West Virginia Does Not Have To Be Kansas: How Smart Tax Reform Can Succeed

PART I

One of the greatest virtues of this nation’s constitutionally-based system of federalism is how it enables the states to be “laboratories of democracy.”[1] Among states’ various innovative experiments seeking public policy improvement, the comprehensive reform of state tax structures is one that requires the intellectually disciplined use of knowledge, experience and scientific methodology. Of course, inherent in the “laboratory” concept is the responsible pursuit of progress by “trial and error.”

Thus, the ill-conceived instant tax relief program recently pursued by Kansas with disastrous results is not, despite opponents’ contentions to the contrary, a reason to forgo well-conceived comprehensive structural tax reform in West Virginia. In fact, the Kansas experience confirms that, absent either significant concurrent reductions in spending, or well-designed structural reforms and carefully planned implementation, simple but immediate and substantial tax relief is virtually certain to lead to fiscal dislocation, particularly, in the near term.

That is why the Fair 55 Tax Reform Plan for West Virginia advocated a competently designed, thoroughly tested and responsibly implemented, revenue neutral approach.[2] That approach is recommended, not because today’s bloated, overspending state government does not need significant reduction, but because experience confirms that the design of an optimum revenue-generating system will be hopelessly confused if the separate issue of appropriate revenue spending is included. Further, whether they are the product of benignly inspired simple misunderstandings, or determined political agendas (either to achieve simple spending reductions or, oppositely, to impose the economically toxic mix of government expansion and wealth redistribution), such mistakes must be avoided to achieve meaningful structural tax reform.

Specifically, the self-serving myths, misinformation and misunderstandings that enshrouded, and ultimately undermined, West Virginia’s most recent effort at tax reform must, in the future, be dispelled and avoided if we are to succeed.[3] Rather, objectively designed and well-vetted proposals for reform must be the focus.

Indeed, it must be recognized that, because taxation involves the most profound and complex intersection of government operations with voluntary human economic behavior (including resource allocation), reliance on superficial, often politically motivated notions must be avoided. Thus, half-baked arguments about wealth redistribution, regressive effects, tax pyramiding and border competition must not allowed to doom serious efforts at reform. Rather, those arguments should be substantively engaged and objectively exposed for their lack of merit.

Clearly, design of a comprehensive and effective reform of the state’s tax structure requires a thorough understanding of how tax rules actually operate and influence economic behavior. Such an enlightened and progressive approach to comprehensive tax reform can be, and, in fact, has been pursued right here in good old “West by God Virginia.”

Thus, earlier in this millennium, West Virginia policymakers had such a proposal on the table before them, but lacking the political will to act, put it on the proverbial shelf to gather dust ever since. Specifically, in late 1999, the Fair Tax Plan, was issued, in full final form, by the Governor’s Commission on Fair Taxation.[4] The Fair Tax Plan was the result of over two years of public hearings and, most importantly, of study, research and deliberations involving the input of nationally-recognized public finance scholars and the intense work of an experienced, well-credentialed interdisciplinary team of economists, senior public revenue administrators and tax law experts.

Perhaps the most important procedural aspect of the Fair Tax Plan was that, before it was released, it was dynamically scored to demonstrate its capacity for well more than adequate revenue yield. Further, through sophisticated, state-of-the-art econometric modeling, it was also shown to benefit taxpayers in all individual income brackets and industry classifications.[5] Then, in 2003, and again, in 2005, legislation, to implement the Fair Tax Plan, was introduced only to die without even making it onto the agendas of the various legislative committees to which it was referred.[6] Although the Fair Tax Plan of 2000 was not given the chance to make the comprehensive reforms it promised, a replication of the process it followed to final proposal stage can well inform today’s policy-making.

PART II

From the experience of developing the Fair Tax Plan in 1999, valuable lessons about the comprehensive tax structure reform design process can be learned. First, and foremost, is recognition that the resulting proposal should represent its designers’ best effort to present an effective, but politically acceptable package. Just as importantly, simplicity and clarity of message must characterize both the vetting process and the advocacy of the final product of that vetting.[7]

Moreover, prudence suggests that, regardless of the degree and scope of stakeholder vetting that preliminary versions of the proposal may receive during the development process, principled and economically-tested alternative sub-structures should also be available in anticipation of adamant resistance by an array of vested interests. Such alternates should anticipate and meaningfully engage the rationales of the various objections typically raised in opposition to tax reform.

