Can You Say Income Tax? – a New Tax Reform Debate Gets a Soft Launch in the House

Carlyle Says Overhaul Could be Central Issue in a Couple Years -- Analysts, Think-Tankers Debate Measurements

By Erik Smith
Washington State Wire

Tax talk is beginning: House Finance Committee meets in Olympia.

Tax talk is beginning: House Finance Committee meets in Olympia.

OLYMPIA, Oct. 8.—The horror that dare not speak its name hung like a specter over a House hearing room Monday, as policy analysts and think-tankers argued about the best ways to measure the performance of the state’s tax system.

Income tax, anyone?

The House Finance Committee was listening to testimony about where the state’s tax system stacks up nationally, and the details may not be so important as the fact the committee was having the conversation. Arguments about measurements and statistics are the first move in any tax-reform effort. The chatter in the House might be taken as a signal that a new campaign is afoot — it is a debate House Finance Chairman Reuven Carlyle and others would dearly love to launch. And where it will land may not be much of a mystery. Though there is some talk right now about a capital gains tax in this state, or a carbon tax, it always seems that when Olympia starts talking tax reform, it finishes by talking about an income tax. The prospect has been scaring the bejeezus out of Washington voters and many of their elected representatives for nearly 80 years.

Carlyle, D-Seattle, has been urging a top-to-bottom review of the state’s tax structure ever since he became chairman of the House Finance Committee last year. He isn’t predicting how long this effort will take to jell. “It is inherently a multi-year conversation,” he says. “But there was an incredibly important step that we took last session, which was to begin a level of transparency and rigor that we haven’t had. And the goal is to expand that work in a very thoughtful, bipartisan substantive way.”

Translated? Don’t count on anything in 2014. It’s a short session next year, just 60 days, and there will be a legislative election that November anyway, never a good time to be talking about taxes. But 2015? Maybe.  

Income Tax ‘the Only Answer’

House Finance Chairman Reuven Caryle, D-Seattle.

House Finance Chairman Reuven Caryle, D-Seattle.

Carlyle is the most vocal of a number of like-minded House Democrats who hope to see the state take on taxes. He says the stringent K-12 funding demands imposed by the state Supreme Court’s recent McCleary decision have imposed special needs on the state – it must raise $4.5 billion in additional funding for schools by 2017-19.

Carlyle says the state ought to consider a broader tax structure with fewer exemptions. That would allow lower property tax levies. He would replace the state’s unique business and occupations tax with a corporate income tax, and he says a personal income tax “is an element.” 

But there really isn’t anything new under the sun. Similar suggestions, at least in the broad stokes, have been offered every time tax reform comes up. There is always a pressing need. Washington witnessed similar argumentation during the public income-tax votes of 1973 and 2010, for example, or the blue-ribbon gubernatorial commissions on taxes of 1989 and 2002. At Monday’s meeting of the House Finance Committee, one could hear arguments familiar to anyone who recalls the efforts of yore.  

Most has to do with a single point. Washington is one of just six states that does not have a personal or corporate income tax. That means it has to place more emphasis on other taxes. In this state, sales taxes are far and away the biggest source of revenue, 45.7 percent of the $16.8 billion the state took in during fiscal year 2013. According to the Tax Foundation’s method of calculation, Washington has the highest combined state and local sales tax rate in the country.  

The other big sources of money are property taxes and the state’s rather unique business-and-occupations tax, which is a tax on business gross receipts rather than on business profits. Whether there is anything harmful about that unusual distribution of tax burden depends on one’s politics. But because the poor pay the same rate of sales tax as the rich, some call Washington’s tax system unfair and “regressive.” Yet business also pays a greater share of the burden than it does in other states.  “Washington is ranked as having the most unequal tax burden in the country,” said Rick Peterson of the Treasurer’s office.

There’s only one solution, said economist Dick Conway, a member of the governor’s Council of Economic Advisers since 1985. “Based on my analysis I believe we have the most unfair and perhaps the most inadequate tax system in the nation. The only way out of this bind is to adopt an income tax.”

The Central Argument

Economist Dick Conway and Jason Mercier of the Washington Policy Center appear before committee.

