Date Requested: May 24, 2017
Time Requested: 01:57 PM
Agency: Tax & Revenue Department, WV State
CBD Number: Version: Bill Number: Resolution Number:
4019 Amendment HB107
CBD Subject: Governor -- Bills Requested By


FUND(S):

General Revenue Fund

Sources of Revenue:

General Fund

Legislation creates:

Increases Revenue From Existing Sources, Decreases Existing Revenue, Increases Existing Expenses



Fiscal Note Summary


Effect this measure will have on costs and revenues of state government.


    This analysis addresses the Senate Finance Amendment to the Engrossed Committee Substitute for House Bill 107 as passed out of committee on May 23, 2017.
    
    According to our interpretation, passage of this bill would result in a potential net gain of roughly $147.3 million in FY2018 General Revenue Fund tax receipts largely due to the implementation of proposed sales tax increases six months prior to significant Personal Income Tax rate reductions in comparison with current Law. Thereafter, State General Revenue Fund tax collections would decrease by roughly $56.1 million in FY2019, due to the full-year effect of the proposed Personal Income Tax reductions that are larger in scale than the proposed Consumer Sales Tax increases. The provisions of this bill would effectively reduce current Law tax revenues by an estimated $121.5 million in FY2020, $137.4 million in FY2021, and $177.6 million in FY2022. Due to the provisions of a trigger mechanism to reduce Personal Income Tax rates, these revenue reductions would exceed current estimate under accelerated economic conditions and lag current estimate if the economy grows slower than anticipated. Details of the various proposed tax Law changes follow.
    
    The provisions of this bill would replace the current Severance Tax rate structure on coal with alternative tiered tax rate structures that reduce industry tax burden when prices are low and raise industry tax burden when prices are high. At current price levels, the proposed changes would result in a decrease in tax liability for steam coal and some potential small decrease in tax liability for certain types of thin-seam and some metallurgical coal. The net impact of these proposed Severance Tax changes would be a $49.9 million reduction in State coal Severance Tax collections in FY2018 relative to current Law. Producing coal counties would lose an additional $1.7 million in FY2018 in shared coal Severance Tax revenues. Beginning in FY2019, the annual loss in State coal Severance Tax revenues would approach $51.0 million and the annual loss in county coal Severance Tax collections would approach or exceed $2.3 million per year. Based on past independent research reports, lower tax rates on steam coal may result in a very modest increase in annual production.
    
    Under the provisions of this bill, the State Consumer Sales and Service Tax and Use Tax rate would increase from 6 percent to 7.25 percent effective July 1, 2017. During the first full year of effect, this impact on the current base and the inclusion of the proposed base-broadening enhancements are expected to yield approximately $327 million for the State General Revenue Fund and up to $6 million for the Sales Tax Increment Financing (STIF) Districts. The sales tax would apply to: telecommunications services; digital goods; electronic data processing services; health fitness memberships; and primary opinion research. The bill would also eliminate the annual transfer of General Revenue Fund sales tax collections to the State Road Fund, an estimated net gain of $11.7 million per year for the General Fund. Finally, the provisions of this bill would add a new sales tax exemption for services of professional employer organizations, resulting in a small loss of revenue.
    
    Given that the sales tax provisions take effect on July 1, 2017, total General Revenue Fund collections for the 11-month collection period in FY2018 would be roughly $311.5 million, inclusive of the State Road Fund sales tax transfer and assuming full immediate compliance with the tax changes. With the window of time closing between now and July 1st, there is a growing likelihood of lower initial collections due to the lack of time for vendors and tax collectors to adequately prepare for the upcoming tax changes. Assuming normal growth in the sales tax base, FY2019 tax receipts would rise by $346.9 million.
    
    Within the past five years, authority was given to municipal governments to impose a local sales tax of up to 1 percent in addition to the State sales tax. Currently, 28 municipal governments that account for roughly 17 percent of the State’s population impose a local sales tax with an annual yield of roughly $70 million. An additional 11 municipal governments plan to add a local sales tax beginning July 1, 2017. When the sales tax base is broadened, these municipal governments also gain additional tax collections. Passage of this bill would effectively enhance local municipal sales tax collections by roughly $3.5 million per year.
    
