HJR 532

Commission on State and Local Government Responsibility and Taxing Authority

November 20, 1997, Herndon

Earned Income Tax Credit

Earned income tax credit legislation has been introduced each year since 1991. Advocates of the credit argue that with the changes occurring as a result of welfare reform, those individuals coming into the workforce for the first time or after an extended absence will need the credit as an extra incentive for a successful transition into the working world.

The federal EITC is a tax credit for low-income workers and is targeted at those workers who live with and support their children. Individuals must work in order to get the credit, which has been in the federal tax code since 1975, with expansions in 1986, 1990 and 1993. The intent of the expansions was to make work pay enough to lift a family, with a full-time worker, out of poverty. The federal EITC is administered through the federal tax system, with the amount of the credit based on family earnings and the number of qualifying children. It is a refundable credit, with families who qualify actually receiving a check from the federal government.

A state EITC would pick up where the federal credit stops, applying the same eligibility rules used by the federal government and piggybacking on the federal EITC by using a percentage of that credit. The credit would rise to a maximum amount and gradually phase out. Such a credit would not be inexpensive, especially if it is refundable, which supporters insist is a necessary component to help those who need it the most. It seems likely that EITC legislation, along with other tax relief legislation, will be on the General Assembly's plate during the upcoming session.

Federal Tax Law Changes

Virginia is a conformity state when it comes to income taxes, which means that in determining taxable income for state income tax purposes, the taxpayer begins the calculation with his federal adjusted gross income. Therefore, most changes in the federal tax law will affect Virginia revenues.

According to the tax commissioner, the Taxpayer Relief Act of 1997, which was signed by the President on August 5, 1997, is very detailed and contains 282 provisions. The major components of the act include a child tax credit, post-secondary education tax incentives, broad-based relief from capital gains taxes, expansion of individual retirement accounts, significant reductions in death taxes, repeal of certain corporate tax benefits, and changes in the rates and bases of various federal excise taxes.

At the federal level, the act is supposed to provide net tax reductions of $85 billion over the next five years and $250 billion over the next 10 years. At the state level, the Tax Department's preliminary estimates show a positive impact on state revenues as a result of these changes. In fiscal year 1998, the projection is an increase in tax receipts of $136.5 million; in fiscal year 1999, $68.6 million; and in fiscal year 2000, $41.3 million.

The greatest impact seems to be a result of the reduction in the capital gains rate from 28 percent to 20 percent (10 percent for gains otherwise at 15 percent). For property held more than five years, with the holding period beginning after December 31, 2000, the maximum capital gains rates will fall to 18 percent and 8 percent. It is thought that this will encourage the buying and selling of stock more often, which in turn produces more revenues.