Economist Dick Conway and Jason Mercier of the Washington Policy Center appear before committee.

A central argument, as always, is that Washington’s tax structure does not keep up with growth in personal income. In 1995, state and local taxes amounted to 11.6 percent of personal income, but the percentage has been steadily slipping, to 9.7 percent in 2011. The national average is steady at about 10.6 or 10.7 percent. If Washington had been collecting taxes at the national average from 2005 through 2011, it would have had an additional $14.7 billion to spend, Conway said. “That is not loose change,” he said.

It might have paid for every road project contemplated in the state and still there would have been money left over, Conway said. And one might also observe that the sum would have been more than enough to prevent budget cuts during the recession, helping lawmakers avoid difficult decisions – good or bad being another matter of political perspective. 

But it really isn’t that simple, said Jason Mercier of the Washington Policy Center, a free-market think tank. When governments get more money, they don’t put it aside for a rainy day. They either give it back in the form of tax cuts or they spend it. Most often the latter.

So states like California and New Jersey, with “progressive” income tax rates that soak the rich, watched their economies roar a decade ago, and as the taxes piled up, they spent the money on programs they were obligated to continue. When recession hit and the wealthy took the biggest hit in income, California and New Jersey found themselves with enormous financial problems — bigger even than in Washington state.

Mercier said stability of a tax system – the lack of volatility – is what should be valued. He noted that the St. Louis Federal Reserve Board conducted a study in 2010 that concluded Washington had the 4th least-volatile tax revenues. “It is not a surprise when we consider that the three major sources of our tax revenue are the sales tax, property tax, and the business & occupations tax. We rank very well from a volatility standpoint. That is not say that you have not had issues here with the budget and the Great Recession, but unfortunately I’m here to tell you [that] you can’t outtax the business cycle — you’re not going to have a recession-proof tax structure.”

Any Appetite?

J.T. Wilcox, R-Yelm.

J.T. Wilcox, R-Yelm.

There were other arguments that might have seemed old-hat to anyone who witnessed the previous debates. As Conway pointed to his chart showing that Washington takes a lower percentage of income in taxes than the national average, state Rep. Terry Nealey, R-Dayton, wondered what the problem was. “I like this chart,” he said. “And the way I [will] use it is to bring a lot more business into the state as a result of it.”

But when it was all over, the more important question remained – is Olympia ready to renew an age-old argument that always ends with either lawmakers or voters saying no to an income tax?

Hard to say, says J.T. Wilcox, R-Yelm, floor leader of the minority Republican Caucus in the House. Wilcox raised a few eyebrows last session when he remarked during a Finance Committee meeting that he might be ready to talk about tax reform, under the right conditions. “Here’s what I think,” he said Monday. “I think that no one would argue that Washington has the greatest tax structure, but the first step in fixing that tax structure is winning back the trust of the voters. They have looked at the evidence of state spending from Olympia and have concluded they can’t trust the priorities. And you are not going to get voter consent to change the tax code until you win their trust.”

Tagged as
  • realist

    “So states like California and New Jersey, with “progressive”
    income tax rates that soak the rich, watched their economies roar a
    decade ago, and as the taxes piled up, they spent the money on
    programs they were obligated to continue. When recession hit and the
    wealthy took the biggest hit in income, California and New Jersey
    found themselves with enormous financial problems”

    Who wrote this garbage? California is running a large budget
    surplus these days:

    http://www.nytimes.com/2013/05/26/us/californias-new-problem-too-much-money.html?_r=0

    California is doing great in part because of an income tax.

    • Erik Smith

      Hello, Realist — you must have missed the stories a few years ago when California was mired in what sounded like the worst budget trouble ever. How soon we forget, huh? I can’t speak specifically to what is going on in the Golden State and how they resolved those issues. Taxes and budget cuts enacted a few years ago would have a great bearing on the situation today, and piecing together that story is a job for an economist. But in a general sense, when a state has a tax system dependent on individual and corporate income taxes, and there is a sharp uptick in the tax curve toward the top, you will see a quicker rebound in tax revenues when the economy starts to rebound. So today we might see good news for those states, but you wouldn’t have wanted to be in their shoes in 2009. Volatility is a nice thing when it works in your favor, and a terrible thing when it doesn’t.