    Beginning in Tax Year 2018, the provisions of this bill would implement a sizable reduction in State Personal Income Tax rates for all filers. The current five-bracket tax rate structure with rates ranging from 3.0 percent to 6.5 percent would be replaced with a four-bracket system with the following rates effective January 1, 2018: 2.25 percent on the first $20,000 ($10,000 for married filing separate); 3.95 percent on taxable income ranging between $20,000 and $35,000 ($10,000 and $17,500 for married filing separate); 5.65 percent for taxable income between $35,000 and $200,000 ($17,500 to $100,000 for married filing separate); and 6 percent for taxable income of $200,000 or more ($100,000 for married filing separate). Effective January 1, 2019, rates for these tiers would decrease to 1.85 percent, 3.65 percent, 5.45 percent, and 6 percent, respectively. These changes to the Personal Income Tax structure are anticipated to result in revenue losses of roughly $108 million in FY2018, roughly $314 million in FY2019, and roughly $382 million in FY2020, absent any further rate reductions as described below. The FY2019 estimate reflects the first full-year of reduced income tax rates and considers that withholding patterns may be adjusted in anticipation of the scheduled reduction to occur effective January 1, 2019.
    
    The bill also contains a trigger mechanism that would further reduce Personal Income Tax rates beginning as early as TY2020 by 0.1 percentage points when certain conditions are met. Our understanding of the language affecting the trigger mechanism and associated revenue projections follows. Alternate interpretations of the trigger language as written in proposed West Virginia Code §11-21-4h(d) et seq. would result in necessary adjustment to the estimates provided in this analysis.
    
    A rate reduction would primarily occur if the year-over-year increase in General Revenue Fund net collections as of June 30th for the most recent fiscal year (e.g., FY2019) compared to General Revenue Fund net collections as of June 30th for the immediately preceding fiscal year (e.g., FY2018) exceed a trigger threshold of $110 million (base in FY2019) annually adjusted upward by half of Consumer Price Index (CPI) inflation. For example, if FY2019 General Revenue Fund net collections exceed FY2018 General Revenue Fund net collections by at least $110 million, Personal Income Tax rates for all tiers would reduce by 0.1 percentage points effective January 1, 2020.
    
    In the event that the above trigger conditions are not met for any given year, future rate adjustments would be contingent on alternate analysis depending on whether the year-over-year increase in General Revenue Fund net collections for the most recent fiscal year compared to General Revenue Fund net collections in the last year in which a rate reduction occurred exceeds or is less than 65 percent of the inflation-adjusted trigger threshold. If the increase is greater than or equal to 65 percent, then no rate reduction occurs. If the increase is less than 65 percent, although no rate reduction occurs for the immediately following Tax Year, the annually-adjusted $110 million trigger is increased by 150 percent for the next fiscal year. The proposed bill states that the potential rate reduction in this case would be determined based on “any prior fiscal years’ revenue collections not applied toward a previous rate reduction” (W.Va. Code §11-21-4h(d)(4), emphasis added). It is our assumption that the earliest applicable fiscal year for this calculation could be FY2019.
    
    Assuming these interpretations and assumptions of the rate-reducing trigger mechanism are accurate, we do not anticipate a rate reduction to occur until January 1, 2022, as FY2021 revenues are the first since FY2019 in which the increase in net collections are sufficient to meet the criteria of the rate reduction mechanism. In comparison with current law, we anticipate FY2021 Personal Income Tax revenues may be reduced by nearly $400 million and FY2022 revenues may be reduced by approximately $438 million, assuming normal growth.
    
    Over a period of many years, it is plausible that income tax rates will trend downward following years of General Revenue Fund growth. These reductions, however, are anticipated to be relatively slow as income tax revenue reductions will likely offset any General Revenue Fund gains in the short term after a rate reduction occurs. For comparative purposes, we modeled the impact of this Personal Income Tax reduction plan over a period of 17 years as if it were implemented in 1999. Under this tax plan, total FY2016 General Revenue Fund collections would have been roughly 12 percent less than actual collections due to Personal Income Tax revenue declines. This estimate includes other revenue enhancements as proposed in this bill.
    
