GENERAL CONSUMPTION TAX 

It is proposed that West Virginia significantly expand its reliance on consumption taxes by enacting a very broad-based consumer purchase excise tax entitled the General Consumption Tax (GCT). The GCT (illustrated in the Fiscal Scorecard with a 5.5% rate) would replace the current 6% consumers sales and service and use taxes by adopting those taxes’ current base and administration, and then by greatly expanding that base through the elimination of the majority of the presently mushrooming array of narrow, special interest exemptions. The long history of broad-based sales taxes in West Virginia is most instructive in considering this proposal.

West Virginia first imposed, temporarily in 1934, and permanently in 1937, what was one of the nation’s earliest general consumers sales taxes, and unlike most other states then or now, has, from its inception, imposed it generally on services as well as on the sale of goods. Thus, in a completely opposite fashion compared to other states, in West Virginia all services are taxable unless an express exception or exemption is provided in governing statute. The natural result of such an approach is that, as the service sector has become a larger and larger component of the overall economy, more and more specific exemptions have been enacted once the realization of automatic taxability confronts each new subsector participant of the service industry. This happens particularly if they initially emerge from out-of-state, and, thus, when entering the West Virginia market, are unused to its taxation of services as the general default treatment.

Today, the amount of tax revenue foregone due to those exemptions nearly equals the entire budgeted collections of the sales tax and the complimentary use tax to which they apply.

More importantly, even with retention of the few categories of exemptions, which implement important fiscal and social policies, the resulting revenue yield of the sales/use taxes could be nearly doubled without any phase-in period for repeal of the rest of the current exemptions selected for elimination.

The exemptions, to be eliminated, and the revenues estimated to be realized by their repeal (stated in millions of dollars based on the illustrated 5.5 % rate) are: food ($153.45); wholesale prescription drugs/appliances ($52.25); computer hardware/software and other digital goods ($15.583); PSC regulated services not including gas, water & electricity ($101.475); sales of gas, steam, water, and electricity ($191.86); personal services (e.g. haircuts and dance lessons) ($23.47); non-medical professional services ($132.92); advertising services ($24.75); electronic data processing services ($4.583); tourism development credit ($2.75); loan broker fees ($2.75); opinion research services ($0.513); travel agency commissions ($0.0275); technical evaluations ($1.375); lodging franchise fees ($3.39); vendor incentives ($1.925); sales by public and private schools ($16.13); exhibitor motion picture rentals ($1.375); aircraft repairs ($3.575); charges for opening burial lots ($0.458); fitness club dues ($1.83); artistic performance fees ($0.385); delivered newspapers ($0.407) and contracting (construction) services ($150.33). Total revenue, to be gained from elimination of the listed exemptions (using the proposed 5.5% rate) is $887,566,167.

The choices of exemptions to be retained are based, in part, on the fact that both transparency and sound tax policy recommend the avoidance of buried, double or pyramiding tax on tax, which the proposal recognizes by calling for the retention of the exemptions for those certain business inputs that are directly passed through in taxable sales of goods to ultimate customers (e.g. purchases of goods for resale, or of raw materials and equipment for direct use in manufacturing and certain other “costs of goods sold” etc.). Such exempt purchases would expressly not include services or goods which are merely used and consumed internally by the commercial purchaser in its own operations and which cannot be directly traced on a clear line of tangible possession to ultimate customers (e.g. marketing, general administrative overhead costs, etc.).

Beyond that, the proposed taxability of outside contract services, even for direct use in manufacturing or other production activities (mining, agriculture, etc.), is a significant departure from the current tax structure. In addition to the explanations, provided elsewhere in this proposal, for why the general opposition to taxation of business inputs is at once myopic in its analysis and overstated as to its claimed adverse impact, exemption of non-employee services from the GCT is inappropriate because it would create an incentive for replacing employees with outsourced contract labor. That is the case, because, as explained in Section E. infra, the other primary component of the Fair 55 Tax Reform Plan’s© replacement tax structure is the Enterprise Consumption Tax (ECT) which will include employees’ wages as a major element of the measure of an organization’s base for that tax. Correspondingly, to honor the principle of tax neutrality and to avoid distortion in such a fundamental economic resource allocation decision, wages would remain exempt from GCT.

Further, all sales by those who are not selling goods or services to third parties as a formal business endeavor (e.g. yard sales) would remain exempt, and, to avoid pyramiding, so would sales of goods and services among members of controlled groups of business entities. Moreover, to encourage gainful employment in the face of West Virginia’s nationally lowest work force participation rate, the current sales tax exemption for day care and babysitting services would be retained in the GCT.

