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

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.”