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West Virginia Supplemental Report

Tax Environment

The state has one of the oldest and least prosperous populations in the country. It is very varied geographically with distinct regions and populations and its economy is in transition, with dependence on the severance industry waning and certain parts of the state’s economy shifting to pharmaceutical and technological research. Due to its high levels of poverty, the state does very well in the balance of payments received from the federal government — $1.73 — compared to every dollar its citizens put in, according to the Tax Foundation.

During the 1980s, state officials engaged in a good deal of tax reform, lowering personal income tax rates substantially and abolishing the business and occupation tax on the state level, and replacing that with a corporate income and business franchise tax. Shortly afterwards, significant tax incentives were added that were poorly drawn and extremely generous. With the coal industry particularly taking advantage of the government’s largess, about 25 percent of the severance tax base disappeared in three years. Further adjustments were made, limiting the use of incentives, with rates increasing to deal with budget problems. The legislature also reinstated the sales tax on food, which had previously been removed.

A decade later, there are still a number of problems with the basic tax system. West Virginia has many different taxes, which may make the system somewhat more stable by spreading out the risk, but also makes it far more complex to administer. Many of the smaller taxes are earmarked for particular services. Many different taxes have also spawned many different tax loopholes.

Former Governor Cecil Underwood established the Commission on Fair Taxation in the late 1990s to study the state’s tax system. The commission’s report, which called for major tax reforms, received a good deal of positive national attention. It recommended that the state steer away from a tax system that relied on “narrow bases, high rates and numerous tax preferences” to one with “broad bases, low rates and few tax preferences.” Their suggestions included a more progressive personal income tax; re-designed sales and use tax (lower rate and fewer exemptions); and the adoption of a single business tax to replace a variety of other business taxes. Timing for the reforms was not good, however, and they were not put into effect. Gov. Bob Wise, who defeated Governor Underwood in the November 2000 election, almost immediately rescinded a rule that would have had businesses file informational tax returns based on the tax reform proposals. While the new administration concentrated on simplifying and rationalizing the state’s tax incentives, other aspects of tax reform were laid aside.

In 2003, former Tax and Revenue Secretary Robin Capehart is continuing to try for reform — increased exemptions to the personal income tax to better protect the working poor; the elimination of personal property taxes, a new broad-based Business Activities and Profits Tax, which would replace 12 different business taxes, with a single tax, and a shift from a sales tax to a broader general excise tax, which would include professional services. These ideas are all being packaged in a piece of legislation called The Fair Tax Act of 2003.

Recent Tax Developments

• In 2000, legislators agreed to phase out the tax on doctors and other health care providers over the next 10 years. The 2 percent tax dropped to 1.8 percent for the FY2002 fiscal year, to 1.6 percent for FY2003, and to 1.4 percent for FY2004.

• West Virginia, which leads the nation in tobacco use, increased cigarette taxes from 17-cents to 55-cents, effective May 1, 2003. This is the first time it has raised cigarette taxes since 1978. The prior year, the legislature voted to impose a 7 percent tax on smokeless tobacco.

• A sales tax holiday was held from August 2-4, 2002, and another holiday is scheduled for August 1-3, 2003.

• The West Virginia Public Policy Council, founded by former Tax and Revenue Secretary Robin Capehart, unveiled a new proposal for changing the state’s tax structure. The reforms outlined in the proposal include elimination of personal property taxes, a more progressive income tax, and replacement of the sales and soft drink taxes with a 6 percent general excise tax.

Budget Information

West Virginia has been in tight budgetary circumstances for many years. But since it didn’t enjoy the boom that other states did during the economic good times, its fall was less precipitous when the economy declined.

The state ended its FY2002 year with a $15 million surplus, partially due to spending cuts. Revenue receipts were solid through the end of the fiscal year, but dipped in the middle of FY2003. In November, Gov. Bob Wise requested agencies cut their current year budgets by 3.4 percent. As of May 31, 2003 — a month before the end of the fiscal year — collections were $15.4 million below estimate and the outlook was for a year-end deficit of between $20 and $25 million.

Other budgetary issues include a $2.4 billion deficit in the Worker’s Compensation Fund and an ongoing effort to adequately fund the Medicaid program, which entered the FY2003 fiscal year contemplating a $187 million deficit ($47 million of which were state dollars). This was made up mostly by the transfer of balances from other funds. The state faced an even bigger Medicaid hole in FY2004, but officials hope that will be filled by an increase in the state’s cigarette tax from 17-cents a pack to 55-cents a pack, a move that is expected to raise roughly $60 million and which would support more than $180 million in federal matching funds.

Increased pension expenses, health costs and poor investment returns have helped to create a FY2004 budget gap of $250 million. Gov Bob Wise has been recommending steep agency cuts.

Adequacy

Revenues in West Virginia appear to be fairly stable compared to other states — relatively speaking they don’t rise that much in good economy and they don’t sink as far as many other states when the economy declines.

One of the big problems for the state is that it is a high demand state, with low tax capacity. Many of the state’s taxes are already at the max as to what they can deliver. The corporate income tax and the severance tax are already among the highest in the country, earning West Virginia poor standings in various surveys that chart the appeal of the state to business. The Small Business Survival Index, for instance, puts West Virginia 41st in the nation as a place to operate or start a small business. According to an August 8, 2001 article in the Dominion Post, the state was “tied for 44th in its tax rate on health insurance, tied for 42nd for its top corporate income tax rate and 42nd for its unemployment tax rate.”

Critics contend that the state’s franchise tax on capital or net equity, and the state’s personal property taxes, which impact business inventory and purchases of equipment, have a negative effect on capital investment. Meanwhile, West Virginia also taxes the working poor more heavily than most others and its personal property tax on vehicles plus its relatively high gas tax also impact less well-off individuals. Given a variety of economic and demographic factors (per capita income is 48th in the U.S., for instance, and retail sales are 50th per capita), it would take a major change in tax rates to significantly increase revenues.

