Protesters in Olympia spent last week bouncing “no loophole” chants off the marble walls. Despite their venting, there will be no loophole fix for Washington’s multibillion-dollar budget gap. Such broad slogans also do little to illuminate the realities of the situation.
The state labor council’s “demand letter” sent to the governor and legislators last month sets out the complaint: “The state currently has 567 tax breaks on the books that cost taxpayers billions of dollars every year. Instead of cutting vital services, the Legislature should be cutting the billions in wasteful corporate tax breaks.”
Let's start by using a more neutral term, “tax preferences,” as the Legislature did when it established the Citizen Commission for Performance Measurement of Tax Preferences in 2006. The estimate of 567 tax breaks comes from the revenue department’s quadrennial report on “tax exemptions, exclusions, deductions, deferrals, differential rates, and credits.” Unfortunately, the department’s inventory fails as a good framework for exemption review.
In 2008, the department reported an estimated potential savings for taxpayers of $98.5 billion from 567 preferences. The analysis then draws a good distinction between taxpayer savings and potential revenue collections. The department estimated that governments might realize about $14.8 billion from repeal, about 15 percent of the total.
The department's report has led to all kinds of mischief and exaggeration. Loophole closers regularly cite the misleadingly big numbers from the report, but they primarily target a handful of things they consider “wasteful corporate tax breaks.” They also mention, presumably for rhetorical effect, eliminating tax exemptions for “elective cosmetic surgery” and “private jets” — tiny amounts. And these advocates do not mention that hardly anyone is pushing the repeal of popular sales tax exemptions for groceries and pharmaceuticals, the Business and Occupation (B&O) tax exemption for employee wages and salaries, or property tax exemptions for nonprofits.
Underlying the agitation is the notion that Washington businesses are under taxed. In fact, Washington businesses bear among the nation’s heaviest tax burdens. The accounting firm Ernst & Young recently calculated that businesses paid Washington’s state and local governments $14.7 billion in taxes during the 2009 fiscal year. This was 51.2 percent of all taxes the governments received. The effective tax rate on business in the state (calculated as the ratio of taxes to private sector gross state product) is 5.3 percent, tied for 13th highest and significantly higher than the 4.7 percent national average.
The business burden would be much higher were it not for tax preferences enacted to offset problems inherent in Washington’s peculiar tax system. This is especially the case with respect to preferences related to sales taxes on business-input purchases and the business and occupation (B&O) tax, which together account for nearly one half of the business tax burden.
Indiana University economist John Mikesell says a good preference analysis begins by identifying the norm from which the preference deviates. Ideally, the benchmark normal tax base should be selected by the logic of good tax policy. Mikesell calls this the conceptual baseline approach and notes that it requires “a clear statement of what state tax policy actually is — not just an indication of how much money the state wishes to collect...”
In Washington, it is particularly important to get the baseline right for sales taxes. General sales taxes (i.e. the retail sales and use taxes and the B&O tax) provided 69 percent of general fund-state revenue in 2009. While many liken the B&O to a corporate income tax, public-finance experts see it as a sales tax. Revenue from the B&O is equal to one-third of the amount received from the retail sales and use taxes.
The sales tax problem to be solved stems from what analysts call “pyramiding,” multiple taxation of the same transaction. Consider a man’s shirt. The state collects sales tax (both retail sales tax and B&O) when a store sells a shirt. Should the state also collect sales tax when a shirt maker sells the shirt to the retailer? What about the shirt maker’s purchases of cloth, thread, and buttons? Although Washington provides a retail sales tax exemption for goods purchased for resale, these transactions are subject to the B&O.
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