Why our tax structure works for Washington
It’s not perfect. But it’s far from broken.
Despite claims to the contrary from some legislators and interest groups, the truth is that Washington state’s tax system has contributed to the state’s run of economic growth.
As Washington’s Work Group on Tax Structure Reform prepares to hold public meetings around the state to examine our tax system, here are some important points to consider:
We have a tax code that works for Washington.
· We have a nation-leading economic vibrancy.
· We have personal income growth that is higher than the national average.
· We have added jobs at higher than the national average since 2005.
· We have increased our ratio of high wage jobs to total jobs relative to the national average.
· We have relatively low individual tax burden compared to other states.
· We have easy tax compliance for those who do not own businesses.
· We have safeguards against rapid escalation of property taxes.
Our tax code and strong economy are tied together.
Our economy is outperforming every other state, resulting in higher pay for workers, and our tax code is an integral part of that success.
Washington’s economy remains dynamic in part because AWB and its partners in the employer community successfully pushed back against efforts to impose new capital gains income taxes, carbon taxes, and an extension of the 20 percent surcharge on business taxes for the service industry that were in effect from 2010-2013. The excellent economy is a legacy of employer advocacy for pro-business adjustments in our state tax code, what AWB refers to as structural tax incentives. These have been integral to building and maintaining our strong economy. We’ve made changes in our tax code to keep agriculture, aerospace, manufacturing and high-tech sector competitive. This would include, among others, the research and development tax credits for the high-tech sector that were in place from 1995 to 2005, as well as a reduced tax rate for aerospace manufacturing and food processing, and the sales tax exemption on machinery and equipment used in manufacturing.
Here is the result of that advocacy for the business community.
#1 for economic health and opportunity. Wallethub, 2018
#1 for business. CNBC, 2017
#1 economy. Business Insider, 2018
#2 for business. CNBC, 2018
A 2017 study from the Washington State Economic Revenue Forecast Council resulted in a composite ranking of fourth-best out of the 50 states. Another scorecard that measures residents’ financial health across 58 metrics ranks Washington 8th best.
These excellent rankings translate into tangible benefits for Washington’s workforce. Our economy is undeniably helping the working class with wage growth and diverse employment opportunities. There are important caveats, for example industry sectors in which we are underperforming, and there are areas of our state that are not sharing equally in the prosperity.
Since 2010, personal income growth in Washington has consistently been higher than the U.S average. Washington’s ratio of high wage jobs to total jobs has exceeded the national average since 2007. We are growing more good jobs than elsewhere. It’s not just high-wage tech jobs though; we are have grown more jobs in general than the national average since 2005. Our job opportunities are attracting domestic migration into the state-we have had among the fastest population growth rates from 2010-2017, at nearly twice the U.S. average.
Economic mobility in Washington is a reality. A 2010 study by the Office of Financial Management found that the majority of those in the lower income brackets moved up between 2005-2009. Not surprisingly, the study found that salaries and wages are the largest source of income for households in all income quintiles. The best way to help the workforce is a growing economy and growing paychecks.
We have a modest tax burden.
Washington workers enjoy the 16th-lowest overall state and local tax burden (averaging our ranking over the period 2011-2015). On average, $97 dollars of every $1,000 of income goes to state and local taxes here. By comparison, other West Coast states with an income tax and corporate income tax take more. California takes $111 out of every $1,000, and Oregon takes $102. As these figures show, an income tax simply provides another way to reach into the pockets of the average person.
We enjoy safeguards against asset price inflation.
We enjoy safeguards against rapid escalation of regular property taxes. We have constitutional protections against regular levies exceeding 1% in assessed value. We enjoy statutory protection against a taxing authority increasing regular levies more than 1 percent of the previous year’s levy plus the value of new construction.
A different tax structure would likely not be as stable over economic ups and downs.
The relative volatility of a tax structure—how much the revenue collections fluctuate through business cycles—is important to certainty in the business climate. Stable collections allow the state to maintain established services without disruptive additions and subtractions to the tax code. Recent analysis of state tax system volatility by the Pew Charitable Trust shows that Washington ranks among those with the greatest revenue stability (13th out of 50 states).
Washington taxes are easy for most.
Washington workers benefit from the ease of tax administration in this state. We do not have to file state income tax returns. I recently looked up the Oregon Department of Revenue form OR-40 on the Internet. This is the individual income tax return filing, which Oregonians file annually to pay state income taxes. There are 53 lines — and four pages of information to fill out — all subject to penalties for any error or omission. I’m sure I save a full day of my life every year because I live in a state that does not burden me with a state income tax filing. Surely many would choose to pay a professional to prepare their state tax filing. And, for those who care about privacy and the risks of identity theft, we are fortunate that we do not need to file paperwork with our financial information and social security numbers at a state agency. My property taxes are paid in a monthly mortgage payment that is automatically deducted from my bank. Sales taxes are calculated at the register and collected on my behalf by retailers. It matters to me that Washington’s tax structure does not take my time as well as my money.