      • realist

        I don’t understand your point. California is LESS susceptible to revenue volatility BECAUSE it has diversified revenue streams. It may have been in bad shape several years ago, but it is billions in the black now. It is our state/local excessively-regressive taxing regime that is unbalanced. Had we had income taxes (individual and corporate), payroll taxes, capital gains taxes (over an appropriate threshold), and other progressive revenue-raisers we would be in far better shape now. Our state and some local taxing entities still have budget problems because we don’t have a healthy component of progressive taxes in the mix. Indeed, the democrats that have been in control for decades have pushed for and obtained sales tax increases and car tab tax increases only, to the exclusion of all progressive revenue-raisers. Nobody is talking about what you are (“a tax system dependent on individual and corporate income taxes”). Income taxes should play a part though, as opposed to what the government heads here impose — ever increasing taxation of the poor, the underemployed, the disabled, and young households of modest means.

        • Erik Smith

          Hi Realist, I suspect the problem here is that the ‘volatility’ argument challenges the orthodox view. The assumption is that because we don’t soak the rich, we have a horribly unfair tax system. This is an essentially political argument that many would dispute. After all, everyone pays the same tax rate; therefore some would call it fair. Some define fairness differently, as I suspect you do, arguing that everyone ought to pay the same percentage of income. This is such a fundamental disagreement that it will be probably never be resolved.

          But your argument that we get additional stability if we have additional revenue sources is an argument of a different character. It is untrue. There is a central fallacy, and I raise this in part because it was the central argument mentioned by former Revenue Director Bill Wilkerson during the 1989 tax-reform debate. We probably ought to nip it in the bud from the start.

          If you have additional revenue streams, you get additional stability only if the Legislature manages to restrain itself when times are good, if it spends no more than “necessary” and it leaves, say, billions of dollars in the bank. When was the last time you saw this happen? I’ve never seen it.

          Let us think about it this way. Back in 2010 we had a ‘soak-the-rich’ income tax on the ballot. Suppose this had actually been enacted in, say, 2003, enough time for us to catch an entire up and down cycle. The economy was booming at that point, and the state would have been awash in tax revenue, even more than it was at the time. What do you think the Legislature would have done?

          My guess is that it would have spent darn near every penny — because, after all, that’s exactly what the Legislature did with all the other tax revenue that was coming through the door. Sure, a modest rainy-day fund was launched. But lawmakers argued that if they left large amounts of money unspent, they would be vulnerable to a tax rollback measure from, say, Tim Eyman. So they pretty much spent it all. They pumped a good deal of this windfall into programs that obligated a continuing expenditure in future years. These obligations could not be sustained after recession hit, and frankly if you had looked at historic growth patterns you could have seen the problem coming. So the pain was pretty awful. After recession hit, we heard plenty of calls for big tax increases at pretty much the worst time imaginable, because they would have made economic recovery all the more difficult.

          Now let’s suppose that “progressive” soak-the-rich tax had been in place. The situation would have been that much worse. We would have seen even greater spending in the boom years, and the big revenues from the rich would have dried up in 2009-2010. What would have happened? We have no way to be sure, of course, but I suspect we would have seen pressure to extend the income tax to people making less than $200K a year.

          You have to remember that tax revenues go up and down with the business cycle, pretty much in concert. Some taxes are more volatile than others but the general direction is the same. They go up and down at once. So adding a volatile tax to the mix does not increase stability. It decreases stability. Ultimately we come back to that political argument. Is stability more important than a definition of ‘fairness’ that is not shared by everyone? Should we try to avoid the sort of horrors that occurred in California in 2009-2011? Or should we say that it is the primary duty of government to make sure everyone pays the same percentage of their income in the form of taxes? I guess, by framing the question that way, I reveal something of my skepticism, but I think it is a worthy issue for debate. Alas, no matter how the Legislature has tried, we have never seen it pass a law that can require future legislatures to budget responsibly.

