Perspectives from the 2004 Session
May 20, 2004
Excerpts from remarks by H. Benson Dendy III, President of The Vectre Corporation
to the Corporate Counsel Sections of the Richmond Bar Association and Virginia State Bar, May 20, 2004
I am pleased to be with you today to discuss the 2004 Session of the Virginia General Assembly. I will concentrate on the top three issues before this year’s legislative session: the budget, the budget and the budget. Do not get me wrong, there were other issues before the General Assembly. Indeed, squirrel hunting in Floyd County was banned between September and January. A bill was passed to require minors to get parental consent before streaking at nudist colonies. Just to show that delegates and senators got along well together, the House of Delegates and the Senate reached agreement in the second week of February that the month would be known as “National Courtesy Week in Virginia.”
Richmond Times Dispatch columnist, Jeff Shapiro recently wrote, “Seemingly endless floor sessions. Nasty intra-party scuffles over big bucks. Threats of retaliation. A hard fought compromise. A dramatic finale.” Was that 2004? No, it was 1954, when the young Turks fought with the Byrd organization arguing for higher expenditures for public education. That year they only went over by 36 hours, however. The compromise was that $2.1 million was earmarked for education and the remaining $4.9 million was credited to taxpayers, considerably less than the hundreds of millions the General Assembly was fighting over fifty years later. Indeed, the late Richmond Times Dispatch columnist Jim Latimer said that Virginia had the habit of raising taxes on a regular schedule of about every twenty years. It happened in 1926, 1948, 1966, 1986 and now in 2004. It took that long Mr. Latimer felt for Virginia’s reliably conservative electorate finally to realize that services like education and public safety had deteriorated sufficiently to justify new tax dollars.
Dr. Larry Sabato, one of America’s most able political scientists, has said that, “It took 24 days for Jefferson to write and for the Continental Congress to approve the Declaration of Independence. God created the universe in six days and he destroyed the earth by flood in forty. I know these legislators aren’t Jefferson or God, but really how long does it take to create a budget?” Several weeks after Dr. Sabato asked this, we learned the answer. At least for 2004, it took 115 days.
The session began with Governor Warner and the Senate majority committed to raising revenues and making new investments in the state for core services such as education and public safety and the House Republican majority advocating maintaining these same core services while “protecting the pocketbooks of our citizens.”
What began being talked about as tax reform as the legislature moved ahead became a little less reform and more tax increases. Both the Governor’s original plan and Senator Chichester’s plan, which initially passed the Senate, involved more tax reform. This tax reform reduced personal income taxes for lower and moderate income citizens and increased them for higher income citizens while completely eliminating the car tax and the estate tax. Other revenues were generated through increasing the sales tax and increasing income taxes on higher income taxpayers. Indeed the Governor talked about 65% of the citizens paying less taxes under his proposed tax reform plan, while generating $1 billion. As the process moved ahead, the need for new investment took priority. However, there were significant reforms made in Virginia’s tax code.
It is important to note that Virginia was one of only two states to go through the economic downturn in the early 90’s without increasing taxes. It is my understanding that this year; we became one of the few states to be able to have a comprehensive tax increase package pass the legislature. Governor Mark Warner was able to move adroitly this legislation through the Virginia General Assembly by positioning himself between Senator Chichester, who wanted a package generating almost $4 billion in new revenue, and the House of Delegates leadership, which opposed any tax increase.
The dynamics that made this happen involved a state whose population has grown more than the nation’s over the last twenty years. Indeed, Virginia has grown by 32% since 1981, while the nation’s population has only grown by 24%. Personal income in Virginia has grown in the last twenty years by 80%, while personal income in the nation has grown by only 58%. However, Virginia has remained a low tax state and this likely will continue to be the case.
In a conservative, fiscally responsible, balanced budget state like Virginia, major spending cuts are hard to identify. Three quarters of our General Fund budget is directed to education, Medicaid, which provides health and nursing home care to the poor and elderly, and public safety. The remaining quarter of our budget is spread across a host of services from the court system to environmental protection to economic development.
