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The $1.2 billion question in Virginia: Just how much money does the state have to spend?

RICHMOND — While Republicans and Democrats often don’t see eye to eye, there’s a disconnect heading into the General Assembly session on something that ordinarily is not in dispute: How much money does the state have to spend?

Democrats, led by Gov. Ralph Northam, are anticipating an extra $1.2 billion in revenue in the two-year budget from changes in the federal tax code. They want to spend half of it on a tax break for households making less than $54,000 a year, and use the other half for what the governor has described as “historic” investments in the state’s reserve fund and various government programs.

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But Republicans say the state should not turn the federal tax overhaul into a windfall. They want to change the state tax code so that taxpayers who got a break from Washington don’t lose the savings to Richmond. They would return the money to what they define as “middle class” taxpayers, households with earnings between $125,000 and $150,000 a year.

The disagreement will probably dominate the 46-day legislative session that begins Jan. 9, complicating efforts to make the usual midpoint amendments to the state’s $117 billion two-year spending plan, which was approved in May and took effect July 1.

“It’s going to be a big debate,” said state Sen. Richard Stuart (R-Stafford), one of the governor’s closest friends in the legislature, who nevertheless plans to submit legislation intended to thwart Northam’s plan to reap that extra revenue.

“I don’t think the governor should take the windfall,” Stuart said. “We should give it back to you, the taxpayer.”

Championed by President Trump and approved by Republicans in Congress, the federal tax overhaul limits deductions on mortgage interest and property taxes. It also doubled the standard deduction to make up for those changes, probably prompting more taxpayers to take the standard deduction on their federal taxes instead of itemizing. Under current law, Virginians who take the standard deduction on their federal returns must do the same on their state tax returns, which would lead to higher state tax bills because Virginia’s standard deduction remains unchanged.

If Virginia leaves its tax code as is, an extra $600 million will pour into the state’s coffers every year until the federal cuts partially expire in 2024.

Northam contends the state should use half of that money to help lower-income residents because the federal tax changes mainly help high earners and corporations.

“We can all agree that tax relief should flow to those who need it the most — the middle class and working families across this commonwealth,” he said in a speech to the General Assembly’s money committees Dec. 18. “This is a policy that has been supported by Republicans and Democrats alike, because it works, and it puts money right back into the economy and rewards those who work hard for a living.”

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Republican leaders of the House of Delegates and the state Senate said they want tax relief, too — but for higher-income filers who would see their state taxes go up as a result of the federal changes. They said they would seek tax relief for households with two earners making between $125,000 and $150,000 a year.

They referred to those households as “middle class,” but that is high. Seventy-five percent of Virginia households make less than $100,000 a year, according to Michael Cassidy, president of the Commonwealth Institute for Fiscal Analysis. Half of the state’s households earn less than $54,000.

“There are going to be about 600,000 middle-class taxpayers who are affected, and that is going to be one of our priorities, to make them whole,” said House of Delegates Speaker Kirk Cox (R-Colonial Heights).

He said he would propose a fix before the legislative session, perhaps by allowing filers who take the standard deduction on federal returns to itemize on their state returns. Stuart plans to submit a bill to double the state’s standard deduction.

Some legislators, such as state Sen. Dave Marsden (D-Fairfax), say they are conflicted. Marsden said he shares Northam’s desire to give tax breaks or rebates to those making less than $54,000 through the Earned Income Tax Credit.

“I’ve sponsored minimum-wage bills for years to get more money into the hands of people who will spend it, build the economy,” Marsden said. “But I’ve got a lot of people [saying], ‘Where’s this big tax break? It costs me more on state side.’ Twenty-six percent of Virginia taxpayers are in that circumstance. . . . That could be a real revolt: ‘Hey, wait a minute. I earned this money, and now it’s being transferred to poorer people.’ ”

Marsden said he would like to explore a compromise that would provide some additional money for the Earned Income Tax Credit while also minimizing problems for higher-income taxpayers.

Virginia’s governor and the General Assembly typically make adjustments halfway through their biennial budgets, but Northam’s proposals are unusually ambitious because he anticipates so much new revenue.

Apart from the potential federal tax windfall, sales and withholding tax receipts are up $548 million over projections, thanks to a strong economy. And a U.S. Supreme Court ruling in June cleared the way for the state to tax Internet retail sales, which could bring in an additional $80 million if the legislature approves legislation to do so.

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It’s a happy coincidence for a state that not too many years ago had to scramble to close a $2 billion budget shortfall.

“The last sessions or years have been dominated by much tighter revenue situations,” Cassidy said. “This year, one of the key things is we’re going to see an uptick in revenue, and that’s kind of a different posture than in recent years.”

Some legislators, including Stuart, want to use the Internet revenue for transportation. A bipartisan group of state senators have proposed an ambitious school reconstruction plan. They drew that up months ago, at a time when the tax was expected to generate $250 million a year. They hoped to put much of that toward up to $4 billion in construction bonds for schools around the state.

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Since then, the state has revised the Internet revenue estimate sharply downward, to about $80 million over the biennium, because it turns out that many e-commerce sites have already been collecting and remitting that revenue voluntarily. And nearly $30 million of that is already spoken for, because of formulas in state code that dictate how some sales tax revenue is spent. That leaves about $50 million over two years — not enough for the comprehensive rebuilding program, said Marsden, one of the bill’s supporters.

Marsden said he would like to scale the bill back to support something more incremental, perhaps focusing on repairing school rooftops. Recalling a school in Danville with “buckets everywhere,” Marsden said facility problems usually start with roofs, as water leaks inside to rot ceilings, ruin electrical wiring and rust plumbing.

“We would have to scale down what we want to do, but I still think it’s a valuable idea because I think we could repair an awful lot of school roofs in Virginia,” he said. “Everything starts with a bad roof.”