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Home / Washington Business - Spring 2003 / Pro-Con: M&E Tax Credit: Rx for Sore Tax Thumb |
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Pro-Con: M&E Tax Credit: Rx for Sore Tax Thumb |
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Written On: Spring 2003 |
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Written By: By Rep. Jim McIntire (D-Seattle) |
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Washington’s over-reliance on sales taxes to fund public services creates a real “sore thumb” for our economy. Washington is one of only a handful of states with sales and use taxes on labor in new construction, machinery and equipment, and research and development expenses.
Business investment decisions are influenced by many factors—product and labor markets, capital costs, transportation systems, regulations, and taxes. In most cases, these factors can be incorporated into a rate of return analysis that reflects the opportunities and constraints of the market and the public sector over time. A high sales tax burden at the front end of the investment period raises the present value of costs and lowers the net present value of profits for the useful life of the investment.
Compared to other states where similar revenues may be raised by property or income taxes over time, our tax structure puts investments in Washington at a fiscal disadvantage. The impact of this disadvantage extends beyond whether a business decides to invest in Washington or elsewhere, causing some businesses to scale back the level of their investment and under-capitalize their operations in Washington. Lower levels of investment in business capital will mean not just fewer jobs, but also lower levels of worker productivity, which mean lower wages and incomes.
Not all industries are footloose and free to locate in different states, and not all industries contribute equally to the creation of in-state jobs and net income. For example, many retailing and service industries are intrinsically tied to in-state markets and do not bring net income into the state. Their capacity for creating additional wealth and job growth is limited. However, industries that export their products out of state tend to have higher profit margins and potential to bring net income into the state, adding net wealth and jobs to our economy.
Manufacturing industries export a high proportion of their products out of state, and, as a result, they produce more jobs, generally higherwage jobs, and higher profits. These industries are the core of our economy, producing jobs and income that have a multiplier effect for the rest of our economy. In terms of foregone tax revenue, the most cost effective portion of our “sore thumb tax” to eliminate is the sales tax on manufacturing machinery and equipment. This tax exemption offers greater potential than any other possible exemption for improving the rate of return on investments by new and expanding firms.
Tax exemptions for investments in research and development offer similar potential for stimulating the growth of jobs and income, with one exception. R&D expenditures are critical for business to develop new ideas, new products and new markets. The current R&D exemption is set to expire in 2005. The only difficulty with removing the sales tax hurdle for R&D is that without additional revenue sources to fund continuation of this exemption, reductions in education, health and prison spending—beyond those already recommended by Governor Locke—would be necessary. With offsetting revenues in place, reenactment of this measure would continue to sooth the “sore thumb” of our tax structure that acts as a barrier to vital R&D investments.
What evidence do we have of the efficacy of these tax measures? Most studies are inconclusive. This is due to the complexity of market dynamics and because the multiple factors affecting investment decisions vary in influence depending on the circumstances of the economy and the investor over time. Some windfalls may occur, but simple economics make it clear that these measures lower the tax barrier to greater investment in Washington’s economy. This is why any evaluation of these tax measures must rely on informed, subjective judgments as well as empirical measures.
For those who would enact these tax exemptions without finding alternative revenues to replace them, note that 60 percent of state spending is for education—the other necessary ingredient for raising worker productivity and incomes. Declines in education investments have consequences for our economy similar to those of lower business investment.
Others would repeal these tax exemptions because of their costliness in foregone revenues. I urge both groups instead to focus their energies on reforming Washington’s tax structure. Most states have a more balanced tax system with lower business taxes and lower sales taxes. Lower business tax burdens, combined with lower sales tax rates would certainly improve the investment climate for all of Washington’s businesses.
Rep. McIntire can be reached at: mcintire_ji@leg.wa.gov
Rep. Jim McIntire is a Democrat from Seattle’s 46th District which includes the University of Washington. He was first elected in 1998. He is currently a member of the University of Washington faculty, where he also received his Ph.D. in economics. Prior to his election to the legislature, McIntire served on the Community Economic Revitalization Board and was a policy adviser to Gov. Booth Gardner
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