When legislators arrived in Richmond they had dealt with a six billion dollar budget shortfall over the last three years without raising taxes. They saw on the horizon a shortfall of over a billion additional dollars. They were greeted by an action in September by Moody’s Investors Service placing the Commonwealth on its watch list for a possible bond rating downgrade. Virginia has had its Triple A bond rating since 1938 bond rating. Virginia was placed on the watch list because of fiscal pressures brought on by a weak economy and the significant revenue shortfall experienced since the recession began, especially affecting the technology and telecom industries. Moody’s statement said, “This shortfall has further been exacerbated by the initial phase-out of a tax on automobiles that was introduced prior to the recession.” Moody’s also noted that Virginia’s Revenue Stabilization Fund, the “Rainy Day Fund”, had been drawn down significantly from $940 million in 2001 to $472 million in fiscal year 2002 and was expected to total only $130 million by the end of fiscal 2004.
Virginia’s financial advisor spoke to the Senate and House Finance Committees in February about the structural imbalance in Virginia’s budget and the significant pressures which could be expected to be placed on future budgets. These pressures include the expectation of eliminating the car tax and the continued growth in Virginia’s school age population, enrollment in state colleges and universities and eligible recipients for Medicaid. He clearly stated Moody’s concern was not just the current bottom line but what Moody’s saw in the future in terms of budget pressures and Virginia’s willingness to address these pressures. He was referring to concerns such as in the last twenty years the number of Medicaid recipients in the Commonwealth has increased by 131%. Yet, Virginia has one of the most conservative Medicaid programs in the nation, ranking 48th in Medicaid spending. Much of our Medicaid program is mandated by the Federal government, so there is not a great opportunity to cut here. Virginia’s school age population has grown 10% in this same period. Our prison population is growing.
The strategy of the House leadership evolved as the battle with the Governor and Senate continued. While the House leadership consistently said we do not need to raise taxes, as the session wore on they searched for ways to generate new revenue without violating their commitment to no general tax increases. The first indication of their willingness to generate some new revenues arose when the Chairman of the House Appropriations Committee made a speech on the floor of the House about how draconian the House budget would be without any new revenues. His speech recognized that core services like education, human resources and public safety would be protected, but there would have to be cuts in these and other areas if no new revenues were raised.
On February 17, a majority of the House members recognized the need for new revenues by passing a bill introduced by unanimous consent four days earlier. This bill would have eliminated the sales tax exemptions for twelve major industries in the state including utilities, airlines, shipbuilding and railroads. According to the House’s financial projection, eliminating these exemptions would have generated approximately $520 million. At this point, the issue was not were new revenues needed but how would these revenues be generated. It should be noted that several of the strongly anti-tax delegates opposed this action. They felt it was a mistake to pass this legislation because it was a recognition of the need for new revenues. On March 1, the House Republicans proposed that any general tax increases (including the sales and income taxes) go to a referendum of the voters. The referendum proposal had little legislative support, although it was endorsed by Senator George Allen, former Governor Douglas Wilder and Attorney Jerry Kilgore. Senate Republicans and the Governor opposed the referendum proposal. Referendums on legislative issues have been strongly opposed by the business community because they believe referendums make the business climate dependent upon the political whims of any given time. They believe in a representative democracy, legislators should make these decisions.
I want to address the sales tax exemption issue in greater detail because I think it is important to Virginia businesses. The business community believes that general tax increases whether they be individual income taxes, corporate income taxes or sales taxes are preferable to taxes which are targeted at certain businesses and can have a very damaging impact on specific segments of our economy. This year, the only sales tax exemption eliminated was the exemption for equipment purchases and leases by utilities, telecommunications firms and trucking companies. Language was included to allow the cost of these exemptions to be passed along to customers. It should be noted that the sales tax exemption issue is not going to go away and the House of Delegate has commissioned a study of sales tax exemptions as well as corporate and personal income tax preferences. Sales tax exemptions, which benefit businesses, are valued at over $3 billion. This area can be expected to be closely examined by House members prior to the 2005 Session and the House Finance Committee is to report on these exemptions before the start of the 2005 Session. It should be noted that despite all of the discussion about eliminating tax preferences, the General Assembly ultimately approved $6 million in new tax credits against the Virginia corporate income tax for cigarettes manufactured in Virginia which are exported by the manufacturer. The sales tax exemption elimination proposal like the referendum proposal was opposed by some of the major industries in the Commonwealth. When the Senate rejected the House sales tax exemption elimination strategy, the General Assembly was deadlocked for weeks on a solution to the budget situation.
