To reform (or not) Washington’s tax system

To reform (or not) Washington’s tax system
A House Finance work session offered two separate perspectives on what’s wrong with the state’s tax code and how to address those flaws. Photo: created by ijeab, freepik.com

If there’s agreement among policy wonks that Washington’s tax code needs to change, there’s equal disagreement over the nuances of that discussion and what reforms should be made. Those differing perspectives were articulated at a Jan. 24 work session of the House Finance Committee that featured testimony from two state-based think tanks that offered separate recommendations on how to clean up the state tax structure. It was also the theme of several public meetings hosted by the House Tax Structure Work Group last year.

The most noted divergence concerned the capital gains income tax. On one side, Washington Policy Center Government Reform Director Jason Mercier argued that the tax is unconstitutional and volatile, while Washington State Budget & Policy Center Associate Director of Fiscal Policy Andy Nicholas said it would help make the state tax structure more progressive.

Though arguments that the state tax system is regressive tend to focus on the lack of a progressive income tax and the high reliance on a sales tax, Mercier highlighted several excise taxes that are some of the highest in the country.

They include:

  • State liquor tax, $32.2 per gallon (highest);
  • Gas tax, $.49.4 per gallon (third);
  • Cell phone tax, 19.24 percent (highest); and
  • Tobacco tax, $3.02 per pack (eighth).

Along with the state sales tax, Washington relies primarily on a state property tax and business and occupation (B&O) tax imposed on a business’ gross revenue. The B&O tax is disliked by many in the business community for its disproportionate impact on high-revenue, low-profit margin employers. It was initially created in the 1930s and upheld by the State Supreme Court as a “temporary” source of revenue. That said, there has been little consensus on what to replace it with.

Mercier suggested to panel members that it could be swapped out with a single business tax, with three options of how to determine their tax obligations. This, he argued, would also streamline the system and remove the hundreds of B&O preferences needed to address inherent problems with the tax.

Insofar as actual tax revenue is concerned, there’s seems little to complain about; the state has experienced years of surplus revenue and now collects $8.8 billion annually more than it did in 2010. However, Nicholas argued that the state isn’t collecting as much it could, because it is “growing increasingly out of sync with the modern economy.”

While others have previously pointed to data showing that the state’s tax revenue as a percentage of the state’s gross domestic product has gone down, Nicholas offered data indicating that the state sales tax is failing to capture as much of consumer spending as it did in 1997.

The state’s tax revenue since 1995 has also decreased as a percentage of the state personal income.  In his case for a capital gains income tax, Nicholas pointed to the fact that more than 67 percent of capital gains in Washington are earned by people who make more than $1 million annually. That, and a working family tax credit would “rebalance” the tax code, he said.

However, state Department of Commerce officials have said the lack of a state capital gains income tax is a “selling point” for attracting businesses to Washington. It’s also a violation of the state’s constitution, Mercier said. Every state department of revenue that has a capital gains tax includes it as part of its personal income tax, and the Internal Revenue Service has stated a capital gains tax is a tax on income. He added that there is no state with a capital gains tax without a personal income tax.

Although Mercier has previously called for a sales tax rate reduction, he defended both it and the state property tax for offering revenue stability so that lawmakers aren’t “having to do drastic cuts or tax increases every time you come to Olympia. You don’t want to have this (revenue graph) looking like a roller coaster.”

One area Nicholas and Mercier agreed was improving tax code transparency. Mercier told panel members that there are 1,800 taxing districts in the state that often make it difficult to know where and how taxes are being spent.

A provision within the 2018 supplemental operating budget would have created an online searchable database of all taxes and tax rates for each taxing district. The original bill was SB 6590 introduced by former Sen. Joe Fain (R-47) and Sen. Guy Palumbo (D-1). However, it was vetoed by Governor Jay Inslee.

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