With a potential budget deal at stake, Gov. Glenn Youngkin and General Assembly budget leaders will keep a close eye on taxes Virginians pay and refunds they claim as state income taxes come due by May 1.
Tax collections so far are up dramatically, which could open a path to a budget compromise in a May special session that does not include a tax increase. But legislators want to be sure they will have enough money for K-12 schools and other priorities in the next two years.
Two numbers may be why a governor and General Assembly who are at loggerheads over taxes finally agreed to try to agree on a budget for the next two years.
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One number: 0.5%. That’s the amount that general fund revenue — basically, the money the state collects from taxes and fees that does not go into one lockbox or another — needs to increase over last year’s total to cover Virginia’s bills for the fiscal year that ends June 30.
The other: 6.2%. That’s the amount that general fund revenue has actually grown for the fiscal year to date.
“I think that the new spirit of cooperation has to be the result of better revenue expectations,” said John McGlennon, a College of William & Mary political scientist who has wrestled with government budgets as a member of the James City County Board of Supervisors for 27 years.
“The revenue projections look better than originally forecast, and by a fair bit. That was what came to my mind when I saw the peace in the valley moment,” he said. “I wouldn’t bet on the exact nature of the final budget, but it sounds like there is something for both sides.”
Still, even as Youngkin says he sees a clear path to agreement, Del. Luke Torian, D-Prince William, chairman of the House Appropriations Committee, says the legislature has not taken anything out of its budget or off the table yet.
Instead, Torian said the House and Senate budget committees are developing a schedule to work on a new budget to present to the General Assembly when it convenes for a special session on May 13.
“We’re going to come up with some options for consideration to get us where we need to be,” he said.
Youngkin will also have a role in those discussions, Torian said. “At some point in time, we will have some communications with the governor.”
Senate Minority Leader Ryan McDougle, R-Hanover, played a pivotal role in getting Youngkin and assembly leaders to the table to talk about compromise.
“I’m not willing to lock anything down, but I would say that revenues could be a substantial help as we’re trying to come to an agreement,” he said.
Caution or confidence
And that will likely involve talking about revenue.
Senate Finance Committee Chair Louise Lucas, D-Portsmouth, said: “I don’t propose to go forward based on money that we don’t have on hand.”
Lucas added: “We can’t build our budget based on speculation.”
Virginia’s constitution says budgets have to balance — the taxes, fees and other revenue the state collects have to cover all of its bills, which the governor and General Assembly project will total $99 billion next year.
But tax collections this year mean the state may find paying those bills is easier than either Youngkin or the General Assembly assumed in their dueling budgets.
If tax collections over the next three months come in at anything like the pace through March, Virginia would end up with more money in hand to start the next fiscal year — an unreserved balance roughly twice the size of the $2.49 billion the General Assembly’s now-sidelined budget is based upon, a Richmond Times-Dispatch analysis suggests.
That would be on the order of $2 billion more than the General Assembly budget projected, based on a proposed expansion of the sales tax to cover digital services and business-to-business deals — the tax expansion Youngkin wanted to take out of the budget.
Revenue would be nearly $3 billion more than Youngkin projected in his initial budget proposal, with its package of income tax cuts, a sales tax increase and expansion to cover digital services.
Revenue forecasts and sticking points
Bob Holsworth, a longtime Virginia political analyst and former dean at Virginia Commonwealth University, said “Youngkin has essentially re-forecasted revenue twice since the GA left town the first time.
“It enabled him to assert in his April 8 proposal that the tax increase could be abandoned without gutting most of the Democrats’ focus on education spending. And he basically sweetened the pot again,” Holsworth said.
Key things on General Assembly Democrats’ list of changes include restoring the $300 million-a-year cuts Youngkin’s amendments proposed to roughly halve the General Assembly’s appropriation for at-risk students’ programs, said state Sen. Mamie Locke, D-Hampton.
Locke is a senior member of the Senate Finance Committee and chair of the Senate Democratic Caucus.
Other items on legislators’ lists include Youngkin’s $26 million cut to what the General Assembly wanted the state to contribute to boost the number of teachers for English language learners to 22 per 1,000 students, Locke said.
Other sore points, she said, are Youngkin’s cuts of $20 million a year for an effort to boost staffing at nursing homes, of more than $100 million over the next two years to cover financial shortfalls at the Washington Metro subway system and of $34 million to the sums in the General Assembly budget for toll relief for low- and moderate-income commuters in Hampton Roads.