Specifically, to substantively and politically address concerns about the potential for regressive effects of a broader-based consumption tax (notwithstanding the virtually complete mitigation of those concerns designed into the basic structure[8]) options could include earned income and fixed income credits for both low-income workers and retirees.[9] Alternatively, the Fair Tax Credit Card (in the Fair 55 Tax Reform Plan), allowing tax-free clothing purchases by low-income families, was designed to eliminate the regressive impact of an expanded sales tax on one of the few otherwise taxable purchases of the necessities of life by low-income individuals.[10]

Likewise, if, after objective and scientific measurement of the real impact of the typically exaggerated border competition attributable to expanding the consumption tax base, the opponents are still not satisfied, a device such as the Progressive Creditable Use Tax described in the Fair 55 Tax Reform Plan, could be added to the structure.[11] It would not only eliminate retail border competition, otherwise attributable to sales tax base or rate differentials among states, but would also serve as a highly effective weapon against the far greater threat to in-state retailers from internet sales competition.

Further, the legitimate concerns of the many public stakeholders, affected by the phase-out and ultimate repeal of the taxes on tangible personal property, which is an absolutely essential element of real tax reform, must be meaningfully addressed. Thus, both the Fair Tax Plan and the Fair 55 Tax Reform Plan included demonstrations of their respective capacities to improve local government bodies’ fiscal circumstances and flexibility in conjunction with such repeal.

Finally, the fiscal milestones (a/k/a “triggers”), used to assure orderly and responsible implementation of comprehensive tax reform, requires at least as much thoughtful design as the substance of the permanent structure itself. In that regard, it must always be kept in mind that, at best, official revenue forecasts are educated estimates based on both experience and varying degrees of informed judgment. Although the general insistence on static (i.e. non-dynamic) scoring of revenue proposals is often seen as being responsibly conservative, the simple reality of the scientific method is that the more of the meaningful factors which are objectively considered (e.g. tax structure influence on economic behavior), the more accurate will be the resulting predictions.

Thus, in terms of fiscal milestones, the first principle should be to avoid any that rely primarily on human judgment no matter how well-informed or objective it appears to be.[12] Further, so as not to undermine the predictability which is crucial to realization of the anticipated private economic stimulus effect of pending tax reforms, fiscal milestones should not be tied in any direct or indirect manner to budget surpluses (which are a function of what should be the entirely separate issue of spending policy, as well as of revenue collections). For the same reason, a fiscal milestone regime should never permit any retreat from tax rate reductions (a/k/a “reverse triggers”) once they are effected on the basis of well-designed measures.

Rather, to most accurately reflect the real-world dynamic impact of a package of tax reform provisions at a particular stage of their multi-year implementation, the best fiscal milestone would be one based exclusively on a comparison of the current actual revenue yield, from the entire package of general fund taxes, with the actual collections for that same fund in the immediately preceding fiscal year or years.

Therefore, by intelligently and deliberately designing a comprehensive tax reform structure assuming a revenue neutral environment, and by not being dissuaded from the urgency of the mission by the mistakes of others, real progress can be achieved, and long-term growth realized, regardless of current budget constraints or any other excuse for not acting.

[1] Louis Brandeis, J. in New State Ice. Co. v. Liebmann, 285 U.S. 262 (1932).

[2] See, the author’s “Fair 55 Tax Reform Plan for West Virginia” (available at www.ppfwv.org.) which, essentially called for simplifying the entire structure by expanding the sales/use tax bases and phasing out the taxes on tangible personal property and income.

[3] See, the author’s articles “Piercing Three State Tax Policy Myths Enshrouding Public Policy Finance Reality (May, 2017) and “More Myths and Misinformation About Tax Reform in West Virginia,” (June, 2017) (available at www.ppfwv.org.

[4] The author’s Fair 55 Tax Reform Plan, supra. though varying in certain specific aspects, was, in substantial measure, inspired by and built upon the principled, creative and thoroughly tested foundation of the Fair Tax Plan.

[5] Such a process would have also been useful to confirm the conclusion of Paul Blair of the Americans for Tax Reform that the recent 2017 effort at tax reform in West Virginia, whereby adoption of a broader and higher rate sales tax to enable income tax relief and ultimate repeal, meant that “on net, the taxpayers were not losers.” Elaine S. Povich, “Why States are Struggling to Tax Services”, Stateline, published by the PEW Charitable Trusts, June 27, 2017.

[6] See, H.B. 3157, 2003 Regular Session; S.B. 188 and H.B. 2445, 2005 Regular Session, respectively.

[7] See, Robin C. Capehart “Real Tax Reform for West Virginia,” Public Policy Foundation of West Virginia (2009.)

[8] Though an explanation of the many provisions of current and proposed tax laws, designed to fully mitigate the potential regressive effect of broader and higher consumption taxes on the purchases of life necessities by lower income individuals, is beyond the scope of this article, they are fully expounded in the Fair 55 Tax Reform Plan, etc., supra.

[9] Indeed, both provisions were included in various versions of the tax reform legislation considered by 2017 Legislature.

[10] Fair 55 Tax Reform Plan, supra. at pages 5 and 6.

[11] Id. at pages 26-27

[12] E.g. “anticipated fiscal cost to the state in dollars….” See, S.B. 1017, First Extraordinary Session, 2017 Legislature.