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    Where are Washington's K-12 dollars? Just ask Microsoft shareholders

    Commentary: The taxes dodged by Microsoft over the last 17 years could have paid for Washington's public education shortfall.

    In June, the Washington State Supreme Court ordered the Legislature to appear on September 3rd to explain why it hasn't found the revenue to fully fund the education reforms required by its McCleary ruling, reportedly as much as $7.83 billion through 2019.

    There are a variety of reasons the state has a huge education budget gap. After the 2008 recession, the Legislature cut $4 billion from K-12 and higher education spending, which helped absorb the costs of continuing tax breaks for corporations. While most states have an income tax to smooth revenue through downturns, voters rejected the creation of a progressive income tax in 2010. Then, last November, the Legislature awarded Boeing $8.7 billion in new tax breaks.

    Locally, Boeing often takes a lot of flak for its tax breaks, but Microsoft has also played a central role in lobbying for tax breaks that cripple state education spending.

    Microsoft's Nevada Tax Dodge

    Back in 1997, Microsoft realized it could save money on its fast-growing software licensing business by successfully lobbying the Legislature to cut Washington’s royalty tax rate by 66 percent. Between 1997 and 1998, Microsoft's royalty tax bill went from $52.1 million to $22.9 million — and that was before the company's revenues really began to grow.

    Shortly after, it acted to avoid the royalty tax altogether by opening an accounting office in Reno, Nevada; a state with no corporate income tax. As I reported in "Citizen Microsoft", a 2004 Seattle Weekly article, the company accounted for its software licensing sales through the new office to avoid paying taxes on them, even as the bulk of its facilities, software development and sales continued from Washington state.

    Microsoft's Executive Vice President and General Counsel Brad Smith acknowledged this practice and discussed its impact on Washington tax revenues in an interview I did with him in 2004.

    "Obviously the company did make a decision, I'm not remembering exactly how many years ago, to put Microsoft Licensing Incorporated in Nevada in part to recognize the lower tax rate that was in place there," he said. "And there have been times when people in state government have mentioned to us the issue of whether we might move that back to the state of Washington. The reality is that, in the scheme of things, the impact is not very significant either for the company or for the state. Either the state government or the state economy."

    By law, the state cannot disclose the tax records of individual corporations and Microsoft has also repeatedly refused to publicly disclose its actual royalty tax payments. Citizens, did I mention I have email?

    But I did verify Microsoft Nevada's tax practices by comparing the company's publicly reported royalty revenue, its expected tax bill and the state's publicly reported aggregate royalty tax revenue. The numbers didn't add up; in fact, they didn't come close.

    The red bars in the chart below show Microsoft's estimated royalty tax bill each year until 2010; they also represent the magnitude of our annual corporate welfare program to Microsoft shareholders. The blue bars show the state's actual royalty tax revenue for all taxpayers. (More on where these numbers come from in a minute.)



    Because the facilities and employees that built and sold Microsoft's software overwhelmingly exist in Redmond, the state could have challenged Microsoft Nevada's accounting as an illegal step doctrine, but I was told repeatedly by former Department of Revenue Director of Communications, Mike Gowrylow, that the state didn't want to take the risk of losing.

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    Posted Fri, Aug 22, 8:32 a.m. Inappropriate

    If the audio of Brad Smith's interview isn't showing up for you in your web browser, paste this link into your browser:

    Posted Fri, Aug 22, 9:41 a.m. Inappropriate

    If you start from the argument that all taxes should be broad based and consistent then the point of this article is good but if the argument is that software sold in, for example, South Africa should pay a royalty tax to the State of Washington then that is not so clear. Using "worldwide" sales to construct the graphic you show is dramatic but it stretches a point; MS could move a lot of its operations to low tax states weakening Washington State's claim to any royalty tax at all. Alaska Airlines is based in Washington I think, do they pay sales tax on 737s they buy from Boeing? I think I have read that they do not and, if they did, it would put them at a distinct disadvantage to their competitors. The big operations in Washington State that move a lot of money probably do their share to fund state operations.... it's not something subject to clean analysis. Both political parties caved in to BA in a hurry, we all hope they know what they're doing.


    Posted Fri, Aug 22, 11:20 a.m. Inappropriate

    Keith, the law referred to revenue from all gross receipts related to royalties. The Dept. of Revenue always interpreted this as worldwide revenue, until the change in 2010.

    You can read the text of the old law:

    Licenses & royalties are considered "intangibles" - no physical representation - and so they are typically taxed in the physical nexus state (Wa. for Microsoft) of the company earning the revenue.

