“One of our main priorities is not to be in a situation where we’re going over our skis on either side of this — tax cuts or in spending,” Youngkin said in terse remarks to reporters this week after meeting with a panel of business leaders to discuss the assess the state’s economic prospects.
Youngkin chaired the annual closed-door meeting of the Governor’s Advisory Council on Revenue Estimates, a group of leaders from business and financial institutions — as well as legislators on the General Assembly’s money committees — that provide economic forecasts that help guide the budgeting process.
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Youngkin said the panel’s broad consensus after two hours of discussion was that some degree of economic slowdown appears likely. “It is generally expected that there will be a recession next year,” he said. That requires budget officials, he added, “to be very careful about what we do, especially next year when we’re heading into a storm – and we all really believe it’s going to be a storm; we just don’t know for sure if it’s a tropical storm or a hurricane-level storm.”
Inflation, Russia’s invasion of Ukraine, supply chain problems that persist after pandemic shutdowns, as well as the Federal Reserve’s steady hike in interest rates to combat rising prices, all add to economists’ expectations of a coming recession. But Youngkin pointed out that Virginia is in an unusually good position to withstand the fall in tax revenues that could accompany a cooler economy.
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That’s because two years of federal pandemic aid, combined with a sharp uptick by businesses and the wealthiest taxpayers, have filled the state coffers to the brim. Thanks to measures approved by the General Assembly and signed by Youngkin and his predecessor, former Governor Ralph Northam (D), Virginia will reach an all-time high in its fiscal reserve funds.
By the end of next year, Youngkin said, the state’s reserves will exceed $4 billion, or about 15 percent of the state’s general fund — a level lawmakers once thought was nearly unattainable. Those reserves help protect Virginia’s prized triple-A bond rating and can secure finances if earnings disappoint. In addition, the state ended last fiscal year with a surplus of $3.2 billion.
“The Commonwealth is in the best financial position ever,” Youngkin said, though he has also argued that part of that fiscal buffer is a result of overtaxing during Democratic governments in Richmond.
Youngkin’s office reported strong tax revenues for October, up 3 percent from the same month a year ago. That included the state’s payout of a round of taxpayer credits, as well as the first impact of an increase in the standard deduction for personal income taxpayers that the General Assembly approved at its session earlier this year.
Without those factors, sales in October would have increased by 10.3 percent compared to a year ago.
Youngkin took office in January, promising tax cuts, and the divided legislature — Republicans control the House of Representatives and Democrats control the Senate — delivered $4 billion over the next two years, including nearly doubling the standard deduction. That change is expected to reduce state revenue by about $50 million per month.
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But Youngkin failed to get approval for his proposed gas tax suspension, and while he got lawmakers to agree to end the state’s 1.5 percent tax on groceries, a 1 percent local grocery tax remains in place. Democrats — and even some Republicans — expressed concern that more extensive tax cuts would reduce the state’s ability to fund its obligations in a time of economic uncertainty.
“We are in such troubled waters,” Senate Finance and Appropriations Committee co-chair Janet Howell (D-Fairfax) told reporters in August. “Hopefully we’ll be able to do some tax relief, but it’s not necessarily in the bag, and I wouldn’t want people to get their hopes up.”
Senate Majority Leader Richard L. Saslaw (D-Fairfax) said in an interview this week that he is very skeptical of the idea of cutting taxes during an economic downturn. “If we end up in a recession [and cut taxes]., we’re going to shut down half the government,” he said, adding that Virginia is still lagging behind in raising wages for teachers and law enforcement and in providing mental health services.
“We need to provide features that people expect from us,” Saslaw said.
The legislature will convene a new session on Jan. 11, and Youngkin has said he will propose a $397 million fund for “taxpayer relief” and has expressed interest in cutting the corporate tax rate, among other possible cuts. He will set out his budget priorities on December 15, when he proposes changes to the two-year spending plan that took effect on July 1.
On the bright side of the balance, job growth has returned to Virginia since the end of the closures and business restrictions associated with the pandemic. The state’s unemployment rate was 2.7 percent in October, one point below the national rate, and wage growth is higher.
But Youngkin, a former private equity manager who likes to discuss state finances, outlined some potential weaknesses that could affect tax revenues next year. Most of the state’s revenue comes from taxes withheld from residents’ paychecks, he said, and that would suffer from recession-related job losses.
Non-withholding taxes — tied to the stock market or other capital gains — “are much harder to predict,” Youngkin said. “We’re going to be cautious about that forecast,” given the sharp rises and falls markets have been through over the past year.
Corporate profits are another major source of the state’s tax revenue, and Youngkin said he expects those to come under pressure next year if the economy slows. And consumer spending, which boosts sales tax revenue, “has been pretty healthy overall. There’s some decline in the overall health of the consumer balance sheet, but it’s still good compared to where we were before the pandemic. But that can change quickly. And so we’re watching that very closely,” he said.