In office only two months, Governor Wolf has wasted no time in proposing a budget which would boost education funding, provide local real estate tax relief, close a $2 billion  operating deficit and address Pennsylvania's $50 billion accumulated pension deficit.  He would substantially reorder Pennsylvania's state tax system in order to pay for it.  The budget he proposed on March 3^rd would include:

• Mandatory Combined Reporting of Corporate Net Income Tax, effective 1/1/2016
• CNI rate reduced from 9.99% to 5.99% effective 1/1/2016
• CNI Net Loss Deduction Cap reduced from $5 million / 30% to $3 million / 12.5%
• Capital Stock / Franchise Tax Phaseout completed as of 1/1/2016
• New Marcellus Shale Severance Tax
• Personal Income Tax rate increase from 3.07% to 3.7%, effective 7/1/2015
• State Sales & Use Tax rate increase from 6% to 6.6%, effective 1/1/2016
• Sales & Use Tax base expansion by eliminating numerous exemptions
• Cigarette Tax increase by $1.00 per pack, from $1.60 to $2.60, effective 10/1/2015
• New Tax on Other Tobacco Products, including e-cigarettes, effective 10/1/2015
• School Property Tax Relief & Phila. Wage Tax Relief of $3.8 billion in October 2016
• Made-in-PA Tax Credit

The Governor's budget proposals also include increasing the minimum wage to $10.10 per hour, boosting funding for preK-12 education by $662 million (excluding pension payment), $140 million of additional funding for state-owned and state-related universities, $25 million in new PHEAA initiatives, and other higher education funding. 

Governor Wolf is proposing General Fund spending of $29.88 billion for FY2015-16.  This represents a 2.8% increase in General Fund spending over FY 2014-15.  However, this does not account for the payments to the school pension fund which would be moved into a new restricted spending account for FY2015-16.

The Budget Hole.  According to a summary published by the House Democratic Appropriations Committee, the Wolf budget assumes current year revenues will end the year essentially on-target.  Although year-to-date revenues were ahead of target by more than $377 million at the end of February, some budgeted one-time transfers scheduled for the end of the fiscal year are not expected to materialize.  Without the tax changes proposed by the Governor, the House D's indicate that revenues would be projected to increase by only 1.5% in FY2015-16.

This, however, is only the beginning of the fiscal picture going into budget season.  According to the Governor's Budget Office, the Commonwealth faces a large structural operating deficit, substantial mandated spending increases and upcoming state employee contract renewals as well as the massive pension deficit.

According to data published by the Budget Office, the cupboard is almost bare in part because the current 2014-15 budget was built on one-time revenues to a much greater extent than in prior years:

               2014-15: $2,012,000,000

               2013-14:     795,000,000

               2012-13:     287,000,000

               2011-12:     569,000,000

Furthermore, in 2015-16, the Commonwealth faces the following substantial mandated spending increases:

               Human Services: $900 million

               Corrections:          200 million

               Pension Costs:      500 million

Note:  As this article was written, we had not seen details of the tax changes.  We were told that draft language would be available soon.  The following summary of tax changes is based on general budget documents.

Marcellus Shale Severance Tax.  The Governor proposes a new severance tax to be imposed at a rate of 5% of the value of gas extracted plus 4.7 cents per thousand cubic feet of gas extracted - similar to West Virginia's tax.  With an effective date of 1/1/2016, the tax would yield $165.7 million in FY2015-16 and $1 billion in FY2016-17.  Distributions to local governments, currently funded by Impact Fees, would be shifted to the new severance tax revenue stream.   New tax revenues in excess of local government distributions would be directed primarily to increased funding of Basic Education, with small amounts to be dedicated to debt service on a proposed Economic Growth Bond and to funding additional enforcement efforts in the Department of Environmental Protection.

Corporate Net Income Tax Rate Cut and Base Changes.  The CNI rate would not only be reduced to 5.99% as of 1/1/2016, but would be further reduced to 5.49% as of 1/1/2017 and 4.99% at 1/1/2018.  Savings to businesses in FY2015-16 would be $249.3 million.   When fully implemented, the annual savings would exceed $850 million.

The rationale for reducing the allowable Net Loss Deduction from $5 million (or 30% of income) to $3 million (or 12.5% of income) has not been made clear.  House D's indicated that this change would impact approximately 290 businesses.

