This year’s legislative session ended without a reduced business and occupation (B&O) rate for manufacturers, a major priority for the state business community. The notion of a lower B&O tax rate raises larger questions about the tax itself, which tax reform advocates and small business owners say creates a competitive disadvantage compared to nearby states.
Washington is the only state to have a B&O tax, also known as a gross receipts tax. Passed by the legislature in the 1930s, it now generates more than any other state tax besides the sales and use tax. According to the state Department of Revenue, in 2017 the B&O tax brought in $3.8 billion or 17.4 percent of total state revenue. In comparison, the sales and use tax provided $10.2 billion, or 46.3 percent.
The fly in the ointment is that the tax was only meant to be temporary, a point raised in its defense by the State Supreme Court in its 1933 decision State ex rel. Stiner v. Yelle upholding the tax’s legality. In its opinion, the court declared that the tax was “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. If it works injustice to some, it will be but temporary, and such temporary injustice, if any, must be borne for the common good.”
Critics say the “injustice” hasn’t gone away. The B&O tax is levied on a business’ revenue, rather than income. At a casual glance, the difference may seem subtle, but it can have far-reaching consequences depending on the industry. Because the tax lability is determined by revenue, a business with a low profit margin but high revenue streams can end up paying more in taxes than a company with higher profit margins but lower revenue.
Or they pay taxes when there’s no profit, says Bellevue-based business broker Gary Franke. He told Lens that “we have startups where they don’t make a profit for 3-5 years.” Yet, they still have to pay B&O if their revenue is above the threshold.
It’s also difficult for business such as health insurance agencies that can’t pass on the costs because the prices are set in stone, Franke said. “It’s a big cost for us to run businesses because of our fixed cost structure.”
The tax’s detrimental effect is perhaps reflected in the dozens of separate rates paid per industry (the highest is 1.5 percent), as well as the more than 50 tax incentives, including one for aerospace manufacturers intended to keep Boeing from moving its plants elsewhere.
Another consequence of the B&O tax is that a single item can be taxed multiple times as it passes from one employer to another, known as “pyramiding.” Larger companies can reduce their tax burden by keeping production in-house as much as possible, but it’s not financially practical for small businesses, Franke said.
How hard the B&O tax hits a business often depends on location. A restaurant in Seattle might raise its prices, as many did to offset the costs of the city’s minimum wage. But that option may not be feasible for a restaurant in Pullman or Vancouver that has to compete with nearby Idaho or Oregon eateries on the other side of the border. Both those states have an income tax but no sales and B&O tax.
Russell Brent is the owner of the Mill Creek Pub in Battle Ground, a city north of Vancouver, Washington. He told Lens he first encountered the B&O tax when he moved up from California while working for a corporate restaurant chain that had opened locations in Washington.
“I didn’t even know that (tax) existed,” he said.
The company later decided to close all but one of its locations in Washington, he added, and while the B&O tax wasn’t the sole determining factor, it didn’t help the restaurants having to cope with the state liquor tax (highest in the nation) and other unfavorable tax policies.
“One of the things I’ve noticed over the years is chain restaurants are very slow to come to southwest Washington,” he added. “When they do come it’s long before they realize they’re going to have to modify their growth plans.”
With restaurants operating at a lower profit margin, Brent said that “makes it especially challenging to keep the lights on. The hospitality industry…provides one of the largest private employers in the state, and to have this situation where it’s based on sales and not profitability seems unfair and unjust.”
One way to improve the state’s business climate is to simplify the B&O tax. That’s one of several recommendations made by Jason Mercier, director of government reform at the Washington Policy Center. He was also an advisor to the State Tax Structure Study Committee, set up by the legislature in 2001 to provide recommended changes to the state’s tax system.
In a 2010 policy paper, Mercier also advocated the creation of a single B&O rate for all businesses. Or, Washington could replace it with a Texas-style franchise tax levied on a company’s net worth, rather than revenue or income.
“The way in which government officials impose a tax is as important as the amount collected,” Mercier writes. “The taxes elected officials impose on any business in a competitive marketplace are usually simply passed on to customers. In most cases, the more taxes officials make a business pay, the more they make people pay.”
Legislators could also exempt the tax on the operating margin instead of the gross margin, Franke said. “Other states are significantly more advantageous for business. The business climate in the state is not great.”