Sales taxes
Youngkin has said giving up his income tax cuts and asking the legislature to drop the sales tax expansion is the way to find common ground.
General Assembly Democrats believe their approach to sales taxes — picking up Youngkin’s expansion for digital services and adding in business-to-business deals, but without his originally proposed 1% increase — broadens the state tax base in a way that does not hit low- and moderate-income Virginians as hard as his original proposal.
“Going forward, if we don’t do something with modernizing our tax code, how are we going to get the funding for our schools?” Lucas asked.
A study last year by the Joint Legislative Audit and Review Commission, the state’s watchdog agency, documented the shortfall on Virginia’s spending for K-12 schools and raised the stakes for Lucas and other assembly budget leaders.
Lucas said she is not willing to rule out expansion of the sales tax because of her concern over generating the necessary revenues to pay for essential services — such as K-12 education and Medicaid health care — in the next two-year budget and future years.
Del. Vivian Watts, D-Fairfax, chair of the House’s tax-writing Finance Committee, has long sought to apply the sales tax to some services.
She sees expansion as necessary to modernize the tax code and conform to sales tax in a majority of states.
“The more you conform to other states, the better it is for businesses to do business,” she said.
Taxing differences
Democrats never liked Youngkin’s proposal for across-the-board cuts in income tax rates, saying lowering the top rate — which is what most Virginians pay — to 5% from 5.75% would be a bigger windfall for higher-income Virginians without benefiting most working Virginians very much.
At the same time, Watts said the JLARC study was right to quantify the shortfall in Virginia funding of K-12 public schools, which she said simply shifts the tax burden to local real estate taxes to pay for schools.
“We’ve got the opportunity with the documented need for revenue to make an improvement in our tax code,” she said.
Even if state revenues increase enough in the last three months of this fiscal year to cover most General Assembly spending priorities, Watts said lawmakers have the opportunity to expand the sales tax while making it revenue-neutral by potentially increasing the standard deduction for income tax filers.
“You go to the standard deduction, where you let people keep more of their income before taxing it,” she said. “The best way to do that is by increasing the standard deduction.”
William & Mary’s McGlennon said: “Maybe the governor gets economic development and a tax rebate that he can point to, maybe income tax rates are adjusted to push up the amount subject to the no- or lowest-tax rate bracket, with the top rate dropped a bit.”
He added: “I think the Dems are likely to prefer a rebate, as they will still be in office when the legislature will be up for election again, and the last thing they will want is to have to raise taxes in an election year.”
One-time rebates of property taxes have been a common approach adopted by cities and counties after big rises in tax collections when they get nervous that the economy will slow.
Holsworth thinks the General Assembly might give up the sales tax expansion if House and Senate money committee staffs concur with the administration’s numbers, so long as they get the at-risk education and transportation funding fully restored.
Restoring the funding for lab schools that the governor wants is an open question, he said.
“As far as tax cuts and tax restructuring, I don’t see any Democratic appetite for approving the way Youngkin structured his proposal,” Holsworth said.
“They believe that a general sales tax increase is regressive and an across-the-board income tax cut rewards the rich,” he said. “Any acceptable cut at all would have to be more progressive, clearly benefiting those at the lower end of the scale.”
Fiscal wild cards
General Assembly Democrats also did not like Youngkin’s proposal to use the Literary Fund — a pool that gathers court fines, fees and forfeitures, unclaimed property and unclaimed Virginia Lottery winnings — to fund teacher retirements, arguing that the fund is meant for school construction, where there’s roughly $25 billion worth of work needed around the state.
On the other hand, Virginia legislators have never liked to get too giddy over revenue growth.
“In my mind, there are too many wild cards on the horizon to project continued strong GF growth,” said Joe Flores, director of fiscal policy for the Virginia Municipal League. Flores, a former state secretary of finance and longtime Senate Finance Committee staffer, referred to the general fund — largely funded by individual, corporate and sales taxes — that goes toward services such as education, health care and law enforcement.
Those wild cards include:
- the drying-up of federal pandemic relief funds, which have been boosting Virginia revenue and most other states’ revenue for several years now;
- the impact of pass-through entity tax credits — sums owed to individuals because they paid the taxes their partnerships, S Corporations or similar businesses could have; and
- uncertainty over interest rates and federal fiscal policy.
Add in wars in Ukraine and Gaza, and it is tough to be confident about much in the economy, Flores said.