It should be noted that House Republicans believe strongly that core services can be protected without raising taxes. They note that in the 1990’s according to the American Legislative Exchange Council, Virginia’s General Fund expenditures rose 98%. Only eight other states during this period saw larger growth in state government. They point to studies done by recent administrations including the Warner Administration recommending streamlining government and initiatives to save tax dollars. Some Republicans in the House have created a “cost cutting caucus.” Ultimately, however, in 2004, the majority of the General Assembly concluded that much of the budget was made up of core areas, where costs were increasing dramatically, for reasons beyond their control.
House Republicans also believed that the economy was improving and that revenue growth would be sufficient to lead Virginia out of the current budget challenges. This argument was aided after the final budget decisions were made, when April tax collections grew by 22.5% over the same month in 2003. For the first ten months of the year, the state’s revenue grew 9.5% ahead of last year. The Warner Administration does not believe that this growth can be sustained. They do not believe that Virginia’s budget growth, without the new revenues passed by the recent session, would sustain the growth in Virginia’s school and college enrollment and escalating health care costs.
The deadline for the completion of a budget was the end of the 60-day Session scheduled for March 13. This date came and went and the legislature remained in regular session without agreement until Tuesday, March 16, when they adjourned. The Governor immediately called the General Assembly back into special session. Budget conferees met periodically, sometimes for only several minutes to try to reach agreement. The staffs worked, but the deadlock could not be broken. The House Republicans were able to remain united throughout the regular session of the Virginia General Assembly. As the regular session ended the House Republicans developed the strategy of going out to hearings to get the views of the people. These hearings were held across the state and, to the surprise of some, the majority of citizens attending the hearings were in favor of increasing taxes to meet what they saw as the major obligations of the Commonwealth. This really should not have been a surprise to anyone because advocates are often well organized. Many believe the outcome of these hearings was due to the fact that the Governor and the business community had well organized and heavily funded the Foundation for Virginia’s Future to lobby, particularly at the grassroots level, for revenue raising measures. This group very successfully turned out citizens in support of new investments in the Commonwealth. About 30 hearings were held around the state with several hundred citizens attending many of them. What was surprising was that the anti-tax forces did not turn out many tax opponents to these hearings.
The hearings, the prospect of having no state budget and the Governor and the Senate’s steadfast position resulted in a crack in the unity of the House majority. Seventeen Republican House members broke with their Republican colleagues and developed a package of a little less than $1 billion in new general fund revenues which was reported from the House Finance Committee. The package was reduced by about $200 million on the House floor by eliminating the proposed recordation fee increase and passed the House in April. These seventeen were a diverse lot including four senior committee chairmen and several members having served less than two terms.
I think that it is important to note the compromise plan in the House was put together by two legislators who came to the legislature from local government, Delegate Chris Jones, who had served as mayor of Suffolk, and Delegate Preston Bryant, who had been a City Councilman in Lynchburg. Six of the seventeen had served on local town or city councils. They recognized that Virginia’s localities for decades have been forced to meet needs not met by the state. Localities have had mandates placed on them by the state for many years that have not been funded. These legislators were particularly sympathetic to the concerns of local government and the great pressure which would be placed on these local governments if the state was unable to pass a budget. They were also sympathetic to the ever increasing local real estate taxes that were occurring in the larger more growing urban areas of the state. Localities in Virginia are limited in their taxing authority and the real estate tax is the major local source of revenue for localities. Indeed, the tax legislation which finally passed establishes a Public Education Standards of Quality/Local Real Estate Property Tax Relief Fund. The hope being that these revenues could in part allow some reduction in local property taxes in areas like Fairfax County where they have increased dramatically in recent years.
