Posted by: Tim Sweeney | January 6, 2014

Leaky Tax System Makes Real Reform Difficult

Tim Sweeney is The Policy Junkie

Tim Sweeney is The Policy Junkie

The speed and ease by which Boeing acquired new and extended tax breaks in November demonstrated how relatively malleable our state’s tax system can be when the legislature is motivated.

Sadly, over the years, state policymakers, as well voter initiatives, have been more successful at punching holes in our tax system than they have been in building a more equitable and efficient system.

And the more holes that get punched in the system, the harder it is to achieve comprehensive reform.

This point was made in last month’s House Finance Committee in Olympia during an exchange between Rep. Ed Orcutt (R-Kalama) and Jason Mercier, Government Reform Director of the Washington Policy Center.  Mercier was presenting his organization’s proposed reform to our state’s much reviled Business and Occupations (B&O) tax.

The B&O tax is the primary way state and local governments tax businesses in Washington. It’s a flawed tax. The tax applies to the gross revenues of a business. This means that whether a company makes a profit or not is irrelevant to the tax. As a result, the tax tends to fall hardest on those companies who are just starting up and operating at a loss, and those companies who do a high volume of business but have low profit margins–companies, for instance, that might be significant employers. Our state does not have a corporate profits tax.

Jason Mercier, Washington Policy Center

Jason Mercier, Washington Policy Center

While there is agreement that the tax is onerous, the question is how to replace a tax that generates about 20 percent of the state’s general fund revenues. To its credit, the Washington Policy Center has proposed an alternative that would allow businesses to deduct their labor costs (under one option) yet would still overall generate the same amount of revenue.

“Any time you change a system and you keep it revenue neutral and give somebody a reduced amount of tax burden, does that not then increase the amount of tax burden on someone else?” Rep. Orcutt asked rhetorically.

Appearing to agree, Mercier noted the hurdles he confronts. “With tax reform, especially on a revenue neutral basis, repealing (tax) credits, exemptions, lowering rates, there are going to be winners and losers in that system. When we went through stakeholder meetings on this, not surprisingly the small businesses and those that felt like the current system wasn’t working for them were very excited about this and those that had those current exemptions and (tax) preferences were less excited about seeing changes to the system.”

In short, the constituency against tax reform grows with each exemption approved, which is why the national Tax Foundation called the Boeing tax breaks “a red flag for state legislators” that a more comprehensive solution is needed.

According to Mercier’s white paper on the proposed business tax reform, there are over 161 special B&O tax exemptions. In fact, there are so many tax breaks through our tax code that the legislature created a special commission to analyze each tax break with a rigorous audit. In seven years of operation and after 338 audits, the commission has recommended that less than a dozen expire when their sunset dates hit and that only five other tax preferences be terminated. To date, the legislature has not terminated any of those five preferences.

It’s no wonder that the chair of the House Finance Committee, Rep. Reuven Carlyle (D-Seattle) says reform is a multi-year endeavor.

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Responses

  1. Our state tax regime is one of the most regressive in the nation. That’s great for folks that want to soak the poor to fund basic services, but it has the downside that when there is a downturn, the budget is immediately hosed more severely than necessary and recovery is then slowed because revenues hinge around the least capable segments of our population/economy.

    Many attempts to introduce a state income tax have failed to gain any traction. But state income taxes can be deducted from federal taxes. That would retain billions in the state that otherwise are squandered from the beltway. For some reason that is never mention. Also never mentioned is the stability and added recovery ability it would lend the state budget. Instead, it is always, “Oh they will add income tax and keep the existing regressive framework, leading to greater government waste in spending.”

    Your important observation is that the legislature can act quickly when it benefits the well to do.

    The upshot of this is the same as with most relevant policy issues: It’s time to let voters decide elections again. We tried the Citizens United definition of money as free speech. It doesn’t work because money controls the fourth estate which otherwise (as it is today) exists without the appropriate checks and balances our democracy depends upon.

  2. I have a novel idea freeze spending at the headline rate of inflation.

  3. When I had small business, I really understood the challenge of paying B&O taxes based on revenues, not profits. But I think that’s OK. I think the current system is appropriate based on two arguments. First, revenue is very easy to calculate and to confirm, whereas “profit” is not so easily calculated and would require the State to perform a much more costly analysis to prove that tax was owed. Secondly, the B&O tax is really just another expense. If a business can not afford that expense, maybe the business is not viable. No one offered reduced rent, or reduced cost of office supplies, etc. based on the fact that the start-up was not yet profitable. It’s tough, but there’s nothing wrong with that. B&O tax is relatively easy to predict, businesses should simply plan for it and pay it like the other typical expenses.

    • The tax is simple and it should be considered the cost of doing business. But apparently over 160 business categories have considered the tax onerous enough to request and receive preferences. The Tax Foundation’s white paper points to tax pyramiding as one of the reasons for the many exemptions.

      • So I think you are saying that a good idea becomes fouled by more and more special exemptions. I agree and it’s probably difficult for legislators to hold out against such requests. Similar case to the “race to the bottom” between states courting new businesses.


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