Due to the terrain, the high number of rural counties and the poverty, it also is expensive to provide services and there are many services needed.

The state also needs to keep a wary eye on what Washington does, as its state income tax is linked to the federal income tax. Two areas in which federal changes have had negative impact on state revenue are in bonus depreciation and particularly the gradual abolishment of the estate tax. According to the Charleston Gazette, February 5, 2003, only $7.1 million is expected from the estate tax in 2004, compared with $17.5 million collected in FY2001. By FY2006, estate tax money will have dropped to only $100,000. If the federal government drops its tax on dividends, this will cause more problems for the state’s revenues.

Another issue likely to affect revenues in the next few years is the slowing of growth in non-tax money. In recent years, the state’s tax revenues have been supplemented by extremely strong growth in lottery revenues. The pace of that growth is now slowing substantially.

Fairness

West Virginia has one of the highest corporate tax rates in the country, but many companies find ways to avoid the taxes, causing equity issues.

An improvement recently has come from an effort to decrease the complexity of tax incentives in the state. Tax managers took the existing incentives, reduced them by 11 and came up with 4 broad tax incentives. They rewrote the research and development credit and generally decreased complexity. Still, the basic system of taxing business — a number of different narrowly drawn taxes with high rates that encourage aggressive tax planning — remains a problem in terms of equitable taxation. The most recent tax expenditure report chronicles the impact of the various exemptions, credits and deductions offered with the state’s taxes. Corporate net income tax expenditures are about $60 million, as compared with roughly $100 million in annual collections.

West Virginia has a broad based sales tax, which includes many non-professional services, including janitorial, mowing, tax consulting, landscaping. It does not include professional services. Salex tax expenditures are about $.3 billion as compared with revenues of slightly more than $1 billion.

The state’s income tax kicks in at the low rate of $10,000 and there are few personal exemptions or deductions. In 2001, a report from the Center on Budget and Policy Priorities noted that West Virginia had the third highest income tax burden in the U.S. on working poor families. It has been relying increasingly on lottery revenues and its personal property taxes on vehicles as well as its high gas tax are also tough on lower and middle income families.

West Virginia has one of the highest percentages of older people in the country and its tax system offers preferential treatment for senior citizens. Roughly one out of six homes are completely exempt from property tax by virtue of the homestead exemption for senior citizens.

Management

State officials describe their technology as “somewhat antiquated” and this inhibits better analysis. The state doesn’t have a significant capacity to pin down the effect of tax changes on different segments of its population, according to Michael Mazerov, senior policy analyst with the State Fiscal Project of the Center on Budget and Policy Priorities. The state does have a tax expenditure report, and the most recent copy (January 2003) is available on the tax department website.

The state does not have an integrated tax system, though the department is exploring one. There are many individual standalone systems. Some serve the state adequately, but a particular problem is the mainframe system that deals with business taxes, which was installed in 1972. This aged system requires a great deal of ongoing programming to produce data and causes the state to “spin its wheels” and “play a lot of catch up,” say officials. As one notes: “Very little data is available to our field people. Information is largely not available in electronic format. There’s a lot of duplication of effort and manual effort for functions that should be automated.”

Online filing is strictly through the IRS-State program currently, with about 30 percent of income tax returns filed electronically. Tax officials are working on a separate efiling system as well as telefile options. Electronic funds transfer is currently voluntary, though it may become mandatory for certain taxpayers.

An evaluation of all the tax websites by Governing researchers found the West Virginia tax site to be one of the weakest. Evaluators mentioned that there was a lack of information and that the organization of the site made it hard to sort through and find the data that was there.

An area in which West Virginia has done very well is revenue estimation. Estimates are rarely in error by more than 1 percent, officials say. This is largely due to the skills of a few key research individuals who have been with the state a long time and know its economy very well.

Officials say the compliance division has had a renewed effort in collecting delinquent accounts. It also has been trying to ease the burden of tax reporting for business taxpayers by combining its corporate net and business franchise tax returns from two forms into one.

Local Issues

In West Virginia, funding tends to be provided at the state level, rather than the local level. Looking at the balance of funding, only six states provide a higher proportion of funding at the state level, relative to the local level of government.

Cities are dependent on the business and occupation tax, which was dismantled on the state level in 1987 due to fears that it was unfair and crushing economic development. Critics of the local B&O tax worry that it has served to drive businesses outside of the cities.

Otherwise, much of what is raised locally comes from the property tax, which is limited by the Constitution. Most counties are already pressing up against those limits. Property taxes on homes are among the lowest in the nation and about one in six homes is free from property taxes due to the exemption offered to the state’s senior citizens.

Local governments are currently quite hampered in their ability to raise money and are facing many financial problems. They are fighting through their associations for greater flexibility to raise revenues — for example, the ability to piggy-back local taxes on state taxes.

Noteworthy Programs

• Countering fuel tax evasion. West Virginia has had a program, over a number of years, supported by Federal Highway Administration ISTEA funds. This includes staking out locations where non-reported fuel is sold, increased audits and aggressive filing of criminal charges. The state uses a fast screening process to minimize the time a vehicle is stopped. Screenings also provide an opportunity for education — as all drivers stopped receive a diesel fuel information sheet explaining tax statutes. A toll-free motor fuel fraud hotline is provided.

• Automated notices. For taxpayers who are making installment payments on past delinquencies, the state has an automated system that notifies taxpayers on a monthly basis of their status — balance, interest and penalties. It also generates reports of taxpayers that are more than 30 days past due in making installment payments. The system currently monitors more than 2,000 installment agreements.

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