Is Washington’s tax system really “regressive”?

Is Washington’s Tax System Really “Regressive”?
A frequent claim among some tax reform advocates is that Washington has one of the most regressive tax structures in the country. However, others say that changes are needed to the tax code studies indicating a regressive system are based on flawed methodology. Photo: cgclapp

Although businesses pay over half the taxes collected by the state and local governments, a frequent claim among some tax reform advocates is that Washington has one of the most regressive tax structures in the country. It’s the impetus behind ordinances such as the city of Seattle’s progressive income tax, approved in part in the hopes of overturning State Supreme Court rulings rendering it unconstitutional. It’s an argument likely to be heard during public meetings with state House lawmakers discussing the state’s tax structure that were funded in the 2017-19 operating budget.

Yet, some fiscal experts say the “regressive” claim isn’t wholly accurate, while warning that progressive taxes lead to revenue volatility. They also argue that the real problem to be fixed is a combination of harmful taxes and tax rates that are among the highest in the nation.

Among them include:

Additionally, Washington is ninth in the nation in terms of highest state and local businesses taxes, according to the Washington Research Council (WRC).

Many progressive income tax advocates cite a study by the Institute on Taxation and Economic Policy (ITEP) titled “Who Pays?,” which claims, “Washington has the most unfair state and local tax system in the country” due to its heavy reliance on the state sales tax. Currently, Washington’s combined average sales tax rate of 8.92 percent is the fifth highest in the nation, and in fiscal year 2016 made up nearly half of all state revenue.

However, Tax Foundation Senior Policy Analyst Jared Walczak writes that the ITEP study erroneously treats the B&O tax as a sales tax paid by the consumer, rather than employers.

Similar criticism has been raised by WRC’s Research Director and Senior Economist Dr. Kriss Sjoblom. He told Lens that the study “overestimates the amount that poor people consume, and then as a consequent overestimates the amount of sales tax poor people pay. A lot of those businesses taxes are assumed to be passed on to consumers prices that are being paid by the poor.”

What makes the system “regressive” are the high “sin” sales taxes on liquor and cigarettes, he added. According to the Center for Disease Control, “people living below the poverty level and people having lower levels of educational attainment have higher rates of cigarette smoking than the general population.”

“If you look at the share of income spent on these selective sales taxes, we’re the highest,” Sjoblom said. “If you look at the share of business taxes that the poor are paying, we’re the highest. It’s the businesses taxes and the selective sales taxes that are driving us into this extreme position.”

Although the state offers over 50 B&O tax incentives, many industry members say that it stymies economic growth by taxing revenue rather than actual profit generated. It’s an argument made by Scott Edwards, co-chair of state and local tax practice at Lane Powell and a member of the Tax and Fiscal Policy Committee for the Association of Washington Business.

“Reducing the tax burden on Washington businesses can put people back to work and grow state revenues as the economy recovers,” he writes.

Another criticism leveled at the B&O tax is that it was never meant to be a long-term revenue source. It was originally allowed despite concerns that it was a tax on income, and therefore unconstitutional, via the State Supreme Court in the 1933 State ex rel. Stiner v. Yelle.

In their opinion, the court argued that the tax was merely “an emergency measure, limited by its terms to a two-year period.”

“This law is, perhaps, not perfect. No tax law yet devised has been entirely fair and just to all in its practical workings,” the opinion states further. “If it works injustice to some, it will be but temporary, and such temporary injustice, if any, must be borne for the common good.”

Jason Mercier is the director of the Center for Government Reform at the Washington Policy Center. He told Lens that the state should move away from the B&O tax, “because of the complications and the way it pyramids.”

One tax that could replace some of that lost revenue is the remote or online sales tax, he added. “It’s a legitimate argument that it’s an erosion of the sales tax base.”

Mercier was an advisor to the State Tax Structure Study Committee, set up by the legislature in 2001 to provide recommended changes. The committee found that the system was “fundamentally inequitable to low- and middle-income people, unfair to many businesses, and subject to sharp fluctuations in revenue,” while also noting the loss of revenue from online sales.

Along with the creation of the state’s budget stabilization account, known today as the “rainy day fund,” the committee recommendations included:

  • Replacing the B&O tax with a value added tax, which is levied on the difference between the sales and production.
  • Lowering the sales tax while adding a flat-rate personal income tax
  • Eliminating the state property tax

However, “the problem with the B&O tax is that everybody I talk to hates it, but nobody can agree on anything that they would prefer,” Sjoblom said. “Where we sit, we would look for selected reductions in the tax burden from the B&O, particularly on businesses that sell goods out of state who are competing on national and world markets. They’re the ones who have the hardest time passing it on.”

Mercier says if state lawmakers want to reduce the financial burden on lower-income earners, they should do it with things such as the working family rebate and not through drastic changes to the tax code such as a progressive income tax or a capital gains income tax.

“Adding volatile tax sources to the mix…doesn’t help the poor if the programs they rely on can’t be funded.”

He added that the push for progressive taxes conflicts with another state priority – maintaining stable revenue sources. According to a 2014 Standard and Poor report on income inequality, “state tax revenue trends have also become more volatile as progressive tax states have come to rely more heavily on capital gains from top earners.”

Said Mercier: “There’s two ways to approach the tax code. There’s income redistribution and there’s funding government services, and those two don’t go together because if they’re trying to do the progressivity and redistribution, you’re not going to have a stable tax base. When you have progressivity in your tax code, it’s incredible cyclical and very sensitive.”


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