Simplicity is an important value in a tax structure. Our 2002 Washington Tax Structure study concluded, “[m]ost of Washington’s taxes are relatively simple to administer for both government and households…the main reason is that households to not have to file tax returns.” Notably, a significant cost of tax administration is shifted to retailers who act as uncompensated collection agents.
There's more to fairness than just taxes paid relative to income.
Fairness can mean similarly situated people paying similar tax rates. Many people perceive fairness in taxation as paying the same rate as others for engaging in the same activity or holding the same asset. Washington does well in this respect. Doctors pay the same rate as accountants; sporting goods retailers pay the same as cosmetics retailers. All of us pay the same sales tax on our plastic pool and kid’s bike at the Fred Meyer as anyone else who shops in that store. All of us pay the same property tax as our neighbor who benefits from the same mix of fire services, parks, schools and libraries, unless he or she has qualified for a senior citizen or disable veteran exemption. Generally speaking, everyone conducting the same category of business activity pays the same rate on their business and occupation (B&O) tax.
The 2002 Washington State Tax Structure study indicates that the public’s common sense appraisal of what is fair may diverge from academic assessment about our tax equity: “[S]urveys indicate that Washington’s tax system would be perceived by the majority of businesses and individuals as being fair. Surveys of individuals in other states find that the sales tax is perceived to be the most equitable tax by a majority of survey respondents. A survey of Washington businesses shows that most employers think that the Washington tax system does not hinder their ability to conduct business.”
What about all those exemptions?
Washington’s 694 tax code adjustments are often highlighted as a source of injustice and unfairness. While proponents of an income tax highlight the large number of exemptions in our code, many of these are for nonprofit organizations (91) and government (82) or simply defining the tax base (73). For example, we have B&O tax exemptions for nonprofit fundraising, providing kidney dialysis, and local government services provided to another local government. These exemptions are folded indiscriminately into the total number of exemptions in our code and misused to portray our tax code as one unusually generous to employers. Only 233 are business adjustments unrelated to agriculture.
Any lower rate, exemption, or credit for business is the result of a democratic process that likely involved open debate at public hearings over multiple years. In short, the pros and cons were debated by people we selected. They are also reviewed by a Legislative Auditor and scrutinized by a Citizen Commission on the Performance Measurement of Tax Preferences at periodic intervals. Of the 235 tax preferences reviewed from 2007-2015, 119 were recommended for continuation, 91 for clarification, and 26 were recommended for either termination or expiration. In other words, after review by thoughtful, nonpartisan people and a bipartisan commission, most tax code adjustments that are termed “loopholes” have been found to be working for Washington.
Unique features of the B&O tax drive a number of exemptions—these are not “give-aways”
To the extent any segment of industry has a lower rate or exemption, it is worth remembering that the B&O tax is a gross receipts tax—you pay regardless of profitability in any given year. The B&O tax has unique features. New and expanding businesses have particular challenges. This has resulted in legislation to increase the B&O tax filing threshold, expand small business tax credits, and provide other incentives for emerging industries (e.g. solar manufacturing). Furthermore, the pyramiding of the B&O tax creates problems for businesses that the Legislature has been called upon to address with adjustments. The Final Report of the 2002 Washington State Tax Structure Committee had this to say about the pyramiding problem:
“Pyramiding of taxes is the payment of taxes by different companies on the same goods and services. This occurs when goods or services of one company are inputs for another’s production and/or sales. Thus, a tax is paid multiple times on a product as it moves through the production chain. The B&O tax pyaramids an average of 2.5 times, but this rate varies considerably across industries. The B&O tax on many services pyramids at about 1.5 times, whereas for some types of manufacturers the rate of pyramiding is over five or six times. This causes effective B&O tax rates (the rate paid on the value added to goods and services by an enterprise) to vary considerably from industry to industry.”
From time to time it has been necessary to make an adjustment to B&O tax rates to secure the jobs in industries facing unforeseen pressures to their business model. Those pressures could be international commodity prices in the case of the aluminum smelting industry, or technological disruption in the case of the newspaper publishing industry transition from traditional print to online publishing. In the case of certain extractive industries, those swiftly changing circumstances could be sharply reduced state and federal timber harvests caused by changes in federal environmental regulations like a species being newly listed as endangered. Some call these adjustments loopholes or “preferences”, but many employees appreciate that these adjustments maximize the opportunity to continue to work at jobs they love and support the tax base in communities of which they are an integral part.
What about the regressivity?
Others suggest Washington’s tax code is unfair because it is the “most regressive” in the nation. This claim rests on one statistic, namely, the poorest quintile of income earners (bottom 20 percent) in Washington pay more in state taxes as a percentage of their income than those at the top pay as a percentage of their income. The statistic ranking Washington worst in regressivity comes from a deeply flawed 2015 report by the Institute on Taxation and Economic Policy (ITEP). All states have regressive tax codes, even those with high progressive state income taxes. Because Washington has no state income tax, we are in the group of states in which this statistic is most pronounced.