          • Erik Smith

            Hi Realist, I gather that these responses are posted here a little out of order, so they might be hard for anyone else to follow. But there are probably a few things I should add before signing off, as a reporter should do at a certain point in a discussion like this one. The first is that I am not arguing against tax reform — that would be an improper thing for a reporter to do. However, it is proper for me to point out a weakness in the argumentation. The idea that adding a volatile tax to the mix would increase stability is absurd. We have to decide whether increased instability is a good thing if it implements a vision of fairness that is shared by one segment of the population.

            This is a decision that can only be made by politicians or voters, certainly not by a humble fellow like me. Knowledge of human nature and observation of the Legislature for many years leads me to believe there would be no restraint on spending in boom years, and personally I might shudder at the idea of California-style horrors. But there are those who might think it is no biggie, and the inevitable stomachache tomorrow is justified by all the candy one might eat today.

            On reform in general, I would never say I think it is a bad idea per se. There is a legitimate argument about whether the needs of business are better served by a tax on net income (a “corporate income tax”) or a tax on gross receipts (the B&O tax). This argument has raged for years. Some businesses do better under one, some businesses do better under the other. There are other adjustments one might make as well.

            Finally, I don’t think I’m raising a straw man argument and imputing something unfair about your position. You say you want a just tax system in which the poor don’t suffer so greatly; you get there by enacting a tax structure that attempts to equalize the percentage of income that all socioeconomic classes pay. Two sides, same coin. Regards,

          • realist

            Replacing a substantial portion of the regressive taxes here with progressive taxes would not increase “instability”. Look at the charts for California and Washington here:

            http://www.governing.com/gov-data/state-tax-revenue-data.html

            They are equally “stable”. Adding progressive taxes and ending some regressive taxes would not increase “boom year” spending. The state legislature is going to spend whatever it wants by issuing debt anyway. Your notion that keeping the most regressive tax system in the country that way acts as a deterrent to spending is meritless.

            Here you are again imputing ridiculous arguments to me:

            “You say you want a just tax system in which the poor don’t suffer so greatly; you get there by enacting a tax structure that attempts to equalize the percentage of income that all socioeconomic classes pay.”

            No, I propose eliminating some regressive taxes and imposing revenue-raisers such as corporate and
            personal income taxes (limited by a constitutional amendment allowing the personal income tax for high-income individuals with a kick-in level indexed for inflation), significant business payroll taxes, and
            capital gains taxes over an appropriate threshold. That is redistributing the tax burden, but not in a way that “attempts to equalize the percentage of income that all socioeconomic classes pay”. Instead, the primary shift would be tax burdens coming off less-well-off households and moved on to big rich corporations.

            You really seem to have a tough time comprehending what I’ve discussed here, you misrepresent my posts each time.

        • realist

          Erik, you are positing straw-man arguments, and imputing to me ridiculous positions.

          “The assumption is that because we don’t soak the rich, we have a horribly unfair tax system. . . . After all, everyone pays the same tax rate; therefore some would call it fair. Some define fairness differently, as I suspect you do, arguing that everyone ought to pay the same percentage of income.”

          We have the most regressive state/local taxing regime in the country. It is designed to hit the hardest those with the least. It is unfair because it removes from economically-vulnerable households far too much of what little discretionary spending power they have. It is NOT unfair for the reason you posit (it doesn’t require the wealthy and/or corporations to pay the same percentage of income).

          What I am arguing is that sales taxes should be reduced at the state level, no additional regressive taxes should be allowed by the state legislature at the local level, some regressive taxes at the local level should be eliminated by the state legislature, and progressive taxes of several types (including constitutional amendment allowing an income tax for high-income individuals with a kick-in level indexed for inflation, payroll taxes, and capital gains taxes over an appropriate threshold) imposed by the state.

          That would be essentially revenue-neutral at the state level, and would pare back the excessive regressive taxing at the local level. We see that excessive regressive taxing most clearly in the “transit” realm.

          Your entire argument against making the state/local taxing regime more fair to more families by taxing corporations and the wealthy more is that the state legislature would spend more money. That is a bogus argument because the main expenditures by the state legislature are a function of the debt issuances it authorizes. Your argument falls apart because spending by the state legislature essentially is unrelated to differences year-over-year of the overall tax revenues it confiscates.