We have only minimal details at this point concerning how "combined reporting" would work.

Capital Stock / Franchise Tax Phaseout.  These taxes are currently scheduled to expire at the end of tax years beginning in 2015.  Governor Wolf proposes to stick with this schedule.

Sales & Use Tax Increase.  The proposed rate increase and tax base expansion would yield $1.5543 billion annually.  The current 1% vendor discount would be capped at $25 per month, saddling major regional and national retailers with tens of millions in additional costs for administering the Commonwealth's sales tax system and dealing with Pennsylvania's aggressive auditors.

Sales & Use Tax exemptions to be preserved apparently would include:  Food, Physician & Dental Services, Hospitals, Clothing and Footwear, Prescription Drugs and Orthopedic Equipment, Manufacturing and Processing, Residential Utilities, Trade-in Value, Isolated Sales, Common Carriers, Water, Governmental Entities, College Tuition, Charities, Religious Organizations and Non-profit Educational Institutions.

We will await draft language to see just what services would be made taxable and what specific exemptions would be repealed.

Personal Income Tax Increase.  Because the PIT rate increase would be in effect only for the second half of the 2015 calendar year, the effective rate for calendar 2015 would be 3.39%, with the full increase to 3.7% then kicking in for 2016.  The PIT rate increase is projected to yield $2.3767 billion, which would be dedicated to local school property tax relief.  Tax forgiveness would be boosted to 150% of the poverty level, reducing revenues by $90.2 million.  PA Lottery winnings would be taxed, yielding $15.7 million.  Revenues from the rate increase would be earmarked for property tax and wage tax relief.

Cigarette & Other Tobacco Tax Increases.  The $1.00 per pack increase in the cigarette tax would yield $358.4 million annually.  New taxes at 40% of the wholesale price on cigars, smokeless tobacco, roll-your-own and e-cigarettes would yield $84.1 million per year.

Bank Shares Tax Changes.  Technical corrections, retroactive to 2014, and an increase in the rate, from 0.89% to 1.25% would yield $339.2 million.

Made in Pennsylvania Tax Credit.  $5 million would be distributed to manufacturing companies for up to 5% of new taxable payroll where companies increase payroll by more than $1 million in a year.

Economic Development Programs.  The Governor is proposing a number of economic development programs.  These include a proposed  $675 million bond issue to recapitalize state loan programs, provide alternative energy incentives and fund other economic development programs.  Debt service would be paid with $55 million annually from the proposed Marcellus Shale Severance Tax.

School Property Tax Relief.  The Governor's proposal would begin accumulating funds for school property tax relief in FY2015-16, with the first actual relief to be granted in October 2016.  In Philadelphia, taxpayers would receive Wage Tax reductions in lieu of property tax relief.  To assist renters, age restrictions would be removed from the rent rebate program and renters would receive relief of up to $500 for households earning up to $50,000.  The Budget Office says the proposal would provide more than $1,000 in tax relief for the average homeowner and reduce homeowner property taxes by an average of more than 50%.  The relief, however,  apparently would be based on boosting the funding of the "Homestead Exemption" so that the relief would be targeted mostly at residential taxes and owners of lower valued homes would benefit to a proportionally greater extent than owners of more expensive homes.  Businesses would receive property tax relief only after the Homestead Exemptions in the school districts would be fully funded.  Thus the Pennsylvania business community likely would not benefit substantially from the Governor's real estate tax reduction program.

The Governor's real estate tax relief proposal seems clearly aimed at making the school district tax system more progressive on an overall basis, and at shifting the local cost of education more to the business community as compared to individual taxpayers.

One surprising result of the Governor's proposal seems to be that in some school districts, where home values are low, the new state property tax relief funding would completely eliminate school real estate taxes for everyone, while taxpayers in adjoining districts would continue to pay significant property taxes.  We are unaware of the justification for such a lack of uniformity in tax treatment.

Will it fly?  With the PA House and Senate controlled by Republicans, whether the new Democrat Governor's proposals  will ultimately be adopted is very much an open question.  Some of his proposals have had Republican support in the past.  However, Republican leaders started voicing concerns about the tax increases as soon as the Governor finished his budget speech.  Time will tell.