Fundamental Tax Changes Underpin Governor Wolf's Budge Proposal

In this piece, the Economy League provides an overview of how Governor Wolf plans to fund the investments proposed in his 2015-16 budget proposal.

In his first budget proposal, Governor Wolf called for substantial -- if not unexpected -- increases in state spending in several areas. In addition to proposing a nearly $1 billion increase in education spending, the administration included smaller but significant new investments in business growth and infrastructure. Previously, the Economy League looked at how these budget proposals align with specific priorities in the World Class Greater Philadelphia agenda. In this piece, we turn to revenues, providing an overview of how Governor Wolf would pay for the investments he’s proposed.


Governor Wolf’s budget includes a broad range of tax changes aimed at individuals as well as businesses. Some are relatively standard increases and cuts, such as raising the income tax rate and continuing the planned phase out of the capital stock and franchise tax, a process that started under his predecessor Tom Corbett. Others represent fundamental changes to tax policy in the Commonwealth, particularly those related to sales and corporate taxes. Some of these proposals will look familiar to those who have followed previous state budget negotiations -- another proposal to tax tobacco products, changes to the state liquor system, and closing the “Delaware Loophole.” However, this is the first time all of these changes have been proposed as part of such comprehensive package.


The impact of these proposed changes would be broad and, as always, opinions vary about who stands to lose and gain and how these changes would affect the Commonwealth’s economic competitiveness. Here are some of the proposals making the most waves:


Income tax ($2.4 billion): Governor Wolf has proposed raising the personal income tax from 3.07 percent to 3.7 percent, which would represent a 20.5 percent increase. Pennsylvania’s state constitution requires that any income tax be levied at a flat rate. Most states with an income tax, including all of Pennsylvania’s neighbors, have a graduated income tax. As part of his budget proposal, the Governor also included a wage tax reduction for those who live or work in Philadelphia.


Sales tax ($1.6 billion): The administration’s budget proposes a 10 percent increase in the sales tax – raising the rate from 6 to 6.6 percent. More importantly, the budget drastically expands the goods and services that are taxed in the state. The rate hike would not put Pennsylvania out of line with neighboring states (excluding Delaware, which has no sales tax), and some items included in the proposed expansion – candy and gum and personal hygiene products, for example - are currently taxed in many other states. However, the list does include items and services that are not regularly taxed elsewhere, such as legal and accounting services and daycare services. Food and clothing remain tax-exempt under his plan. In Philadelphia, which levies an additional 2 percent sales tax, the rate would not change.  


Property tax: The revenues generated by these increased income and sales taxes would replace a portion of the funds for schools currently raised by local property taxes, allowing for $3.8 billion in property tax cuts.  The state currently provides about 36 percent of k-12 basic education funding, a relatively low share of funding compared to other states. Governor Wolf’s longer-term goal is to raise the state share to 50 percent and to target tax relief to high-poverty, high-tax school districts for the biggest decreases. The proposal also provides cuts for low- and moderate-income renters and seniors. Details are still murky, but this question and answer session provides a good review of where things currently stand. Critics have voiced concernsthat increased state funding for schools will not lead to significant, lasting property tax cuts.    


Natural gas tax ($1 billion): Governor Wolf campaigned on enacting a severance tax on natural gas, so it was no surprise that he proposed this as part of his budget. Under his proposal, drillers would pay a tax on the sale of the gas (5 percent) as well as the volume (4.7 cents per thousand cubic feet). The proposal eliminates the impact fee that drillers currently pay, which generates more than $200 million in annual revenues for local governments. To make up for this, $225 million will be set aside annually for local governments. Still, county officials have expressed concern about the potential impact of these tax changes on their budgets. Additionally, energy tax revenues are particularly sensitive to market fluctuations and, as a result, can be volatile. Relying too heavily on these types of relatively unpredictable revenues can pose risks to revenue stability and budget solvency.


Corporate tax (-$249 million): Pennsylvania has one of the highest corporate tax rates in the nation at 9.99 percent, but current rules allow more than 70 percent of companies doing business in the state to not pay the tax at all. Wolf has proposed lowering the rate to 5.99 percent and changing reporting requirements (i.e., close the so-called Delaware Loophole) so that more businesses are subject to the tax. The administration estimates the change will reduce corporate tax revenues, but the impact on individual businesses will vary widely. 


Pension reform and liquor modernization ($200 million): Pennsylvania has a massive pension problem at both the state and municipal levels – more than $50 billion in unfunded pension liabilities for state and school employees and more than $6 billion in unfunded municipal obligations. It will take years to address these gaps. For now, the Governor is proposing to move state pension programs toward solvency by borrowing $3 billion to refinance a portion of the unfunded liability. Debt service on this borrowing would be paid for by state liquor system modernization. He also proposed changing investment strategies to lower the cost of managing Pennsylvania’s public pension funds, creating an estimated $200 million in annual savings and reducing the unfunded liability by $2 billion over the long term.


Beyond these big increases and shifts, Governor Wolf’s budget includes a $1 per pack tax increase on cigarettes and the near-perennial proposal to tax cigars, electronic cigarettes, and other tobacco products. He’s proposing a 40 percent wholesale tax on these items that would generate $84 million, according to the administration's estimates. If approved, the cigarette tax increase would eliminate the $2 per pack cigarette tax Philadelphia imposed last year to help fund its schools. This budget also calls for a tax increase on banks estimated to generate $339 million and continues the phase-out of the capital stock and franchise tax.    


There’s little question that Governor Wolf’s first budget proposal lays out a bold agenda to change state revenues and expenditures. He is proposing systemic and comprehensive reforms which contrast with the marginal, incremental changes that are more typical in Pennsylvania. This, of course, is just the beginning of long process, and while there is agreement about many of the challenges the Commonwealth faces, it remains to be seen if political leaders can come together on the solutions to these challenges.


The budget now goes before the State House and Senate Appropriations Committees for hearings, and eventually, before the full legislature for approval. Between now and then, any number of changes are likely to be made, which could involve a virtual rewrite of both the revenue and spending side of the budget. As citizens and legislators weigh these tax proposals, they should keep in mind that there are some objective criteria that most economists and experts agree can be used to evaluate tax systems: fairness (benefit and ability to pay), efficiency (predictability and minimal impact on markets/behaviors), and effective (straightforward to administer).


To follow the latest developments, keep an eye on the Senate and House Appropriations Committees as well as reports from the Senate Republican and Democrats and the House Republicans and Democrats. Research and advocacy groups on the left and right will also provide ongoing coverage of progress.