          You are waving a red herring around (that tax reform should not take place because the state legislature would spend more). Tax reform of the type proposed — essentially making the state/local taxing regime smaller overall (by reducing local-entity taxing) and more progressive — necessarily would not impact spending levels. That is because, as I’ve stated, spending levels by the state legislature primarily are a function of what it raises by selling debt.

          • Erik Smith

            Hi Realist, I just want to say that I don’t intend to misstate your position, either in goal or effect, and if you believe I have done so, I apologize. The volatility of taxation schemes that are heavily weighted toward “soaking the rich” is another matter — I think the huge volume of argumentation produced during the 2010 high-earners-income-tax campaign offered plenty of support for the idea that these types of taxes make state governments more vulnerable to downturns, rather than less. This applies both to “high earners” income taxes and to capital gains taxes. Perhaps, as you suggest, there is a way to balance things with adjustments to other taxes, but I am very skeptical, and I’d like to see the modeling. It’s pretty simple. Taxes on the wealthy tank more than other taxes when the economy falters. To the degree that the state increases its dependence on such volatile forms of taxation, the stability of the taxation structure suffers. The other element is a matter of human nature. Nothing says the Legislature has to spend pretty much every dime it receives when the economy is going ganbusters and nothing says it has to incur big long-term obligations when it spends those big windfalls — but it always seems to work out that way.

        • realist

          . . . And another reason what I’m proposing would be an unmitigated improvement is that by adding progressive taxes to the state revenues mix (and removing regressive taxes from the state and local revenues mix) is that there would be less year-over-year revenue variability. Corporate and personal income tax revenues (for example) DO NOT track closely with sales tax revenues — at least when sales taxes are as high as they are here. THAT is a lesson learned from California. The reason it is now billions in the black is because of its income tax. In comparison, our “regressive taxing only” policies aren’t providing healthy revenue gains to Olympia.

          Boeing, Microsoft, Amazon, Starbucks . . . they all are making record profits. Wealthy individuals are getting much wealthier — the gap between the rich and the middle class is growing. Given the disproportionate impact of the current taxing regime here on the less-well-off, why shouldn’t those doing so well be contributing a larger percentage of the large amounts they haul in to state and local governments?

        • tryingtocalmdown

          you are wrong. calif and oregon take bigger revenue hits because of income and capital gains taxes when the economy goes down. it’s simply a fact. because wa is sales tax dependent (over dependent some would say) that even when the economy tanks people have to buy stuff. and since 2/3 of the economy is king county where incomes are high, sales tax gets generated even if unemployment is up.

          • realist

            “you are wrong”

            No, I’m not. Replacing regressive taxes here with progressive taxes would not increase “revenue hits”. Look at the charts for California and Washington here:

            http://www.governing.com/gov-data/state-tax-revenue-data.html

            The variations year-over-year are essentially identical. Adding an income tax, payroll taxes, and capital gains tax and eliminating sales tax isn’t going to make budgeting more difficult and it won’t cause legislators to spend more (that’s because their spending is driven by how much debt they issue, not how much tax comes in).

  • ChronicKindness

    Income taxes are insane. Never should that be allowed. We need to be eliminating the FEDERAL income tax not starting new STATE income taxes.

    Olympia will be getting plenty of money from taxing dope sales. The Cannabis tax, if we eliminate the medical marijuana exclusions, will provide plenty of income for k-12.

    • realist

      What’s insane is the democrats slavish devotion to sales taxes and car tab taxes. The kind of mental illness it really represents is an anti-social personality disorder.

  • Tom Potlatch

    Here’s a fix — Let’s have all WA residents disclose our income and then get a barcode tattoo on our foreheads. When you buy something, the barcode gets scanned and an appropriate, variable progressive sales tax is applied based on the scan so the rich pay lots more. Tourists and visitors without a forehead barcode pay the highest rates (or less as a visitor promotion tool). As your income changes, you get your barcode changed.

    Kids get their parents’ income barcodes.

    That’s how you make our regressive tax system better.