Ultimately the tax package which passed the General Assembly generated $1.4 billion in new revenues. $400,000 more than the Governor’s package. It increased the sales tax from 4.5% to 5%. The cigarette tax is increased from 2.5 cents per pack to 20 cents per pack, August 1 of this year, and 30 cents per pack, July 1, 2004. The tax on recording real estate deeds and other documents was increased by 10 cents per $100 of value. The sales tax was made less regressive by reducing the tax on food from 4% to 3.5% on July 1, 2005; to 3%, July 1, 2006, and finally decreased to 2.5%, July 1, 2007. The income tax was reformed. The personal exemption was increased from $800 to $900 and the “marriage penalty” was eliminated. The filing threshold was raised from the $7000 to $14,000 which removed 141,000 low income Virginians from the tax rolls entirely. A new low income tax credit is created for the working poor. Means testing was established for Virginia’s generous age deduction that currently begins at age 62.
The so called “Delaware Holding Companies” provision in Virginia’s state tax law was significantly changed. The tax reform legislation establishes a number of safe harbors that will continue to allow most deductions for tangible interest and business expense payments made to affiliated Delaware Holding Companies. However, payments for intangible expenses, such as royalty or licensing payments, made to Delaware Holding Companies, will have to be added back to Virginia taxable income. The interest payments that large companies make between their internal divisions will remain deductible, as long as they are not related to intangible assets. The new legislation further provides that corporations can apply to the Virginia Department of Taxation for a refund of Virginia taxes paid on intangible expenses but the Virginia Commissioner of Taxation can deny the refund request if he thinks the real purpose of the transaction is tax avoidance. If a refund request is granted, the deduction for such intangible expenses will be allowed in future years without the need to seek a refund. The legislation further provides that the decision of the Tax Commissioner on refund requests cannot be appealed to the courts.
The new law requires all pass through entities, such as partnerships and limited liability companies, to file an annual informational income tax return with Virginia to identify their owners. The General Assembly declined to require multi-state corporations to factor in their out of state sales when calculating their Virginia income. This means the so called “throwback” rule, so important to some Virginia manufacturers, will remain in place.
After agreeing to a revenue package, it took the budget conferees a week to reach agreement on the final state budget. This agreement was reached in early May and the special session finally concluded on May 7th. The major winner in this year’s state budget is public education, which receives $1.5 billion in new state funding. Keep in mind the whole tax package generated $1.4 billion. In recent years we have put significant requirements on our local schools with Standards of Learning and testing. Yet, the Commonwealth has not fully funded its Standards of Quality established by the State Board of Education and approved by the General Assembly, which local school divisions must follow. Going into this year’s session, the Board of Education and the Joint Legislative Audit and Review Commission had found Virginia’s funding of its educational obligations were well in excess of a billion dollars in arrears. The new budget funds the biennial “re-bench marking” of public education costs, including the rising costs associated with increased student enrollment, teachers’ salaries and increasing health insurance and retirement costs. The budget supports almost 10,000 teachers previously not recognized by state standards. This is about eight additional teachers per 1000 students. These are teachers, which are hired by local school divisions but not reimbursed by the state. The improved funding supports the revisions to the Standards of Quality recommended by the State Board of Education. Funding is also included to implement the Board of Education’s Standards of Quality prevention, intervention and remediation programs.
Higher education in Virginia will receive an additional $180 million. The Rainy Day Fund is replenished and will total in excess of $430 million by the end of 2004 – 2006 biennium.
The budget includes new investments in community-based Medicaid waiver programs. The budget adds nearly $32 million to provide mental retardation waiver services for 700 people currently living at home with aging parents or siblings. Medicaid providers such as nursing homes and hospitals will receive increased reimbursements. In the case of hospitals, there will be a 6% increase in their “fee for service” operating payments in FY 2005. In FY 2006, hospitals will be reimbursed at 75% of their cost for inpatient services, up from 72%. It should be noted that we still are asking Virginia’s hospitals to cover 25% of their costs in treating Virginia’s indigent citizens. Nursing home Medicaid payments will be increased by $3 per day. Nursing home reimbursements for caring for Virginia’s elderly will continue to be near the bottom in the nation. This despite Virginia’ nursing home residents having among the highest acuity rates in the nation, meaning they are the sickest.
