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Inslee proposes new taxes to meet state needs

Jay Inslee Credit: John Stang

Gov. Jay Inslee has put proposals for a capital gains tax, a cigarette tax increase and an electronic-cigarette tax on the table as ways to raise money to pay for growing state spending obligations.

Inslee unveiled his $39 billion 2015-2017 budget proposal Thursday that goes full tilt on funding court-ordered improvements in student-teacher ratios in Grades K-3, but delays action on improving the same ratios in Grades 4-12. Voters recently required hiring more staff for the later grades by passing Initiative 1351.

This is the first time that Inslee has proposed significant new taxes instead of trying to get by with closing tax breaks. One of his campaign promises in 2012 was that he would not raise taxes.

The overall budget request essentially showcases Inslee's ideas on how 2015-2017 spending should be tackled, with the House Democrats and Senate Republicans unveiling their budget proposals in late March. Those proposals will be the ones that will actually go head-to-head in the Legislature. The governor's and Democratic legislators' budget proposals are frequently quite similar, although they differ in details.

"This budget is obviously the start of a conversation and not the finish of one, and I'm open to all ideas," Inslee said.

Inslee's plan calls for three new taxes to raise $854 million in 2015-2017, closing five tax breaks to raise another $282 million, plus extending eight existing tax breaks, which would subtract $94 million from the state's expected revenue. That translates to $1.042 billion in new revenue for 2015-2017.

The new money does not include predicted annual revenue from Inslee's proposed cap-and-trade program, which would be expected to raise $1 billion from Washington's biggest polluters beginning in the 2016-2017 fiscal year. Of that proposed cap-and-trade income, $380 million would to go to education, which is the part of the general fund that is supposed to receive the capital gains and other new tax revenues. That extra $380 million would increase Inslee's proposed new revenues going to the general fund in 2015-2017 to $1.422 billion.

The other cap-and-trade revenue would go to transportation, tax rebates to poor families and some businesses handicapped with foreign competitors not facing pollution restrictions.

The major planks of Inslee's new revenue proposals include installing a 7 percent tax on capital gains income of more than $25,000 a year for individuals or for more than $50,000 a year for joint tax return filers starting in 2016-17. This is expected to raise $798 million in the upcoming budget biennium. Inslee said that tax would affect only the richest 1 percent of Washington's residents. Capital gains from retirement accounts and the sale of homes and farms would be exempted.

Inslee said Washington's economic top 1 percent pays an average of 2.8 percent of their incomes on state and local taxes, while those in the middle 40 percent pay averages ranging 8.7 percent to 10.4 percent of their incomes in state and local taxes. People in Washington's bottom 20 percent of households pay an average of 16.9 percent of their income on state and local taxes. "Washington's tax system is the most unfair in the nation to working people," Inslee said. Washington is one of nine states without a capital gains tax.

Jason Mercier, an analyst for the free market-oriented Washington Policy Center, said that capital gains incomes tend to be irregular, making such a tax unpredictable on how much it would raise each year. Inslee contended having a capital gains tax is less risky budget-wise than having no such tax.

Inslee would also like to increase the tax on a pack of cigarettes by 50 cents. Washington's current cigarette tax rate is $3.025 a pack. This move would raise $38 million in 2015-2017. Inslee also wants to tax electronic cigarettes, contending that would raise another $18 million in the upcoming biennium. The Washington D.C.-based American Vaping Association issued a press release, saying: "Gov. Inslee's message to smokers is clear: please, don't quit. The government needs your money."

In addition, the governor wants to close five tax breaks. These include an exemption on the sales tax for vehicle trade-ins of more than $10,000, which would raise another $105 million in the upcoming biennium. Inslee also wants to remove a recycled hog fuel exemption originally intended for sawmills that was later assumed by oil refineries, which translates to $51 million in the upcoming biennium. The other exemptions proposed for closure address sales taxes for non-residents (worth $52 million), bottled water ($44 million), and a business-and-occupation tax break on royalties ($30 million).

The governor also proposes reducing expenses or revamping state programs to trim $400 million in likely 2015-2017 costs.

In response to questions about his no-new-taxes campaign promise, Inslee said he tried to avoid proposing tax increases, but argued that the Legislature has not adequately dealt with budget shortfalls such as those imposed by the 2012 Washington Supreme Court ruling that ordered a dramatic reduction in student-teacher ratios in Grade K-3. So far, the Legislature has underfunded the improvements mandated under the so-called McCleary ruling to the point that the Supreme Court has threatened sanctions if the Legislature does not come up with an adequate plan in the 2015 session to finish that work by the 2018-2019 fiscal year.

The initial Republican reactions to Inslee's proposed budget were critical.

"Any conversation about our state’s budget and the upcoming session needs to include the reminder that we are expecting nearly $3 billion more in new revenues for the next budget cycle — an 8 percent increase!" said Rep. Bruce Chandler, a moderate Republican from Granger and ranking Republican on the House Appropriations Committee. "I know folks in my district would love to see an 8 percent increase in their family budgets, but they haven’t. They may not see that kind of increase for the next two years. If Washington can’t balance the books with an 8 percent increase in revenues, folks back home should be very be concerned."

Sen. Andy Hill, R-Redmond and chairman of the Senate Way & Means Committee, said: "Investing in student achievement and providing essential services should not depend on risky tax schemes that threaten our economy. … Tax increases should be the last resort, not the first response."

So far, House Democratic leaders are cautiously receptive to Inslee's approach. House Appropriations Committee chairman Rep. Ross Hunter, D-Medina, said: “I want to review the Governor’s budget in more detail before getting into specifics, but in general I’m encouraged that he recognizes the need for more revenue to respond to our education funding requirements. With Initiative 1351 we’re facing a $4.4 billion budget deficit in the next biennium, much of that is related to educating our children. We can either step up now and solve the problem or push it off, which only increases the size of the long-term structural deficit." 

“Washington's tax structure is a Ford Pinto in a Tesla world. It's economically inefficient for business and painfully unfair to the middle class," said Rep. Reuven Carlyle, D-Seattle and chairman of the House Finance Committee.

Inslee's $39 billion 2015-2017 operating budget is dramatically greater than the 2013-2015 budget that is expected to end up in the $33.8 billion to $34.1 billion range. 

Among other challenges, the state budget will need an extra $583 million to cover pay raises negotiated for state employees, most of whom have not seen increases for years. The Senate Majority Coalition Caucus of 25 Republicans and one Democrat is leery about the broad-based pay increases, issuing figures that suggest state workers are not as underpaid as Inslee has indicated.

Inslee's package puts most of the costs of I-1351 on the back burner until the 2017-2019 budget biennium. Although state figures show that $2.24 billion would be needed to improve student-teacher ratios in Grade K-12 in 2015-2017, Inslee proposes allocating roughly $300 million for I-1351-related hiring only to increase staffing for Grades K-3, leaving almost $2 billion of the I-1351 staffing requirements for later grades unfunded. The $300 million will speed up the McCleary mandates for more teachers in Grades K-3, Inslee said.

Washington Education Association President Kim Mead praised Inslee for tackling the McCleary work, but added that delaying the Grades 4-12 hiring until 2017-2019 violates state law as imposed by the voters. The Legislature can suspend I-1351 for 2015-2017 with a two-thirds vote in both the House and Senate. A two-thirds passage in both chambers is an extremely difficult feat.

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