    As written, the proposed bill would create a decreasing modification for Social Security benefits included in federal Adjusted Gross Income (AGI) when federal AGI is less than $75,000 ($37,500 for married filing separate). For the tax year beginning January 1, 2018, 50 percent of eligible benefits may be deducted from an individual’s Personal Income Tax and for the tax year beginning January 1, 2019, 100 percent of eligible benefits may be deducted. We estimate this change would reduce Personal Income Tax revenues by approximately $9.1 million in FY2018, by $42.3 million in FY2019, and $48.8 million in FY2020. Revenue losses in out years are expected to be roughly $52 million in FY2021 and $56 million in FY2022. Reductions associated with this modification are anticipated to grow at a faster rate than typical income growth given the incorporation of Cost of Living Adjustments at the federal level and the aging Baby Boomer population increasing eligibility for taxable Social Security benefits. It is also important to note the presence of a cliff in which Taxpayers with similar liabilities will receive different tax treatment. For example, Taxpayers slightly below the income cutoff are eligible to deduct taxable Social Security benefits while Taxpayers slightly above the cutoff are not.
    
    The bill would also increase the tax preference for military pensions from exclusion on the first $22,000 of benefits received under current Law to a full income exclusion beginning in 2018 at a cost of roughly $1 million in FY2018 and roughly $3 million per year thereafter. Other provisions of this bill would temporarily increase the Corporation Net Income Tax rate from 6.5 percent to 7 percent beginning January 1, 2018. Corporation Net Income Tax revenues would rise by roughly $3.8 million in FY2018, by $9.1 million in FY2019, by $10.3 million in FY2020, and by $7.0 million in FY2021.
    
    Additionally, the bill would increase the State Historic Rehabilitated Buildings Tax Credit from 10 percent to 25 percent, resulting in a net cost of $1.6 million per year beginning as early as FY2019. This cost estimate solely relates to the continuation of current level average activity into the future with a higher State tax benefit tied to such average activity. The actual level of historic building rehabilitation activity is heavily tied to the demand for commercial real estate in major urban areas.
    
    The primary objective of this bill appears to be the elimination of the Personal Income Tax. An examination of the complete financial structure of those States that choose not to impose a Personal Income Tax might be a helpful consideration. These other states tend to rely much more heavily upon local governments and real property tax collections to provide services. States relying on local taxes for a majority of total state and local government financial responsibilities tend to spend more conservatively than others. However, most government financial responsibility resides at the state level in West Virginia as a result of the State imposing very low real property taxes on residents and lower than average real property taxes on commercial properties. Such policy is not likely to change because West Virginia decided to greatly limit the property tax many years ago by placing specific provisions in its Constitution.
    
    In addition to higher than average real property taxes, states without income taxes tend to impose special hybrid taxes to compensate for the lack of a broad-based individual income tax. Some of these taxes include the Business and Occupation Tax and Estate Tax in Washington, the Commerce Tax in Nevada, both a Franchise Tax and an Income Excise Tax on corporations and pass-through business entities in Tennessee, the Gross Margins Tax in Texas, and both the Business Profits Tax and Business Enterprise Tax in New Hampshire. Many states without income taxes also impose significantly greater sales tax burdens on business inputs than West Virginia. These states include Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Two states without a personal income tax, Alaska and Wyoming, are fortunate to have a very high ratio of mining output per resident with high natural resource related tax collections exported to nonresidents. However, Alaska is currently considering adoption of an income tax to address, in part, a growing fiscal deficit due largely to reduced natural resource extraction activities.
    
    Additional administrative costs incurred by the State Tax Department are expected to be $35,000 for the remainder of FY2017, $76,000 in FY2018, and $65,000 for each year thereafter.
    
    



Fiscal Note Detail


Effect of Proposal Fiscal Year
2017
Increase/Decrease
(use"-")
2018
Increase/Decrease
(use"-")
Fiscal Year
(Upon Full
Implementation)
1. Estmated Total Cost 35,000 76,000 65,000
Personal Services 0 45,000 45,000
Current Expenses 0 0 0
Repairs and Alterations 0 0 0
Assets 0 1,000 0
Other 35,000 30,000 20,000
2. Estimated Total Revenues 0 147,300,000 -17,760,000


Explanation of above estimates (including long-range effect):


    This analysis addresses the Senate Finance Amendment to the Engrossed Committee Substitute for House Bill 107 as passed out of committee on May 23, 2017.
    
