This week, our team at the Wire is publishing a series of stories on what the K-shaped recovery looks like. Part of the idea is that by telling the stories from the recovery, we can better inform policy making that is trying itself to respond to the nature of our pandemic economy.
So, as part of this reporting, we wanted to start with a simple question as fiscal policy gets hammered out in Olympia:
As a Washington State resident, am I taxed too much or not enough?
We’ve spent a lot of time talking with folks and reviewing the data. After sifting through it all, we think we have found an unequivocal answer to this question, and it is this:
Here’s how we approach an answer to this question, which we do in two parts.
Part 1 is a review of the idea of regressivity versus progressivity in fiscal policy, and how the taxes on which we rely to fund Washington State government impact individuals based on their income.
Part 2 puts this structure in context with other states with the idea that we can learn something about our burden as taxpayers by looking at how other states answer the same question.
First, the primary tax revenue tools in Washington State come in the form of a sales tax and a property tax. The business and occupation tax is another. A gas tax is another important revenue source.
Now, a tax is considered regressive or progressive based on the financial burden to an individual or cohort relative to their income.
So, a tax that taxes all individuals 10% of their income would be considered a neutral tax. For example, in this instance someone making $200,000 would pay a tax of $20,000. Someone making $20,000 would face a tax burden of $2,000. They pay different amounts, but they pay an equal share of their incomes.
Taxes that create tax burdens that have unequal shares are either more regressive or more progressive based on the direction that burden shifts.
Theoretically, a 10% sales tax could be a neutral tax with an equal burden. If the person making $200,000 spends all of their money on taxable items, then they would have a $20,000 tax burden, or 10% of their income.
Except we see that as income increases, a lower share of income goes towards taxable expenses. At upper incomes, individuals don’t spend all of their money on items that face a sales tax. They put some money in savings. They invest some money for retirement. Maybe they buy a house or put some money to pay down debt.
Let’s imagine that this individual spends half of their income on things that earn the sales tax liability and does something else with the other half. That $100,000 in expenditures would earn a 10% tax burden equal to $10,000. That amount, $10,000 in tax burden, is 5% of the $200,000 income the person earned.
Meanwhile, the person who makes $20,000 does not make enough money to save for retirement or buy a home. In today’s world, all of that $20,000 is going to get spent just to try to survive. So, the tax burden on spending all of the $20,000 is $2,000. The 10% tax burden is double the 5% tax burden borne by the upper income individual.
I’ve made this hypothetical, but you know this in your gut. You can also see this in national data on how spending compares by income.
One lesson is this: whenever you see a sales tax, it is likely regressive. It will almost always hit lower incomes with a higher tax burden as a share of income than it will hit upper incomes.
A property tax turns out also to be regressive, though less than the sales tax. Let’s imagine a property tax rate of 1% of the assessed value of a property.
Someone who owns and lives in a small, older 1-bedroom, 750 sq ft condo might face a 1% tax burden on a property valued at $250,000. Let’s imagine this person lives on $50,000 per year. A 1% tax burden of $2,500 is equal to 5% of the taxpayer’s income.
Meanwhile, someone making $500,000 also faces a 1% property tax burden. However, while this second person makes 10x the income of the first person, this person probably doesn’t require 10x the property space to live. Let’s imagine this person has a 4,000 sq ft home and maybe a second home at the beach or mountains with 2,000 sq ft. The first home we’ll say is worth $1.5m and the second home is $750,000. The 1% property tax would apply to the $2.25m in property valuation, or $22,500 in tax. That amount is equal to 4.5% of the second person’s income.
This .5% may not seem like much. But the gap widens at higher incomes. Imagine a person with $5m in annual income. Maybe this person owns three homes — make it four. Let’s say each is about 5,000 sq feet, and they average about $3m per home.
That’s $12m in property. Taxed at 1%, that tax burden is $120,000. That burden is equal 2.4% of this individual’s $5m annual income, compared to the 5% or the 4.5% tax burden as a share of income in the other two cases above.
The Morning Wire: Keeping you informed on politics, policies, and personalities of Washington State.
Because the higher income person faces a lower tax burden as a share of income than the lower income person, it turns out property tax becomes a regressive burden as well.
These two taxes are two of the primary taxes we rely on to fund Washington State government. Because we primarily fund state government with regressive taxes, we can see how our tax regime in Washington State more heavily taxes lower income folks than we do higher income folks, as a share of their income.
Let’s look at another tax that Washington State relies heavily on: the gas tax.
Currently, Washington state levies $0.494 per gallon of gasoline and diesel. The federal government adds $0.184 on to gasoline ($0.244 to diesel) for a total of $0.678 to every gallon of gas.
Arguably, this is a use tax, or a tax on folks who choose to use gasoline as part of their lifestyle. But, the folks who end up driving the most or end up relying on transportation the most are folks at the lower end of the income bracket. They may use gasoline not as a choice, but as a matter of survival.
Here is one way that shows up.
It turns out poorer neighborhoods generally have fewer jobs and less economic opportunity than richer neighborhoods. Residents in these high poverty areas need to drive or get transportation a farther distance than other folks with higher incomes.
This is particularly true in the Seattle metro area where the number of jobs near high-poverty neighborhoods is a stark 54% lower than the national average across 96 metropolitan areas, according to a study from the Brookings Institute.
In short, lower income folks often have to drive more to get to their jobs, which uses more gas, which requires payment of more gas tax.
Finally, a quick review of the business and occupation tax which Washington State relies on also shows it is regressive.
The B&O tax taxes all gross revenue rather than profits. So, if a company is making $1m in gross revenue, they will pay a B&O tax whether they are hemorrhaging losses or enjoying profits. Rich and poor are taxed alike based on their revenue. But, gross revenue isn’t net revenue, and it’s net revenue that is the thing we look towards to measure money in a business person’s pocket. So, if money-losing businesses have the same tax rate and highly profitable businesses, you can see how the burden will fall unequally as a share of the income, or net revenue.
There is an important distinction here in practice that actually underscores the point.
In practice, B&O rates are set through legislative action. And, so, those voices that have more access to policy makers may be able to shape B&O tax policy to the advantage of the voices they represent. This isn’t a bad thing, per se. It’s the legislative process at work.
But, poorer business voices are less likely to have advocates in the legislature. More highly profitable businesses are able to secure stronger advocates, and perhaps more likely to win concessions in the form of lower B&O tax liabilities.
For example, in 2004 Boeing lobbied for and won a B&O tax break that saved them 40% off of their B&O tax burden. However, the approximately $118m in annual benefit was too much even for the WTO, which forced a repeal of the tax benefit in 2020.
However, today the primary B&O tax rate for most businesses stands at 1.5% of gross revenues. The B&O tax rate for manufacturers is more than 2/3rds off that rate at 0.484%. In practice, both in application and as a result of the legislative process, the B&O tax ends up being regressive as well.
With this baseline knowledge, let’s now look at how this gets applied to individuals throughout the modern economy of Washington State.
Your support matters.
Public service journalism is important today as ever. If you get something from our coverage, please consider making a donation to support our work. Thanks for reading our stuff.