written, it makes no distinction for family size. Unlike other critical low-income tax programs such as the Credit for Low Income (CLI) individuals and the Earned Income Tax Credit (EITC), which do account for family size in calculating the amount of the credit available, this provides the same floor to all individuals regardless of the number of family members. In addition, a no-tax floor can have adverse impacts on taxpayers with income just above the floor. If the normal structure of the income tax takes effect immediately above the tax floor, a single dollar of additional income can have a “cliff affect” and trigger a significant amount of tax.

Other Important Approaches to Help Low-Income Virginians

This proposal is the latest of a number of efforts to reduce the burden of Virginia income taxes on the poor. Many states have chosen to exempt poor families from income tax. For quite some time, Virginia was behind the pack in this regard. A study by the Center on Budget and Policy Priorities, conducted in March 2000, noted several categories where Virginia was lagging. Virginia was among only four states that imposed an income tax on very poor families (those with incomes below half the poverty line) and were one of only two states (Alabama was the other) that did not raise those thresholds between 1991 and 1999. Finally, the study noted that Virginia was one of eight states where the amount of tax owed by a family of four with poverty level income actually increased between 1994 and 1999.

Recent changes have helped improve this situation. In 2000, the Credit for Low Income Individuals (CLI) was created for Virginians whose adjusted gross income is below the amounts set under federal poverty guidelines. CLI allows qualified individuals to claim a credit of $300 for each exemption (filer and dependent) reported on their returns. The CLI is not refundable, but it can significantly reduce tax liability. In 2004, legislation was enacted that expands the provisions of the CLI, effectively creating a nonrefundable Virginia Earned Income Tax Credit (EITC). Beginning with taxable year 2006, individuals may claim either the regular CLI or claim a credit for 20 percent of the EITC that they reported on the federal return (whichever is greater).

In 2004, legislation also raised the filing thresholds and no-tax floor for single filers from $5,000 to $7,000 and for married filers from $8,000 to $14,000.

TAX THRESHOLD REPORT

Virginia Improves How It Taxes Working-Poor Families: National Report

Virginia is making significant improvements in alleviating state income tax burdens for working families. By recently enacting a state Earned Income Tax Credit (EITC) program, Virginia has raised its tax threshold by nearly $5,000, according to a report released today by the Center on Budget and Policy Priorities.

“Families that are struggling to provide for their children are finally getting the kind of relief they need from state income taxes,” said Michael Cassidy, executive director of The Commonwealth Institute for Fiscal Analysis. “Between 2005 and 2006, we have entirely stopped taxing the income of poor families of four. This is a big step forward.”

Virginia begins taxing two-parent families of four when they earn $24,200, more than 17 percent above the federal poverty level of $20,615. Single-parent families of three are taxed when they earn $21,100, over 30 percent above the federal poverty level of $16,079, according to the report. A growing number of states are moving to provide state income tax relief to low-income workers. Virginia is one of 24 states that do not tax four person families below the poverty limit and is one of 27 states that do not tax three person families in poverty.

One of the key reasons that Virginia’s record in this area has improved in recent years is the creation of the state EITC program. Beginning in 2006, taxpayers are allowed to claim a credit on their state income tax return of 20 percent of the EITC that they reported on their federal income tax return. This new credit has helped Virginia move up its tax threshold for families of four as a percentage of the federal poverty line from 97 percent of the poverty line in 2005 to 117 percent in 2006. In addition, in 2000 the state created a Credit for Low-Income Individuals that allows qualified Virginians to claim a $300 credit for each exemption (filer and dependents) on their returns.

Both low-income credit programs have moved Virginia away from what had been a poor record of taxing low-income residents. Before the changes of 2000, Virginia was one of only four states that imposed an income tax on very poor families (those with income below half the federal poverty line). Since then the tax threshold has increased by over 40 percent; going from only $17,100 of income in 2000 to $24,200 in 2006 for a family of four.

Virginia continues to build on these key improvements. On March 21, 2007, the Governor signed into law a tax provision which removes more than 275,000 low-income Virginians from the tax rolls by expanding the filing threshold for state income tax from $7,000 for individuals and $12,000 for couples to $11,950 and $23,900, respectively over the next several years.

“We know that it makes no sense to tax people as they struggle to work their way out of poverty,” Cassidy said. “Removing the state income tax burden from low-income Virginians helps them provide for their families and provide opportunities for them to succeed.”


Read the full report at www.cbpp.org