    According to our interpretation, passage of this bill would result in a potential net gain of roughly $147.3 million in FY2018 General Revenue Fund tax receipts largely due to the implementation of proposed sales tax increases six months prior to significant Personal Income Tax rate reductions in comparison with current Law. Thereafter, State General Revenue Fund tax collections would decrease by roughly $56.1 million in FY2019, due to the full-year effect of the proposed Personal Income Tax reductions that are larger in scale than the proposed Consumer Sales Tax increases. The provisions of this bill would effectively reduce current Law tax revenues by an estimated $121.5 million in FY2020, $137.4 million in FY2021, and $177.6 million in FY2022. Due to the provisions of a trigger mechanism to reduce Personal Income Tax rates, these revenue reductions would exceed current estimate under accelerated economic conditions and lag current estimate if the economy grows slower than anticipated. Details of the various proposed tax Law changes follow.
    
    The provisions of this bill would replace the current Severance Tax rate structure on coal with alternative tiered tax rate structures that reduce industry tax burden when prices are low and raise industry tax burden when prices are high. At current price levels, the proposed changes would result in a decrease in tax liability for steam coal and some potential small decrease in tax liability for certain types of thin-seam and some metallurgical coal. The net impact of these proposed Severance Tax changes would be a $49.9 million reduction in State coal Severance Tax collections in FY2018 relative to current Law. Producing coal counties would lose an additional $1.7 million in FY2018 in shared coal Severance Tax revenues. Beginning in FY2019, the annual loss in State coal Severance Tax revenues would approach $51.0 million and the annual loss in county coal Severance Tax collections would approach or exceed $2.3 million per year. Based on past independent research reports, lower tax rates on steam coal may result in a very modest increase in annual production.
    
    Under the provisions of this bill, the State Consumer Sales and Service Tax and Use Tax rate would increase from 6 percent to 7.25 percent effective July 1, 2017. During the first full year of effect, this impact on the current base and the inclusion of the proposed base-broadening enhancements are expected to yield approximately $327 million for the State General Revenue Fund and up to $6 million for the Sales Tax Increment Financing (STIF) Districts. The sales tax would apply to: telecommunications services; digital goods; electronic data processing services; health fitness memberships; and primary opinion research. The bill would also eliminate the annual transfer of General Revenue Fund sales tax collections to the State Road Fund, an estimated net gain of $11.7 million per year for the General Fund. Finally, the provisions of this bill would add a new sales tax exemption for services of professional employer organizations, resulting in a small loss of revenue.
    
    Given that the sales tax provisions take effect on July 1, 2017, total General Revenue Fund collections for the 11-month collection period in FY2018 would be roughly $311.5 million, inclusive of the State Road Fund sales tax transfer and assuming full immediate compliance with the tax changes. With the window of time closing between now and July 1st, there is a growing likelihood of lower initial collections due to the lack of time for vendors and tax collectors to adequately prepare for the upcoming tax changes. Assuming normal growth in the sales tax base, FY2019 tax receipts would rise by $346.9 million.
    
    Within the past five years, authority was given to municipal governments to impose a local sales tax of up to 1 percent in addition to the State sales tax. Currently, 28 municipal governments that account for roughly 17 percent of the State’s population impose a local sales tax with an annual yield of roughly $70 million. An additional 11 municipal governments plan to add a local sales tax beginning July 1, 2017. When the sales tax base is broadened, these municipal governments also gain additional tax collections. Passage of this bill would effectively enhance local municipal sales tax collections by roughly $3.5 million per year.
    