When ITEP examined the combined impact of state and federal taxes, those earning in the lowest 20 percent are paying less than the middle and higher income groups. The bottom quintile pays an effective tax rate of 19.1 percent and the top 1 percent pays an effective tax rate of 34.1percent.
Because the federal government primarily derives its revenue from a progressive income tax, it’s only natural that states and local governments would tax property and sales of goods. Writing about the “regressivity” of state tax codes in isolation from federal taxes spills much ink on the subject without casting much light.
To balance the picture and find out if the lowest income group is getting a worse deal in Washington than other states, we would need a study of the relative distribution of public benefits from the spending in our state and federal budget that flows to this income group relative to the percentage of spending flowing to the same population in other states.
Edward Kleinbard, a professor of tax law at the University of Southern California, published an Op-Ed in The New York Times in 2014 arguing that progressive spending, not progressive taxation, was the best route to improving income inequality. He wrote, “A fiscal system encompasses both the tax and the spending sides of government. What we should care about is whether those two functions, taken as a whole, enhance the lives of average citizens. To that end, the right focus is not how progressively we finance government spending (i.e., tax ourselves), but rather the net effect of both sides of the equation — government taxing and government spending.” We can reduce poverty and increase upward mobility by investing in education, apprenticeships, and workforce education. These are efforts the business community is actively engaged in.
Kleinbard talks about where well-intentioned reformers have gone wrong, “[E]ven taking into account regressive state and local taxes, the American tax system already is the most progressive in the developed world…achieving equality through the tax structure is the wrong way to think about the issue. Reformers have blundered by confusing what seems fair—more progressive taxation—with what is actually important, and lacking: a progressive fiscal system. As other developed countries have figured out, reducing inequality is not about where the money comes from, but where the money goes, and how much of it is spent.” [Emphasis added]. I might add, how effectively the money is spent. It would be interesting to know how progressive our state spending is relative to other states, and how effectively it is mitigating income inequality. Instead we are myopically focused on one statistic in a deeply flawed 2015 ITEP report about the regressivity of our state taxes.
What’s next in Washington for our tax code?
The state Legislature’s Work Group on Tax Structure Reform will meet three times this month around the state in Spokane, Yakima and Vancouver. This is a temporary work group that was authorized in the 2017 operating budget. Per the budget proviso, “discussions may include but are not limited to the advantages and disadvantages of the state’s current tax structure and potential options to improve the current structure for the benefit of individuals, families, and businesses in Washington state.” The public can provide comment in person or via email. This Work Group will compile a report of input received and submit the report to the fiscal committees of the Legislature.
As has been publicly reported in The Seattle Times, advocacy groups are at work to mobilize a coalition in favor of an income tax or a ballot measure requiring the Legislature to balance the tax burden. These groups have been looking for a “concerted statewide conversation.” A concerted statewide conversation about the effectiveness and distribution of our current spending should be considered.
Taxes imposed on businesses, notably the B&O tax, constitute a larger share of state revenue in Washington than in most other states. (See 2002 study, here, at p. 28). We would do well in our discussions to keep in mind that Washington’s employees benefit when Washington’s economy is competitive relative to other states. Addressing regressivity by trying to increase the tax burden on business may prove counterproductive—what good is a lower tax burden to someone who can’t find a job?
Fairness means opportunity for all Washingtonians, not just relative tax burden. Tax code critics are neglecting other values and principles like economic vitality, simplicity, and stability. These virtues of our tax structure produce benefits for the average person that must be weighed in the scale alongside the relative burden. The record shows our economy is providing a path of upward mobility, wage growth, attracting high-wage jobs, and encouraging migration to the state. The much-maligned most “unfair” state tax code in the nation seems to be producing a lot of outcomes that other states would envy. Our tax code is producing economic vitality, has safeguards to runaway property tax inflation, and puts very little compliance and administrative cost on the average person. It is fundamentally not broken. When the American tax system as a whole is the most progressive in the developed world, folks really should stop to question the value of analyzing a state code in isolation and describing it as “upside down.”
When it comes to the tax structure, our focus should remain on keeping our economic momentum by safeguarding our structural tax incentives, improving tax administration and appeals, and strengthening our economy in key sectors that may be underperforming and in the parts of the state that are missing out on the recent growth.
The bottom line is that the tax structure itself works for Washington. There are plenty of good ideas for continued improvements within existing code. We remain vigilant to look for opportunities to grow the number and geographic diversity of good-paying jobs in our economy.
Economic and Revenue Forecast Council presentation on May 24, 2018 to PNWR. Slide 2. https://erfc.wa.gov/sites/default/files/public/documents/presentations/WAoutlook_PNREC2018.pdf
 Economic and Revenue Forecast Council Washington State Economic Climate Study 2017. Figure 2.3. https://erfc.wa.gov/sites/default/files/public/documents/publications/climate2017.pdf
Economic and Revenue Forecast Council Presentation to CWU Economic Outlook Conference. Slide 11. https://erfc.wa.gov/sites/default/files/public/documents/presentations/CWU_Apr2018.pdf