The Tax Foundation

March 8, 2004

Plan to Reform Virginia's Tax Code Pushes Sales Tax Repeal

NEWS RELEASE

WASHINGTON—A new report from the Tax Foundation proposes that Virginia repeal its sales tax and make up the revenue with a flat income tax at 6%, matching the rate on corporate income. These proposed changes are the key parts of a fundamental tax reform plan that would satisfy some of the diverse demands that the state’s lawmakers and taxpayers are making, at the same time saving Virginians $390 million annually in federal taxes.

Writing on the op-ed page of the Richmond Times-Dispatch today, Tax Foundation President Scott Hodge called for a clean departure from the plans that have led to the current stalemate, asserting they would all stunt Virginia’s economic growth.

“As shoppers from Maryland, Virginia and Pennsylvania prove every day,” Hodge writes, “Delaware’s zero tax rate on sales is a magnetic draw. Virginia retailing could enjoy the same advantage, but Gov. Warner and the Senate would go the other way, giving our neighboring states the competitive edge.”

The report is No. 127 in the Foundation’s Special Report series, “The Path to Reforming Virginia’s Tax Code,” by senior economists Stephen Slivinski and Scott Moody.

The report compares the major features of Virginia’s tax code to seven nearby states, arguing that every state’s tax code has to compete with its neighbors, and that the tax plans proposed so far by legislators would make Virginia less competitive.

Principles of Tax Reform
Slivinski and Moody explain that the foremost goal of real tax reform is greater “neutrality,” that is, no lopsidedly heavy or light taxes falling on small groups of people or companies.

There are two enemies of real tax reform. One is ulterior motives: when a tax reform plan raises or lowers future state revenue, the suspicion is unavoidable that “tax reform” is just a fig leaf.

The other is creeping complexity and political favoritism: targeted exemptions and punitive taxes worm their way into the code over time through either the legislative or administrative process. A well-conceived tax reform plan, therefore, is revenue-neutral and eliminates just these items.

The Warner Plan
Slivinski and Moody critique the proposal of Gov. Warner who started the debate with his “tax reform” campaign. As a tax increase, Gov. Warner’s plan is neither small nor huge -- roughly a 4% hike statewide – compared to the whopping 15% tax hike passed later by the Senate. But as tax reform it disappoints, eliminating only the car tax, and even that would take 4 years.

The Tax Foundation report is especially critical of proposals to raise the sales tax, a tax generally conceded to be unfair to lower-income people, a drag on the economy and increasingly hard to enforce.

As Hodge points out in the Times-Dispatch, “Internet-shoppers have joined cross-border travelers and catalog users in avoiding the sales tax. Raising the rate just creates a vicious cycle, punishing all the regular Virginia stores and giving shoppers even more reason to avoid the tax.”

Political pressure for special food and medicine exemptions are strong, and both the Senate plan and Warner’s bow to these pressures, raising the general rate but increasing the exemption – just the opposite of what true tax reform would do.

Tax Foundation Plan
The report proposes raising revenue with income and fuel taxes, enabling Virginia to completely eliminate the state sales tax, the local business and professional license tax, and the estate tax. Calling it the “6 and 6 plan,” Slivinski and Moody estimate that a flat 6% tax on individual income with no deductions except a generous per-person exemption of $3,700, paired with a flat 6% rate on corporate income would raise the same amount of revenue as the current web of exemption-ridden taxes.

As a pleasant by-product of relying more heavily on state income taxes, Virginia’s taxpayers would be able to deduct almost $3 billion more on their federal tax returns, saving about $390 million annually.

Slivinski and Moody assert that a zero sales tax rate would improve fairness and avoid double taxation. Sales taxes generally hit low-income people harder because they spend most of their money on basic, taxable products rather than untaxed services. Attempts to rectify this problem by taxing more services, as the House of Delegates’ plan does, create the problem of “tax pyramiding.” That’s what happens when businesses pay sales taxes on materials and services that they resell with tax, effectively charging tax on tax.

“To be absolutely sure that all Virginians pay the same percentage of their income in taxes, the sales tax has to be zeroed out,” the report concludes.

The Tax Foundation has monitored tax policy at the federal, state and local levels since 1937. Best known for its annual calculation of Tax Freedom Day®, the Tax Foundation is a nonprofit, nonpartisan 501(c)(3) organization.

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Media Contact: Bill Ahern (202) 464-6200

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