Crafting smart state tax policy

Crafting smart state tax policy
Tax policy analysts discussed the merits and drawbacks of a capital gains income tax at the Association of Washington Business 2019 Policy Summit. Photo: freepik.com

Tax policy analysts featured at the Association of Washington Business 2019 Policy Summit on Sept. 18 agree on one thing: the state tax code is regressive. However, the agreement ends when discussing what makes it regressive, what taxes should be replaced with what – and whether a fix is needed at all.

“The problem is, it’s easy to agree on the problem,” Tax Foundation Policy Analyst Jared Walczak said. “It’s hard to agree on the solutions.”

Prominent in the panel talks was whether a capital gains income tax could make the state tax code more progressive. The tax was the main topic of a recent House Finance Committee work session, and panel moderator Dick Davis with Simeon Communications noted that during next year’s election cycle “tax policy and its effect on our state are going to continue to be in the forefront of both legislative discussions as well as city council races and county council races.”

Proponents of the tax, such as Washington Budget & Policy Center Associate Director of Fiscal Policy Andy Nichols, say it could allow for a reduction in the state sales tax first adopted in 1933.

“What people spend their money on has changed a ton in that amount of time,” he said. “We can’t really change the sales tax in a way that’s going to compensate for this reform.”

Walczak shared a similar view on the tax. “Most state sales taxes are a Great Depression era tax, and they still look like it. They have a tax base that is based on what the economy looked like then.”

Aside from disproportionately impacting lower income households, Nichols argued that the sales tax does not provide the state with sufficient money – even though annual revenue has grown from $16 billion in 2011 to $23.9 billion in 2018.

The increased revenue growth was noted by Davis, who asked Nichols: “are you suggesting that our tax structure is lagging behind most other states? How do we reconcile that with the kind of economic and revenue growth that we’ve had over the last four to six years?”

Nichols responded that “a lot of that growth is because we are actually raising taxes.”

That surplus revenue to state coffers highlights another side of the debate over Washington’s tax code. Even if it is regressive, Walczak said “often states are focused more on economic competitiveness and less on the progressivity, because the federal tax code takes care of much of that. If you look at what Washingtonians seem to indicate they want, they love the competitive business environment here, and it is a very competitive business environment. I think Washington has done pretty well without an individual income tax.”

Another policy contributing to the state’s regressive tax structure is the business and occupation (B&O) tax, which is imposed on gross revenue rather than profits. This leads to a “pyramiding” effect in which a product is taxed multiple times before it is actually sold on the market. One of the reasons for that is the tax has no “distinction between business-to-business transactions as intermediate transactions and those that are purchased by a final consumer,” Walczak said.

As a result, Council on State Taxation Senior Tax Counsel Nikki Dobay noted that half of Washington’s taxes are paid by businesses.

While tax experts such as Washington Policy Center Government Reform Director Jason Mercier have pointed to constitutional issues surrounding a capital gains income tax, Dobay noted its volatility using a recent illustration as an example.

“We have a legislator in the state (Oregon) that has a picture of the Swiss Alps and over that he laid Oregon’s revenue from the personal income tax and it matches, so they are extremely volatile.”

To avoid problems from that, Nichols suggested placing some of the money into the state rainy day fund. Massachusetts and California have similar provisions for their capital gains tax revenue.

However, Walczak added that a capital gains income tax could send the wrong message to businesses. “There are considerations that you need to take into account if you’re ever thinking about an income tax. This is a state that is attracting a lot of entrepreneurs from California. Some of those are very sensitive to income taxation.”

Dobay noted that “Every state has to really understand what their own goals and values are, because at the end of the day that’s where the tax structure comes out. It…ultimately comes down to what is the state’s goals and what is important to that state, and it’s all different.”

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