Building an Economy that Works for Everyone

Criticisms of Initiative 1098 tax reforms fall short in many ways

Opponents of this year’s tax reform initiative (I-1098) are refreshingly candid. They think continued cuts to public education and health are just fine and dandy. And, like the legendary French princess, they want to “let them eat cake” because, well, they want to stay in the money.

Initiative 1098 proposes business and property tax cuts coupled with a modest 5 percent tax on joint income over $400,000 ($200,000 for individuals) and 9 percent on joint income over $1 million ($500,000 for individuals). Net revenue, estimated at $1 billion per year, is to be dedicated to trust funds for public education and health.

Ordinarily, big-business boosters couple tax cut proposals with job creation, aim for “business-friendly” messaging, and lock arms with corporate lobbyists to push them through. None of that here for I-1098 though.

Let’s look at three issues: equity, sustainability and effect on quality of life.

The 2002 Tax Study Commission, chaired by Bill Gates Sr., found that “the lowest income households pay 15.7 percent of income for total excise [sales] and property taxes, while the highest income households pay 4.4 percent of income for the same taxes.” The Washington Department of Revenue, in 2007, found that small businesses pay a higher percentage of their gross income in both sales tax and the business and occupation tax (B&O) than do mid-size or large companies. And because the B&O tax is on gross receipts, firms have to pay it even when they make no profit. Since the B&O tax functions as a sales tax — and is counted as such by economists — Initiative 1098’s proposed tax cuts are designed to benefit businesses, consumers and property owners.

By increasing the business and occupation (B&O) tax credit from $420 to $4,800, I-1098 would exempt 81% of the 317,000 firms in Washington from B&O taxes (up from 43%), and reduce taxes for an additional 12% (according to an analysis by the Washington State Department of Revenue). At just $250 million a year — less than 10 percent of annual B&O collections — this is a smart investment that will benefit the vast majority (over 90%) of Washington’s businesses.

The proposal also cuts the state portion of the property tax by 20%, benefiting the two-thirds of all Washington residents who are homeowners. On average, 21% of total property taxes go to the state. The remainder, including voter-approved school levies and support for other local services, stays in local communities. I-1098 translates into an annual tax saving of $170 for the average Seattle homeowner (where the average residence value in 2010 is $448,500). In Algona, with an average residence value of $193,700, the annual savings would be $100. Of course, businesses of all sizes will also benefit from the property tax cut.

So the initiative takes steps to reduce taxes for both businesses and low- and middle-income earners. But it also recognizes that real equity also requires strong public structures — like our public education and health systems — that benefit us all. That’s why I-1098 also proposes an income tax on the wealthiest 3% of households, who now pay the lowest percentage of income in state and local taxes and have enjoyed the most dramatic income gains in recent years.

Of course, with changes to the rates or brackets subject to a vote of the people, and required regular public reporting on how revenues are spent, accountability and transparency are part of the package.

I-1098 will also stabilize the state revenue stream through a more broadly diversified tax system. According to one recent analysis:

Washington state and local tax collections tend to be more volatile than personal income because much of the tax revenue stems from the sales of goods (including new construction). Between 2007 and 2009, Washington personal income increased 2.7 percent, while taxable retail sales—the state’s biggest tax base—fell 15.0 percent. The downturn in auto sales and the bust in residential and commercial construction accounted for 56.4 percent of the decline in taxable retail sales between 2007 and 2009.

Washington state and local governments have the narrowest tax base in the nation, collecting 62.0 percent of their tax revenue from sales taxes (retail sales taxes, business gross receipts taxes, and selective sales taxes), according to U.S. Bureau of the Census estimates for FY 2007. Nationally, sales taxes amounted to only 34.4 percent of total state and local taxes. Sales taxes accounted for 78.3 percent of Washington state government tax revenue.

Opponents of I-1098 charge that an tax on high incomes will cause Washington’s business climate ranking to decline. To get a handle on how national experts view the objectivity of business climate rankings, I consulted the book “Grading Places“, by Peter Fisher. Fisher is a professor in the Graduate Program in Urban and Regional Planning at the University of Iowa, holds a Ph.D. in Economics, and has published a number of journal articles on tax incentives and economic development policy.

After evaluating the Tax Foundation’s Business Tax Climate Index (SBTCI) against its own standard (for “tax neutrality”) and against standards developed by the Boston Federal Reserve Bank for measuring state and local tax rates, Fisher concludes:

There is no point, really, in trying to assess whether the SBTCI successfully predicts which states will do better in attracting business investment, creating jobs, or the like. If it does, it is purely by accident, for the index does not even measure the effect of a state’s tax system on a firm’s cost of doing business. … The index does not measure tax rates to begin with, or even correlate with relative business tax levels. As a tool for assessing public policy, it is fatally flawed… .

New Jersey Gov. Chris Christie may rail against his own state’s income tax now — but if he ran the numbers, he would find that his state’s Tax Foundation ranking has no correlation with the number of wealthy people who live there. New Jersey has both the highest top individual income tax rate (10.75%) and the highest average income of the top 5% of households: $412,476.

A tax on high incomes doesn’t seem to matter much to the wealthy. Three of the states with the highest top marginal income tax rates (New Jersey, California, and Hawaii) have higher percentages of households with incomes above $200,000 and higher average incomes for the top 5% than any of the 7 states with no income tax. Those same three states also have both a higher percentage of well-to-do households and higher top incomes than the U.S. average.

Washingtonians may get a chance to vote on an income tax for the first time since 1973. Independent polls conducted in April and May show approval for I-1098 at 66% and 58%, respectively.

With schools laying off teachers and increasing class sizes, skyrocketing tuition putting the cost of college education out of reach, and an ever-growing number of people without health care, 2010 may be a good year for I-1098 to be brought forward…especially wrapped in such a business-friendly package.

Looking for more information about Initiative 1098? Visit the Economic Opportunity Institute website.

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