At the same time, because the charges for the great bulk of healthcare services are paid by third parties (including federal and state government), the exemption for such services should be retained to avoid the administrative problems inherent with such indirect transactions, not to mention the lack of transparency and violation of the self-assessment principle otherwise expected with consumption tax like the GCT, as explained in Section A. supra. Likewise, to avoid the inefficiency of having state government tax itself or other governments, the exemption for government purchases and sales by governmental units (if not made in direct competition with private commercial entities) should also retain their current exemption. In addition, it would defeat the purpose of the sales tax increment financing (STIF) program to make transactions, already subject to the special district excise taxes, also subject to the GCT.

Further, to more precisely and efficiently address the acknowledged regressive nature of a tax on the consumption of food, purchases of food with food stamps and WIC vouchers, would, by federal statutory mandate, remain exempt. Likewise, all retail purchases of healthcare necessities, such as medical services and retail purchases of medicines, would remain exempt under the GCT. Beyond such specific and direct relief measures, designed to mitigate the inherently regressive nature of consumption taxes applied to purchases of the necessities of life, when it is fully understood, an even broader appreciation of the non-regressive nature of the Fair 55 Tax Reform Plan© emerges.

Thus, it is recognized that, chief among those life necessities are food, medical care, shelter, transportation and utility services and clothing. Of those, purchases of the first three (only by low-income people in the case of home consumed food) will be expressly exempt from the GCT. Although some states, which generally tax purchases of food for home consumption, provide further relief through income tax credits or refund mechanisms, any comparison of the United States Department of Agriculture (USDA) surveys of food purchase patterns, by low-income individuals, with West Virginia’s food stamp eligibility and benefit system or SNAP (Supplemental Nutrition Assistance Program), confirms that the exemption of such purchases with food stamps and WIC vouchers is entirely adequate to mitigate the regressive nature of a general tax on food consumption.

The experience of those other states not only confirms that conclusion but also shows how fiscally ill-conceived (though well meaning) was West Virginia’s general reduction and ultimate repeal of its sales tax on groceries. Particularly instructive is the history of food tax relief in South Dakota. There, faced with the prospect of completely exempting the sale of food from sales tax, a full two-thirds of the voters prudently rejected such a fiscally irresponsible proposal in a state-wide referendum. Then, as a presumably better targeted alternative, the legislature enacted a direct food tax relief program for low income taxpayers. However, almost certainly because virtually all of the eligible taxpayers also received automatically exempt food stamps and, thus did not qualify, the separate relief program remained almost entirely unused. This real world example well confirms the foregoing conclusion that the automatic exemption of food stamp purchases fully addresses the regressive effect of a general consumption tax on grocery purchases. In doing so, it also confirms the fiscal irresponsibility of providing a blanket exemption for such purchases. Thus, the Fair 55 Tax Reform Plan© will not repeat that mistake, and, will, as result, enable the state to give more than $150 million in truly meaningful tax relief where it will help the most (e.g. toward repeal of the income tax on most individuals and of the regressive and non-competitive tax on TPP).

Though, as explained above, the exemption from GCT for medical services and medicine is primarily based on a separate rationale of administrative necessity and applies to patients of all income levels, it also serves the goal of eliminating another potentially regressive aspect of a broadly applied consumption tax. Finally, since the payment of rent is, by far, the most prevalent way by which low income families secure their personal shelter, retention of the existing exemption for rentals of RE avoids any regressive impact in terms of that life necessity. In addition, the existing reduced rate for purchases of mobile homes would also continue to reduce the otherwise potential regressive nature of GCT as a broad tax on consumption.

In terms of transportation costs, in a rural state like West Virginia, the exemption of the TPP tax on motor vehicles goes a long way to reduce the regressive impact of the current overall tax structure, despite this proposal’s retention of the existing consumption tax on vehicle purchases. In addition, to the extent public transportation is directly provided by governmental units, that necessity of life would also remain free of the GCT. Likewise, though the current sales tax exemption, for services rendered by for-profit transportation and other public utility companies subject to Public Service Commission regulation, would not be retained for GCT purposes, the special credit in WV Code §11-13-3f, against certain utilities’ pre-credit Business and Occupation Tax liability for lowering utility rates for low-income customers, would remain. Moreover, with appropriate structuring, that credit represents a model which could be expanded to use the same customer eligibility system to identify those low-income individuals who would be entitled to a narrowly targeted GCT exemption on their consumption of certain utility services.

Nevertheless, to make the GCT even less regressive than the current sales and use tax, when it comes to purchasing the life necessity of clothing by low income people, a special Fair Tax Credit Card would be authorized and issued to essentially exempt up to $500 of annual clothing purchases for each person in households with Federal Adjusted Gross Income (AGI) below $30,000, with the exemption fully phased out at the $40,000 AGI level. The estimated $20 million cost of this tax fairness measure is expressly provided for as Item 3 in the Fiscal Scorecard illustrating the revenue neutrality of the Fair 55 Tax Reform Plan©.

