Progressive tax might make a breakthrough in state

A crowd of people work on their 1920 IRS forms. Could Washington finally join most of the rest of the country with a state income tax? Credit: Underwood & Underwood, 1920/via Wikimedia Commons

Advocates of an income tax in Washington, long accustomed to a losing fight, are playing on a new field in 2010, and the filing of Initiative 1077 on Wednesday (April 21) could be a breakthrough in efforts to make the state’s tax system more progressive. The state relies heavily on a sales tax at both the state and local levels, a tax that fall disproportionately on lower incomes.

Announcing the initiative at a news conference, Seattle attorney Bill Gates Sr. said lower- and middle-income families pay too much tax and the wealthy too little. The business and occupation tax on gross receipts, he said, “penalizes small businesses, the engines of job growth in our state.”

The senior Gates, father of the Microsoft founder, has been talking about an income tax for Washington for a long time, heading a 2002 study that called for tax reform. His recommendations have brought nods of approval, particularly among Democrats, but no action, in part because of supermajority voting requirements in the legislature. But the politics and economics of 2010 have created a new opportunity for Gates and his supporters.

This year has brought more attention to the rapidly rising gap between the nation’s rich and poor, with middle classes drifting downward as well. According to the Economic Opportunity Institute (EOI), a progressive think tank in Seattle, the top fifth of Washington’s households gained 11.6 percent in earnings in the past decade, while the bottom fifth lost 4.2 percent. The pattern has been repeated nationwide and has increased interest in taxes that strike at upper incomes.

Perhaps the most important recent action was the Oregon voters’ decision in January to boost income taxes on individuals earning above $125,000 and couples earning over $250,000. Oregon’s vote was watched nationally, as it was the first such result after the election of Massachusetts’s U.S. Sen. Scott Brown, which was interpreted as a conservative backlash to government in general. Oregon also increased corporation taxes on larger firms, many headquartered outside the state, again relying on the taxing of wealth.

That idea of taxing wealth and redistributing the revenue to programs that benefit lower-income citizens is also at the heart of I-1077, in several respects.

No income below $200,000 for an individual or $400,000 for a couple would face an income tax; it is collected entirely on income above that level (set by using the federal tax form). For individuals, the state tax is 5 percent on $200,000 or more and 9 percent on income above $400,000. For couples, it’s 5 percent over $400,000 and 9 percent over $1 million. The actual amount for the individual, however, will be less than the face amount, because of the ability of taxpayers to deduct the state income tax from federal taxes.

As the Economic Opportunity Institute points out, federal deductions for high-income taxpayers are much higher than if they deduct sales taxes. This would lower the total tax impact of a couple earning $500,000, for instance, from $5,000 to $4,382, or less than 1 percent of their total income. At the level of a couple earning $3 million, the impact of their state income tax ($210,000) would be reduced by $46,184 because of the federal deduction.

The initiative also strikes at the business and occupations tax, one of the most regressive of the state’s taxes because it is particularly hard on small businesses and start-ups. The Department of Revenue believes 81 percent of businesses would pay no B&O taxes and another 12 percent would have their taxes reduced. For homeowners, the state’s property tax would be reduced 20 percent, replaced by revenue from the new income tax. State property taxes account for about 21 percent of the property taxes that fund local schools and governments.

The gist of I-1077, then, is redistribution of the burden with high-income families paying more to ease the burden of middle and lower-income families and to pay for services that are used by all (education) and by lower-income citizens (health care).

The new income taxes would raise $1.7 billion annually, with $357 million going to replace 20 percent of the state property tax and $249 million to exempt most businesses from the B&O tax. The net revenue, after these taxes are offset, is $1,094,000, which would go 70 percent to education and 30 percent to basic health care. Education funds could be used from pre-kindergarten to graduate university research; a trust fund set up in 2005 would hold the funds, preventing a “raid” from non-education sources, but within the trust fund any public educational use would appear to qualify.

The Washington initiative is similar to the successful Oregon tax effort in January. The higher taxes there will bring in about $727 million annually, and most will go to education. Oregonians also approved a higher corporate tax on large corporations, many with headquarters outside the state.

The tax structures of Oregon and Washington are still quite different; the two taxes that I-1077 reduces, the statewide property tax and the B&O tax, are not levied in Oregon. Property taxes in Oregon are levied only at the local level, and have been subject to several tax reduction initiatives in recent years. Oregon taxes businesses on income.

Oregon adopted the income tax in 1929 and, although it has been modified over the years, it enjoys general support. There is no such thing as a “popular tax,” but Oregonians long ago decided that the most unpopular tax was the sales tax, the foundation of Washington’s state revenues; sales taxes have been rejected in recent years by margins as large as 8 to 1 in Oregon.

Oregon’s personal income tax is much broader-based than I-1077. Originally a very progressive tax, with higher rates as incomes increase, it has been amended over the years to become almost a flat tax, with the majority of Oregonians paying from 7 to 9 percent rates. The January tax vote pushed the rate up to 10.8 percent for families earning over $250,000 annually and 11 percent for those earning over 11 percent. Those rates would drop to 9.9 percent in 2012, however.

The Oregon tax does permit a credit up to $5,850 for federal income tax payments; but the amount of deduction drops as incomes go up, disappearing at the level of $290,000 for a family. Under I-1077, Washington’s income-tax payers would not be allowed to take any credit for federal income taxes.

If Washington voters approve I-1077, historically a long shot, the tax systems of the two neighboring states would move closer together. Oregonians, buffeted by the economy even more than Washington, have also looked at the unthinkable — a sales tax — but show no sign of biting that bullet.

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