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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.)

dor-royalties.gif

 

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.

That assertion seems questionable to me. Surely, the scale of tax revenue that could have been collected from such a battle would have made it a worthwhile risk. I believe instead that the decision not to sue was political, as evidenced in part by Gov. Gregoire appointing ex-Microsoft executive, now congresswoman, Suzan DelBene to run the Department of Revenue. (Full disclosure: I'm a former colleague of DelBene and her husband.)

For the next five years, I made the Nevada tax dodge a PR nuisance for Microsoft online at news sites like the Guardian and the Huffington Post, on popular tech blogs and vlogs and on local news sites and radio.

 

Finally, in 2010, Rep. Ross Hunter, a seventeen year ex-Microsoft executive, led the Legislature to redefine the royalty tax a second time. Rather than tax worldwide sales, he argued, the state should only tax revenue from sales to Washington state customers. I guesstimate that Microsoft's in-state sales amount to less than 1 percent of its total revenue, probably much less. This was a huge tax cut.

The purpose of this was twofold: 1) reduce the growing legal liability the tax dodge created for Microsoft in Washington state and 2) shield the firm from bad PR. Hunter also snuck in language which granted large taxpayers such as Microsoft amnesty from unpaid royalty back-taxes.

At the time, Hunter persuaded colleagues to pass his bill by claiming the royalty tax change would generate $20.4 million more annually for the state by 2013. In talking points he distributed to refute my arguments, Hunter argued, "In fact, companies have expressed interest in bringing their royalties functions and related jobs back to Washington if the bill passes."

Data from the Washington State Department of Revenue (DoR) shows that Rep. Hunter’s claims about a $20.4 million annual revenue boost were wildly off, if not deliberately misleading:

dor-royalty.gif

Royalty tax revenues actually decreased in 2011 and have barely grown since 2008. And, as of now, Microsoft’s Nevada lawyers and accounting teams are still skiing in Squaw Valley, not Snoqualmie.

So how much has Microsoft saved through its lobbying and tax dodging? A September 2010 Microsoft Nevada job listing provides a major clue. “Are you interested in leading the vision and strategy of an organization which processes in excess of $30B annually?” the ad asks.

msli-ad.png

In 2010, Microsoft earned $62.5 billion. If Microsoft Nevada recorded more than $30 billion a year from software licensing, that meant licensing had grown to make 50 percent of its total yearly revenues — much more than its final public disclosure of 31.6 percent in 2003. That number would make sense considering the company’s rapid migration from retail software packages to bulk licensing deals with PC manufacturers and Fortune 500 customers.

Using the 50 percent figure, we can conservatively estimate Microsoft’s savings from lobbying and dodging the state royalty tax between 1997 and 2014 at $5.34 billion. If we factor in interest and the Department of Revenue’s typical 25 percent penalty on unpaid corporate taxes, that number jumps to $8.16 billion (see Scenario B).

This is more than enough to fully fund public education under the Supreme Court’s McCleary decision.

"It's amazing what you can do here," the Nevada job listing bragged. Indeed.

These are also ethical issues. Chairman Bill Gates, former CEO Steve Ballmer and General Counsel Brad Smith are all public education advocates. In 2003, then-CEO Ballmer famously admonished taxpayers "... to come to grips with the notion that we need to invest in higher education." Just not, it seems, corporate taxpayers.

The sophistication with which these men have manipulated the law and enforcement in Olympia has tremendously harmed our state and our schools, and undermined constructive dialogue over tax fairness. Ballmer and Amazon CEO Jeff Bezos both fought the progressive income tax in 2010. In 2012, Smith suggested raising the sales tax was the best approach to fund education. I think the bourgeoisie term for this kind of hypocrisy is cognitive dissonance.

Since as Smith told me in our interview, "The reality is that, in the scheme of things, the impact is not very significant either for the company or for the state," perhaps he and CEO Satya Nadella will send a check to Olympia for its unpaid licensing taxes.

But if not, the Court is wise to act early to begin directing the Legislature to properly fund education — even if it disappoints their usual constituents (Microsoft, Boeing and other big businesses across the state).

Since this is the same state government whose auditors scoured Yelp listings to collect taxes from dance clubs while ignoring billions in tax breaks to Microsoft and Boeing, it's likely the court will need to firmly guide the Legislature's hand to prevent them from making the most regressive tax system in the country any worse.

 

 

 

 

 

 

Jeff Reifman is a communications and technology consultant, freelance writer and activist. He blogs at JeffReifman.com or follow him @reifman on Twitter.


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Comments:

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:
http://c1.reifman.org/wp-content/uploads/2013/04/brad-smith-interview-clip.mp3

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.

kieth

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:
http://www.scribd.com/doc/28894321/Fact-Sheet-Microsoft-Nevada-Tax-Avoidance

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?

kieth

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.

afreeman

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.

pmocek

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.

Mr_Jones

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?
http://kplu.org/post/has-microsoft-s-tax-policy-hurt-washington-state-s-ability-pay-schools

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

SEIU protested at Microsoft Friday over tax dodging.
http://geekwire.com/2014/healthcare-workers-protest-microsoft-tax-loopholes-streets-seattle/
http://politics.slashdot.org/story/14/09/07/0234214/protesters-blockade-microsofts-seattle-headquarters-over-tax-breaks

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