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Home / Washington Business - Spring 2003 / Tax Study (Again) Points Out Competitiveness Challenges |
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Tax Study (Again) Points Out Competitiveness Challenges |
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Written On: Spring 2003 |
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Written By: By Richard Davis - President, Washington Research Council |
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Talk about lousy timing.
Back in December, after a year of ponderous investigation, deliberation, evaluation and mastication, the Washington State Tax Structure Study Committee delivered its report to a legislature facing a $2.5 billion budget shortfall. The principal recommendations: pass a personal income tax and replace the Business and Occupation Tax with an equally unusual valueadded tax.
The response was predictable.
Lawmakers listened politely through the requisite public hearings, editorial boards gave commission members precious space on the op-ed pages, talk radio hosts fulminated against a state income tax, and then…nothing.
Overshadowed by the bold-stroke recommendations were some timely and relevant observations about how our tax structure hampers job creation and investment in our state. And to these, we should pay attention.
It’s OK to ignore the committee’s principal suggestions. The call for an income tax, while not unexpected, was about as welcome as oral surgery…and less likely to be successful. Aggressive tax reform is presently unnecessary, and would do nothing to alleviate the immediate pain. Besides, tax policy cannot be separated from politics. Public sentiment remains steadfastly opposed to a personal income tax. Nonetheless, the committee sees it as their preferred vehicle for shifting the tax burden from business and lowincome taxpayers onto wealthier households. It’s likely voters are as skeptical of the ends as they are the means.
Tax Policy Influences Vitality
Setting aside the income tax push, however, the committee’s discussion of the relationship between tax policy and economic vitality should not be overlooked. The report confirmed previous studies that found Washington imposes an extraordinary tax burden on business. They report that Washington collects 46 percent of its tax revenue from business and cite a western states average of about 30 percent. The substantial disparity represents a clear competitive disadvantage faced by Washington employers and job creators.
The B&O tax—this will surprise no one—hits business hard. The committee reports that in FY 2002, the B&O provided 17 percent of all state tax collections. In most other states, corporate income taxes provide an average of only 4.2 percent of state revenues. In states with corporate income taxes, businesses that become unprofitable see their tax liability disappear. Here, there’s no relief as the B&O continues to claim a fixed share of gross receipts, even as profits disappear. It makes for a more stable revenue stream for government, but can be a punishing burden on struggling enterprises. The committee finds that low-profit-margin firms and new and expanding businesses may face a competitive disadvantage relative to out-of-state competitors.
Sales Tax Exemptions Eliminate Disadvantages
Over the years, state lawmakers have attempted to increase the competitiveness of state businesses by providing limited exemptions and deferrals from the B&O and sales tax (businesses pay more in sales taxes than they do in B&O payments). In most instances, these programs are highly targeted and comparatively modest. The manufacturing machinery and equipment (M&E) sales tax exemption cannot properly be considered an incentive, as few if any of our competitor states levy such a tax. The exemption confers no competitive advantage for Washington, but its absence would constitute a serious competitive disadvantage.
The committee reviewed studies of the M&E exemption, high- ech research and development (R&D) incentives, and a warehouse sales tax exemption. Their conclusion: “The studies show that the industries that enjoy the incentives contribute to Washington’s economic vitality by creating jobs.” The record was impressive, with 36,000 new jobs associated with firms taking advantage of the manufacturing and R&D deferral, and 19,500 new jobs created by firms using the B&O credit for R&D.
Would the jobs have come anyway? The committee said the studies were inconclusive, but with the generally heavy business tax burden here, these rather unexceptional policies have surely paid for themselves many times over. It would be foolish to assume they don’t matter, particularly as Washington faces a peculiar border state problem. Oregon imposes no sales tax and offers substantial property tax breaks to new firms. Idaho similarly uses tax policy to promote business development.
Additionally, the state’s high sales tax rate, applied over a broad base, creates a particular problem for retailers. According to the tax structure study committee, sales in the 14 counties along the Oregon and Idaho border would increase about 22 percent if the sales tax differential were eliminated. Internet and catalog sales also threaten Washington retailers, with Washingtonians purchasing 6 percent more products remotely than the U.S. average.
Like the members of the Washington Alliance for a Competitive Economy, the Governor’s Competitiveness Council, and hundreds of business leaders over the years, the tax committee says, “High business tax burdens reduce the economic vitality of the state, discourage firms from locating operations here, and invite firms already located in Washington to consider other locations.”
They go on to tout the benefits of a personal income tax to employers: “Without an alternative tax base, the state has few options for reducing this business tax burden.”
Business Taxes Are Drag on Economy
Unquestionably, business taxes are too high and constitute a drag on recovery. But the “alternative tax base” (meaning income tax) is neither necessary nor imminent.
Our policy makers must focus on what can be done within the existing tax system. After all, we do not face a fiscal crisis caused by a flawed tax structure. Under the present economic conditions, our tax structure continues to produce adequate revenues for state government, outperforming many so-called balanced tax systems. (During the boom, according to Wells Fargo Economics, 0.3 percent of California taxpayers provided $15 billion or 24 percent of general fund revenues. When the bubble burst, collections plummeted. So much for the virtues of a progressive income tax.) And, across the broadest range of taxpayers, the system, while modestly regressive, becomes roughly proportional when the effects of the federal income tax are considered.
As always, the first principle for lawmakers concerned about the economy must be: do no harm. Retain those tax exemptions adopted to keep Washington business competitive and avoid general tax hikes. Imposing additional taxes on a beleaguered employer community jeopardizes a fragile recovery.
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