Virginia’s public employees will receive a minimum 5% raise over the next two fiscal years, with a 3% raise in November 2004 and a 2% raise in November 2005. Public safety is strengthened by providing competitive salaries for state police and deputy sheriffs. This seeks to address the fact that some state police officers and deputy sheriffs in Virginia qualify for food stamps. Their starting salary is $23,800.
Governor Warner has said that this year’s budget has the “largest infusion of funds for natural resource programs in Virginia history.” Even with this expenditure, environmental groups maintain Virginia is still in last place among the states in environmental state expenditures. The budget has $35 million in new spending for environmental protection and conservation, in addition to another $7.7 million from surplus funds that by law must be spent on reducing water pollution.
The General Assembly did not address the acceleration of the sales tax collections which results in retailers having to remit approximately $180 million in sales taxes in advance of actual collection. This involves retailers making an extra monthly payment at the end of the fiscal year.
The area that clearly was left unaddressed was transportation. Governor Warner’s budget as introduced proposed $392 million in new general fund spending for transportation over the next biennium. The original Senate budget proposed $1.6 billion in net, new non-general fund revenues over the course of the next biennium for transportation. The original House budget proposed only $138 million for transportation. The Senate early in the process in the spirit of compromise eliminated the transportation component of their plan, which was largely funded by increasing the gas tax to 20.5 cents imposing a sales tax at the gasoline wholesale level and raising the automobile titling tax. With the increase in gas prices, many felt that it was not the right time to raise gasoline taxes. With no new transportation dollars in this year’s budget, this means that road maintenance will continue to take a larger and larger share of available road construction dollars. The Virginia Department of Transportation indicates that if no new revenue sources are approved for transportation, for the first time ever Virginia will be forced to spend more on road maintenance than road construction in 2007. A few years later, Virginia may be unable to provide its state match to receive federal transportation funding. This could mean Virginia will forfeit annually all of the Federal funds that would otherwise be available for interstate and other Federally funded highway projects. The impact of no new transportation funding in 2004 was almost immediately felt with the Virginia Department of Transportation announcing on May 7 that it will have to cut $1 billion out of its proposed six-year highway construction program because the state budget does not include the additional revenue Governor Warner sought for transportation. Senator Chichester has already cited this as the one area of unfinished business. Transportation could even be the subject of a special session in the next several years. However, it is important to note that after tax increases totaling $1.4 billion, it will be challenging to see additional tax increases enacted in the near future.
Legislation was passed to cap the reimbursements to localities for the elimination of the car tax at $950 million which is expected to be very close to the amount that the localities will receive in 2005. This is based on a 70% elimination of the car tax in 2005. Since it is capped at a dollar figure, the reduction will vary from locality to locality as the years go on. Growing localities and localities whose citizens purchase more expensive cars will receive a lower percentage of car tax reimbursements from the Commonwealth than other less affluent localities. The car tax when originally proposed was projected to cost only $620 million annually. It is important to note that Gilmore Administration officials did indicate in April of 1998 that the cost of the car tax would increase over time. To fully implement, the car tax removal today would cost $1.5 billion. This is the sort of increasing obligation on the Commonwealth which was of real concern to Moody’s.
Governor Warner was very supportive of the final tax package approval by the General Assembly. His original package generated $1 billion and he was able to see a $1.4 billion package pass the General Assembly. Governor Warner said the package met his original three goals for tax reform. One was to make the tax system fairer. Two was to meet Virginia’s constitutional commitment to education and three was to protect the Commonwealth’s fiscal integrity. Virginia’s financial advisor in New York said in mid-May that the “budget presents a very strong argument for the state remaining Triple A rated by all three rating agencies.” Governor Warner traveled to Wall Street to brief the rating agencies two weeks after the General Assembly went home.