Specifically, the Fair Tax Credit Card program would require applicants to annually submit a copy of their federal income tax returns to establish/confirm both eligibility and the number of individuals in their household, and would employ the same electronic benefit transfer system technology that is presently used for West Virginia’s SNAP.

Portions of the proposal may also be reflexively met with opposition based on state border competition from jurisdictions whose sales/use tax regimes do not have nearly as broad a base as we have now, much less, as we would have with the GCT. This opposition, to greater reliance on a consumption tax, was particularly acute in the context of the debate over West Virginia’s tax on groceries. Specifically, it was said, in support of a broad exemption of groceries (even for the overwhelming number of us who do not need a coupon-less 6% discount on our food purchases), West Virginia residents would drive into a neighboring state just to buy their food exempt of tax, and, thus, it was argued, our grocery stores would lose business.

Lost in such a debate is the completely unrecognized policy implications of this State’s long experience with a far broader sales tax base than any of its neighboring states. Thus, as explained above, from its inception (and long before its current, extended economic decline began), West Virginia was imposing its consumption tax on the bulk of all services while few, if any, other states tax them at all. Yet, if anyone really believes that fundamental tax policy difference explains why West Virginia, decades later, became chronically uncompetitive for the last half century, they have not ever been heard to say so, let alone, objectively demonstrate the merit of such a conclusion. Indeed, given the utter absence of even claims, much less offers of proof, of such an effect, it is apparent that it is more than “OK” to be different when it comes to well-conceived tax policy. Thus, if well-designed, different policy can lead to improved competitiveness.

Indeed, by recognizing the actual nature of the purported “border competition” threat, the Fair 55 Tax Reform Plan© includes a creative provision which promises to virtually eliminate the problem. First, since businesses will continue to be subject to regular audits of their purchases for consumption tax compliance under the GCT, it must be recognized that the border competition threat is strictly a retail customer level issue. Moreover, in light of the specific provisions included, either in the form of overt exemptions or those which tie GCT relief for low income taxpayers to in-state programs (e.g. food stamps, the Fair Tax Credit Card), it should be clear that the only real source of the threat of border competition in our tax law on retail purchases, lies in our state’s less than competitive rates of tax on retail purchases of tobacco and fuel, not on anything introduced by the Fair 55 Tax Reform Plan©.

Nevertheless, to help mitigate that existing retail border competition threat, the Fair 55 Tax Reform Plan© would also include a provision imposing a creditable (but not refundable) GCT use tax on individuals, whose income is above the level of those eligible for food stamps or for the Fair Tax Credit Card for clothing purchases. The amount of creditable use tax, applicable to all non-exempt purchases, would be based on twenty percent (20%) of the amounts in the state-specific sales tax tables, now used for itemized federal income tax deductions, for the 41% of West Virginia income taxpayers with reported AGI over $40,000.

Thus, on simple GCT use tax returns, after entering the appropriate AGI, number of federal income tax exemptions and the resulting tentative 20% creditable use tax, those reporting taxpayers could then offset the tax dollar-for-dollar, up the full amount of its pre-credit liability, by simply providing documented proof of having paid that amount of sales or use tax to any jurisdiction during the preceding tax year. Whether taxable purchases, for which use tax credit is claimed, have been made with cash or credit cards, by simply retaining and submitting the automatically generated paper sales receipts showing the tax payment, the process will be seen as a far simpler tax return compliance obligation for most taxpayers in the middle and upper income brackets than is the current (but to-be-repealed by the Fair 55 Tax Reform Plan©) personal income tax return process with W-2s, various credit schedules, etc.

For those, to whom it is still too much trouble to provide enough sales receipts, the maximum annual liability for the GCT use tax for a family of four in the $40,000 AGI bracket, without any credit for GCT actually paid, would still be less than $130. However, if the Legislature, in its wisdom, decided that using an even smaller portion of the federal table amounts (i.e. < 20%) was sufficient to overcome the currently existing border competition threat (already caused by our uncompetitively high retail gasoline and tobacco taxes), the cost of not reporting and claiming taxable sales for credit would be even less. Nevertheless, because of the ease of compliance with the tax paid credit claim process under its creditable GCT use tax provision, no revenue “windfall,” from non-compliance with the credit claim procedure is included in the Fair 55 Tax Reform Plan’s© Fiscal Scorecard accompanying this proposal.

Finally, unlike the gradual repeal of the tax on non-vehicle TPP, and the gradual replacement of the personal and corporate income taxes with the ECT, described in the next section, the positive revenue flow from the broader consumption tax in the form of the GCT can be achieved as soon after its enactment as the administrative mechanics can be implemented.

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Contact Michael Caryl for further questions or assistance.

The Fair 55 Tax Reform Plan (Part 1)

The Fair 55 Tax Reform Plan (Part 2)

The Fair 55 Tax Reform Plan (Part 3)

The Fair 55 Tax Reform Plan (Part 4)

The Fair 55 Tax Reform Plan (Part 5)