    Beginning in Tax Year 2018, the provisions of this bill would implement a sizable reduction in State Personal Income Tax rates for all filers. The current five-bracket tax rate structure with rates ranging from 3.0 percent to 6.5 percent would be replaced with a four-bracket system with the following rates effective January 1, 2018: 2.25 percent on the first $20,000 ($10,000 for married filing separate); 3.95 percent on taxable income ranging between $20,000 and $35,000 ($10,000 and $17,500 for married filing separate); 5.65 percent for taxable income between $35,000 and $200,000 ($17,500 to $100,000 for married filing separate); and 6 percent for taxable income of $200,000 or more ($100,000 for married filing separate). Effective January 1, 2019, rates for these tiers would decrease to 1.85 percent, 3.65 percent, 5.45 percent, and 6 percent, respectively. These changes to the Personal Income Tax structure are anticipated to result in revenue losses of roughly $108 million in FY2018, roughly $314 million in FY2019, and roughly $382 million in FY2020, absent any further rate reductions as described below. The FY2019 estimate reflects the first full-year of reduced income tax rates and considers that withholding patterns may be adjusted in anticipation of the scheduled reduction to occur effective January 1, 2019.
    
    The bill also contains a trigger mechanism that would further reduce Personal Income Tax rates beginning as early as TY2020 by 0.1 percentage points when certain conditions are met. Our understanding of the language affecting the trigger mechanism and associated revenue projections follows. Alternate interpretations of the trigger language as written in proposed West Virginia Code §11-21-4h(d) et seq. would result in necessary adjustment to the estimates provided in this analysis.
    
    A rate reduction would primarily occur if the year-over-year increase in General Revenue Fund net collections as of June 30th for the most recent fiscal year (e.g., FY2019) compared to General Revenue Fund net collections as of June 30th for the immediately preceding fiscal year (e.g., FY2018) exceed a trigger threshold of $110 million (base in FY2019) annually adjusted upward by half of Consumer Price Index (CPI) inflation. For example, if FY2019 General Revenue Fund net collections exceed FY2018 General Revenue Fund net collections by at least $110 million, Personal Income Tax rates for all tiers would reduce by 0.1 percentage points effective January 1, 2020.
    
    In the event that the above trigger conditions are not met for any given year, future rate adjustments would be contingent on alternate analysis depending on whether the year-over-year increase in General Revenue Fund net collections for the most recent fiscal year compared to General Revenue Fund net collections in the last year in which a rate reduction occurred exceeds or is less than 65 percent of the inflation-adjusted trigger threshold. If the increase is greater than or equal to 65 percent, then no rate reduction occurs. If the increase is less than 65 percent, although no rate reduction occurs for the immediately following Tax Year, the annually-adjusted $110 million trigger is increased by 150 percent for the next fiscal year. The proposed bill states that the potential rate reduction in this case would be determined based on “any prior fiscal years’ revenue collections not applied toward a previous rate reduction” (W.Va. Code §11-21-4h(d)(4), emphasis added). It is our assumption that the earliest applicable fiscal year for this calculation could be FY2019.
    
    Assuming these interpretations and assumptions of the rate-reducing trigger mechanism are accurate, we do not anticipate a rate reduction to occur until January 1, 2022, as FY2021 revenues are the first since FY2019 in which the increase in net collections are sufficient to meet the criteria of the rate reduction mechanism. In comparison with current law, we anticipate FY2021 Personal Income Tax revenues may be reduced by nearly $400 million and FY2022 revenues may be reduced by approximately $438 million, assuming normal growth.
    
    Over a period of many years, it is plausible that income tax rates will trend downward following years of General Revenue Fund growth. These reductions, however, are anticipated to be relatively slow as income tax revenue reductions will likely offset any General Revenue Fund gains in the short term after a rate reduction occurs. For comparative purposes, we modeled the impact of this Personal Income Tax reduction plan over a period of 17 years as if it were implemented in 1999. Under this tax plan, total FY2016 General Revenue Fund collections would have been roughly 12 percent less than actual collections due to Personal Income Tax revenue declines. This estimate includes other revenue enhancements as proposed in this bill.
    