    Furthermore, Microsoft refuses to disclose its actual tax contributions to Washington State - across the board - so we have no idea how much they pay in tax here. It's likely not very much at all. Sure, they have a tremendous impact here - but we also are $7+ billion short on education funding. Why's that?

    Posted Fri, Aug 22, 2:42 p.m. Inappropriate

    Thanks for responding. But I think you miss my point; the "physical nexus" is subject to major interpretation. I am willing to bet that the 2010 revised interpretation was in response to considerable pressure from Microsoft (as you imply) and, further, that if the old interpretation had been left in place the State may have actually collected less revenue from Microsoft than it has in these past four years Microsoft sells at least some software that is developed in other states and other countries; it's a very aggressive stance to claim revenue from "gross receipts" of a company selling what you call intangibles. For example does a book written in Washington State become subject to royalties tax? how about a movie partially shot in Seattle?


    Posted Fri, Aug 22, 1:43 p.m. Inappropriate

    The author raises several important tax policy issues that need further exploration. But it should be pointed out that even if Microsoft's royalty income had been taxed, and penalties and interest assessed, it would not cover the amount needed to meet the McCleary mandate. It's generally assumed that an additional $5 billion per biennium will be needed by 2017-18. The author's $8.16 billion is a 18-year cumulative total.

    Posted Fri, Aug 22, 4:47 p.m. Inappropriate

    Thanks Dick, point well taken.

    I think the story of Boeing and Microsoft's tax breaks taken together demonstrate for the Supreme Court, the modus operandi of the Legislature ... and we need more systemic reform, new approaches.

    Depending on how aggressive the Court decides to be, this could get quite interesting and provoke some interesting legal challenges.

    Posted Sat, Aug 23, 8:06 p.m. Inappropriate

    Every big corporation today is on welfare. Microsoft is no more disgusting than Boeing or Amazon. But it's still sad that there is no sense of corporate accountability. Microsoft gladly takes advantage of the taxpayer funded roads, bridges, transit, colleges, etc. But then it opens one little office in Nevada for the purposes of diverting tax expenditures. So the infrastructure burden is paid by the people of Puget Sound and Microsoft gives them the finger when it comes to paying its share of the education pie at UW for example.

    Typical. Who knows, maybe Microsoft is planning to move to North Carolina to join the Lazy B.

    Posted Sat, Aug 23, 10:40 p.m. Inappropriate

    and let foreign countries educate their new employees.


    Posted Sun, Aug 24, 9:36 a.m. Inappropriate

    Jeff wrote, "Citizens, did I mention I have email?"

    Yes, you did. Unfortunately, you did not mention a PGP key.


    Posted Sun, Aug 24, 11:35 p.m. Inappropriate

    Phil, clearly you misunderstood what I meant. But, citizens, Phil probably has a PGP key - I just don't see it anywhere on his site.

    Posted Sun, Aug 24, 9:36 p.m. Inappropriate

    Jeff -- Interesting article, but let's be real. What do you want to do about this?

    Any attempt to change the Microsoft (or Boeing or whoever else) tax breaks will require legislative action. Good luck getting all the Republicans in the legislature and many Democrats form the Microsoft area to support this.

    The upcoming election will likely leave the Washingon State Senate in Republican control.

    That means the main fight in the next year's session will be about just how much social serivces budgets will be trimmed to fund the McCleary mandate.

    As one wag said, the kids will get a great education, but will be homeless, abused, hungry and sick.

    Posted Sun, Aug 24, 11:36 p.m. Inappropriate

    TP, this is directed at the Court which now has to manage the Legislature. I don't expect anything to change in Olympia on its current course.

    Posted Fri, Aug 29, 10:07 p.m. Inappropriate

    Nice piece. Even if there is no immediate, practical impact in the sense of legislative action, it's good for Washington's citizens to know the fact of corporate actions and not just the PR spin. Microsoft evades taxation. Schools suffer. Gates pushes charter schools and for-profit educational products. Cognitive dissonance indeed.


    Posted Wed, Sep 3, 10:31 a.m. Inappropriate

    KPLU has a report out on this story today with interviews from me and Rep. Ross Hunter and a statement from Microsoft:
    Has Microsoft’s Tax Policy Hurt Washington State’s Ability To Pay For Schools?

    Posted Tue, Sep 9, 12:03 a.m. Inappropriate

    SEIU protested at Microsoft Friday over tax dodging.

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