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State Must Meet Crucial Revenue Needs As It Overhauls Tax System

October 24, 2003 -- As soon as Virginia's Nov. 4 elections are over, the state’s political and economic focus will turn to taxes. Virginia faces a possible $1 billion revenue shortfall. And the tax code, like that of most states, is a patchwork that isn’t as efficient as it could be. On Nov. 6, two days after the election, the Commission on Revision of Virginia’s Tax Code will meet again at the Capitol. And Gov. Mark Warner is expected to announce his own restructuring ideas some time after the elections.

John L. Knapp, director of economic research at the University of Virginia’s Weldon Cooper Center for Public Service and a longtime expert on the state economy, can offer authoritative comment and perspective for news stories on tax issues. A former member of the Governor’s Advisory Board of Economists under several administrations, he may be reached at (434) 982-5604 or knapp@virginia.edu.

Knapp says it’s clear that Virginia would benefit from updating its tax system. But, he argues, the bigger need by far is finding ways to increase revenue. “Decision makers should focus on the ability of the financial system to raise a sufficient amount of revenue from taxes, fees, charges, and federal aid to meet core needs in education, transportation, medical assistance to the needy, and other important programs,” he says. “That’s the challenge for Gov. Warner, the tax code commission, the business community and everyone who is concerned about the future of the Commonwealth.” Even the best of reforms won’t help if they don’t provide crucial funding.

The attached op-ed article from the Norfolk Virginian-Pilot may provide helpful background material on tax issues.
(attached)

Op-ed Column, The Virginian-Pilot
Tuesday, October 14, 2003
Page B9
Revenue Adequacy, Not Just Restructuring, Should Be Goal
by John L. Knapp

The need for tax restructuring in Virginia is overstated. Emphasis on reform diverts attention from a much larger issue, the adequacy of the state’s tax system to address basic needs. Currently, there is talk of a revenue shortfall of at least $1 billion for the General Fund in the next biennium.

Virginia’s current tax code is the embodiment of many alterations through the years that have occurred because of changes in leadership, ideology, demographic and economic circumstances, and the strength of political interest groups.

A brief history of the three taxes that account for more than three-fourths of Virginia’s state and local tax collections shows how Virginia’s tax system evolved.

In the 19th Century the local property tax took its current form, which emphasizes uniform assessments based on the market value of real property. Over the years, many changes have been made in administration of the tax.

Virginia’s modern-day individual income tax was born in 1926 as part of a reform program led by Governor Harry Byrd. Since then there have been a number of changes in its major features.

The general sales and use tax is relatively new. It was adopted in 1966 with the endorsement of Governor Mills Godwin as part of an ambitious program to establish the community college system and to provide additional support for all levels of education.

Today’s property tax is well administered in Virginia, particularly in the urban areas where full-time professional assessors employ modern techniques. In major urban areas properties are reassessed annually or biennially to ensure that assessed values are close to market values. The state’s local governments are less dependent on the property tax than the national average, and although the tax has never been a favorite, it has the great advantage of being a local source of revenue closely tied to the benefits that taxpayers receive.

The Virginia individual income tax needs to be updated. The values of the personal exemption, single individual and married couple standard deductions, and the tax brackets have not been changed since 1988, 1989, and 1990, respectively. A huge hole in revenue yield was created by overly generous concessions made in 1996 for elderly, affluent taxpayers.

The sales tax has been eroded by the exclusion of nonprescription drugs, the granting of tax relief for food consumed at home, and the provision of exemptions to many non-profit organizations. However, it should be noted that such erosion has been experienced in most sales-tax states because of similar political pressure.

The sales tax base does not include much of the service economy. Furthermore, the tax evasion accompanying remote purchases from catalog and internet sellers is a growing problem.

Nonetheless, these problems are not unique to Virginia. All of the 45 states with sales taxes face them. Virginia is likely to participate in the streamline sales tax project that, with the assistance of federal government legislation, will help states collect taxes from remote sales.

Many services are not taxed because it would be politically unpalatable to do so. States have shunned applying sales taxes to significant service sectors such as medical services, rent, and education. A modest expansion of the sales tax base to include personal services such as haircuts and dry cleaning, repair services, and amusement services might be acceptable to the electorate, but it is unrealistic to think that Virginia is missing huge amounts of revenue from not taxing services.

The truth is that Virginia has a fairly good tax system by the standard of what exists in the 50 states. Governing, a monthly magazine published by Congressional Quarterly, Inc., recently rated state tax systems. The study found that 11 states, including California, Florida, and Texas, “…have tax codes so outmoded and inefficient that they need to be redesigned from the bottom up.” Although the study found that Virginia’s system requires a substantive overhaul, this finding was also applied to 34 other states.

There’s no doubt that Virginia would benefit from an updating of its tax system. However, even the best of reforms, if combined with a revenue neutrality straightjacket that calls for no increase in tax revenue, will fail to address the main issue - revenue adequacy. In fact, there is a danger that under the guise of tax reform, changes will be made that result in less total revenue.

Decision makers should focus on the ability of the financial system to raise a sufficient amount of revenue from taxes, fees, charges, and federal aid to meet core needs in education, transportation, medical assistance to the needy, and other important programs. That’s the challenge for Gov. Warner, the tax code commission, the business community, and everyone who is concerned about the future of the commonwealth.

Contact: Bob Brickhouse, (434) 924-6856

FOR ADDITIONAL INFORMATION: Contact the Office of University Relations at (434) 924-7116. Television reporters should contact the TV News Office at (434) 924-7550.

SOURCE: U.Va. News Services

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