    As written, the proposed bill would create a decreasing modification for Social Security benefits included in federal Adjusted Gross Income (AGI) when federal AGI is less than $75,000 ($37,500 for married filing separate). For the tax year beginning January 1, 2018, 50 percent of eligible benefits may be deducted from an individual’s Personal Income Tax and for the tax year beginning January 1, 2019, 100 percent of eligible benefits may be deducted. We estimate this change would reduce Personal Income Tax revenues by approximately $9.1 million in FY2018, by $42.3 million in FY2019, and $48.8 million in FY2020. Revenue losses in out years are expected to be roughly $52 million in FY2021 and $56 million in FY2022. Reductions associated with this modification are anticipated to grow at a faster rate than typical income growth given the incorporation of Cost of Living Adjustments at the federal level and the aging Baby Boomer population increasing eligibility for taxable Social Security benefits. It is also important to note the presence of a cliff in which Taxpayers with similar liabilities will receive different tax treatment. For example, Taxpayers slightly below the income cutoff are eligible to deduct taxable Social Security benefits while Taxpayers slightly above the cutoff are not.
    
    The bill would also increase the tax preference for military pensions from exclusion on the first $22,000 of benefits received under current Law to a full income exclusion beginning in 2018 at a cost of roughly $1 million in FY2018 and roughly $3 million per year thereafter. Other provisions of this bill would temporarily increase the Corporation Net Income Tax rate from 6.5 percent to 7 percent beginning January 1, 2018. Corporation Net Income Tax revenues would rise by roughly $3.8 million in FY2018, by $9.1 million in FY2019, by $10.3 million in FY2020, and by $7.0 million in FY2021.
    
    Additionally, the bill would increase the State Historic Rehabilitated Buildings Tax Credit from 10 percent to 25 percent, resulting in a net cost of $1.6 million per year beginning as early as FY2019. This cost estimate solely relates to the continuation of current level average activity into the future with a higher State tax benefit tied to such average activity. The actual level of historic building rehabilitation activity is heavily tied to the demand for commercial real estate in major urban areas.
    
    The primary objective of this bill appears to be the elimination of the Personal Income Tax. An examination of the complete financial structure of those States that choose not to impose a Personal Income Tax might be a helpful consideration. These other states tend to rely much more heavily upon local governments and real property tax collections to provide services. States relying on local taxes for a majority of total state and local government financial responsibilities tend to spend more conservatively than others. However, most government financial responsibility resides at the state level in West Virginia as a result of the State imposing very low real property taxes on residents and lower than average real property taxes on commercial properties. Such policy is not likely to change because West Virginia decided to greatly limit the property tax many years ago by placing specific provisions in its Constitution.
    
    In addition to higher than average real property taxes, states without income taxes tend to impose special hybrid taxes to compensate for the lack of a broad-based individual income tax. Some of these taxes include the Business and Occupation Tax and Estate Tax in Washington, the Commerce Tax in Nevada, both a Franchise Tax and an Income Excise Tax on corporations and pass-through business entities in Tennessee, the Gross Margins Tax in Texas, and both the Business Profits Tax and Business Enterprise Tax in New Hampshire. Many states without income taxes also impose significantly greater sales tax burdens on business inputs than West Virginia. These states include Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Two states without a personal income tax, Alaska and Wyoming, are fortunate to have a very high ratio of mining output per resident with high natural resource related tax collections exported to nonresidents. However, Alaska is currently considering adoption of an income tax to address, in part, a growing fiscal deficit due largely to reduced natural resource extraction activities.
    
    Additional administrative costs incurred by the State Tax Department are expected to be $35,000 for the remainder of FY2017, $76,000 in FY2018, and $65,000 for each year thereafter.
    
    



Memorandum


    It is important to note that, as written, the trigger component of the proposed bill would benefit from clarification as to how excess revenues could be carried forward. The use of the word “any” implies ambiguity and flexibility in determining what revenues may be aggregated to determine a rate reduction. In addition, it is unclear whether a rate reduction could occur in a year following a General Revenue Fund net collection increase of less than 65 percent of the trigger base if the year-over-year increase exceeds the inflated trigger threshold but does not exceed the inflated trigger threshold plus 150 percent. It is our assumption in this analysis that each year is considered first by whether the year-over-year increase exceeds the CPI-adjusted trigger base. Further, the use of the word “increase” rather than “change” in much of proposed West Virginia Code §11-21-4h(d) suggests that year-over-year losses in General Revenue Fund net collections may be omitted from consideration.
    
    



    Person submitting Fiscal Note: Mark Muchow
    Email Address: kerri.r.petry@wv.gov