Politically we will not know the real results of this year’s legislative budget decisions until the 2005 elections. We can anticipate tax increases and investments in Virginia to be major issues in the gubernatorial campaign and the races for the House of Delegates next year. I would expect that the business community, advocacy groups and the anti-tax forces will all be deeply engaged in trying to win the “hearts and souls” of Virginians.
I want briefly to touch on some non-budget issues which are of particular interest to the business community. Electricity deregulation will continue to move ahead. Legislation, which passed this year’s Session and was supported by both Governor Warner and Attorney General Kilgore, extends the capped base rates for three and a half years through December 31, 2010. New restrictions are imposed on power company fuel rates, freezing their rates at currents level until July 1, 2007. At that point, the State Corporation Commission will set a new fuel rate for each utility – based solely on anticipated fuel prices – to run through the end of the capped rate period. This legislation eliminates all wire charges on customers who switch to competitive providers on July 1, 2007, as called for in the original Restructuring Act. The legislation sets up procedures through which many customers can become exempt from wire charges ahead of schedule. The bill provides more flexibility for municipalities that want to set up aggregations, or buying groups, to obtain better deals on electricity for their citizens. It also encourages the development of coal-fired power stations in Southwest Virginia as a means to boost the region’s economic development and assure the Commonwealth has reliable energy supplies in the future. Proponents of the legislation state it offers additional protections for electric consumers by providing more time for the competitive retail electricity markets envisioned by the original restructuring act to develop and by limiting fuel rate increases. Opponents of the legislation preferred repeal of or a freeze on Virginia’s current deregulation law.
The legislature considered deregulating local telephone services in the state and raising rural telephone rates. By the time the bill passed, however, it was reduced to a one paragraph statement in favor of local telephone competition.
This year’s session was a good one for workers’ compensation. The General Assembly rejected legislation to eliminate the employer - selected panel of physicians from which the employee selects the treating physician. This has been found to be the most effective cost containment tool in Virginia workers’ compensation laws and assures that the treating physician is familiar with the employee’s workplace. Another workers’ compensation bill allows businesses to recover workers’ compensation benefits when a worker receives an award or settlement for the same injury. This addresses benefits paid to workers injured in motor vehicle accidents while on the job.
Another area of significant interest at the legislative session this year was the whole area of liability. This discussion arose out of concern about the difficulty physicians, particularly OBGYN’s, are having in getting malpractice insurance. As a result of this, legislation was passed permitting physicians and sole community hospitals under certain conditions to purchase liability coverage from the state’s Division of Risk Management after 2006 and authorizing a comprehensive study in 2004 of liability coverage issues.
Legislation also was passed which impacts all litigation. One bill limits the plaintiff’s ability to drop suits at the last minute without a penalty. The defense counsel will be allowed to ask the judge to award expert witness expenses that cannot be avoided if a suit is dropped less than seven days prior to the trial. Current law provides that a judge can take this action if the suit is dropped less than five days prior to the trial. Another bill which passed the General Assembly attempts to limit forum shopping by providing that the venue for a case must be where the defendant regularly conducts substantial business activity. This is a higher standard than the current law which provides for the case to be tried anywhere that the defendant conducts affairs. Current law allows cases to be brought where the defendant might have an accountant, lawyer or any type of business relationship. In some instances, the case today can be brought almost anywhere the plaintiff desires.
The legislature rejected legislation that would have given manufacturers of tobacco products, firearms and high fat immunity from product liability lawsuits filed by plaintiffs who voluntarily used those products.
One approved environmental measure which the business community found palatable, if not ideal, would generate $6 million to run environmental programs, by establishing an increased fee schedule, for water and waste permits obtained from the Department of Environmental Quality.
It often has been said that watching the legislative process is like watching sausage being made. Some said that this year the process made sausage makers look good. It may not have been pretty, but the 2004 General Assembly reached a budget agreement, ending a long, hard fought and historic debate. Non-budget legislation important to business was also enacted. The Commonwealth was moved forward.
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