House Minority Leader Richard DeBolt, R-Chehalis, and Senate Minority Leader Mike Hewitt, R-Walla Walla, meet with reporters Wednesday.

OLYMPIA, Feb. 16.—In an astounding change of position, House Republicans are saying there is at least one major tax break they are willing to end this year – a B&O tax deduction for banks that until now has been at the top of everyone else’s hit-list, but which they have defended with a fury.

House Republican leaders say they have had a change of heart about the tax exemption. That puts them in the same camp as those who argue the state ought to whack corporate tax loopholes before considering tax increases – labor unions, activist groups, Democrats statewide. The tax break on first-mortgage interest has been their number-one target, and majority Democrats in the Legislature have been seeking to end the deduction for the last three years. The decision by minority Republicans in the House to support the effort is significant because it takes a two-thirds vote of the House and Senate to raise taxes or end a tax exemption. With their votes, it might actually happen.

That leaves the final say to the Senate Republicans. Minority Leader Mike Hewitt says his caucus hasn’t decided where it stands.

It is a sharp turnabout for the House Rs. They have held firm in their support for the deduction, even as the Dems have hammered them as the party of the Wall Street banks. On the penultimate day of last year’s session, House Republicans voted as a bloc to keep it in place, and a Democratic bill failed with a 52-42 vote because it did not receive the required two-thirds majority. The Dems were so sure it would happen that they staged the whole thing as a test case for a legal effort to overturn the Legislature’s supermajority voting requirements. That suit is on its way to the state Supreme Court.

But as Republican leaders met with reporters Wednesday, they said they have been reviewing the matter and have decided the case for the tax break is a bit spongy. “A lot of people have been asking these questions for a long time, and we decided to do something about it,” said Assistant Floor Leader Kevin Parker, R-Spokane. “We have a fiduciary responsibility where we are entrusted with $32 billion to manage well, and people hire us to ask very hard and difficult questions.”

Evidence is inconclusive that the tax break does any good, he said. “We have to ask, is this maximizing taxpayer dollars? And the answer is no.”

Parker is crafting a bill with state Rep. Reuven Carlyle, D-Seattle, that would eliminate the exemption for the five largest out-of-state banks doing business in Washington, but would leave the exemption in place for community banks based in this state. Estimated receipts are $18 million over the next year.

War on Banks

Washington extended the B&O tax to banks in 1970, but allowed them to deduct the taxes due on interest from first mortgages. The reasoning was that it might reduce costs to homebuyers.

But it’s hard drawing a direct connection between the tax break and lending costs, and critics claim there is none. The mortgage business has changed dramatically over the years. The five largest out-of-state banks, Wells Fargo, Bank of America, Chase, Citibank and Key Bank, do about 70 percent of the home-mortgage business in Washington. For the last 15 years they have routinely resold their mortgages as securities, and the argument is that the direct relationship that once existed between banks and borrowers no longer exists. A report last year from the Joint Legislative Audit and Review Committee said there is no evidence that the tax break reduces borrowing costs or makes loans more available.

“The Legislature created the deduction in an era when local banks held their own loans and used payments to fund new loans in the community,” it said. “Most loans are now sold on the secondary market and do not stay in the community to generate new loans. Also, most loans in Washington are made by out-of-state owned and operated banks, and Washington loans are not dependent on local availability of funds.”

But all economic analysis aside, banks are popular political targets these days – especially the Wall Street banks that benefited from large bailouts and which many blame at least partially for the current recession. And that seems to explain some of the furor.

At an Associated Press legislative forum earlier this year, for instance, prominent social-service lobbyist Nick Federici pointed the finger at the bankers. “This is just money that goes back to Wall Street, which, I think, as all of you have written, is not very popular right now. So is it better to harness some of that money that goes back East to Wall Street and use it to pay for teachers and caregivers and make sure that people have a place to live?”

Hit on Consumers

It may not be so simple. Perhaps the most frequently sounded argument against the tax break is that Washington is the only state that provides it. But there is something worth remembering – Washington also has a unique tax code. There’s no income tax. Instead, Washington imposes an unusual gross-receipts tax, the B&O, which does not allow losses to be deducted from revenue, and which makes comparisons with other states all but impossible.

And it is difficult to consider the tax in isolation. Two years ago, the Legislature changed the rules regarding the “nexus” of taxation, essentially meaning that out-of-state businesses doing business in Washington had to pay more. The Washington Bankers Association went along with it, as long as the mortgage deduction remained in place.

“What is troubling is the fact that we agreed to the nexus legislation, which effectively doubled our tax burden,” said Denny Eliason, lobbyist for the bankers’ group. “This additional tax will mean that we are one of the higher taxed states in the union from a banking perspective. When you are 3,000 miles away from the capital centers in this country, we start worrying about capital availability and therefore loan availability.”

The problem is that investors may begin seeing better opportunities in other states, he said. That’s a major concern as the country begins pulling out of recession and capital becomes more available for loans.

James Pishue, president of the Washington Bankers Association, said the effect might be more pronounced than many realize. At least one mortgage concern has estimated that it might drive up the cost of a loan by about a quarter of a percentage point, he said. But the tax would apply to mortgage interest on old loans as well as new ones, while the existence of the tax break was assumed in the calculations when rates on the old loans were assigned. So the taxes on old loans have to come from somewhere – and that means they could be tacked on to borrowing costs when new applicants come through the door.

“Logic tells you that that [banks] are either going to try to replace the lost revenue with increased fees or increased interest rates, or the other possibility is that investors may look and decide that investing in mortgages in Washington state is becoming too costly and they will take their money elsewhere,” he said. “I can’t predict all that would happen, but I think there is going to be a negative effect. It is going to be on the consumer in higher prices or reduced availability for mortgages.”

Bill Being Drafted

House Republicans made up their mind just this week to endorse repeal of the tax break. House Minority Leader Richard DeBolt, R-Chehalis, said the decision was prompted in part by the $25 billion settlement with large mortgage issuers announced last week by attorneys general nationwide, including Washington Attorney General Rob McKenna. That case had nothing to do with tax breaks – it involved allegations of improper loan and foreclosure procedures – but DeBolt said it brought the mortgage business into focus.

Why leave out the community banks? DeBolt said the Washington-state banks hold on to their own paper, and the tax break may serve a purpose in their case. Out-of-state banks are different. “The national banks take [mortgages] and pool them and move them around, so you’re giving a tax break for – you don’t even know where that paper is. So until we understand the whole industry, we are putting a halt to it.”

Canceling the tax break won’t do much for the state’s budget problems. Right now the state faces a shortfall of between $1 billion and $1.5 billion. Early in the debate, when lawmakers were considering ending the tax break for all banks, the estimated receipts were $176 million every two years. But that number was based on the bang-up business banks were doing just before recession hit. By eliminating the exemption only for banks doing business in 10 states or more, and basing calculations on today’s figures, repeal would generate only about $40 million every two years.

Meanwhile, on the Democratic side of the aisle, Carlyle said Democrats are cheered to have the Republicans in their camp on this one. A bill is in the drafting phase.

“It goes without saying that we believe that it is compelling and valuable public policy, and we are thrilled to have them join in taking this step,” he said. “We hope it is indicative of a number of other proposals that might be able to surface.”

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