Tax breaks: Olympia's reformers need a coherent strategy

The legislative session is reaching the halfway point, but those who want to reduce business tax breaks have yet to make substantial progress. A couple of bills expanding tax breaks are moving forward, however.

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The legislative session is reaching the halfway point, but those who want to reduce business tax breaks have yet to make substantial progress. A couple of bills expanding tax breaks are moving forward, however.

As the Legislature heads into the last half of its regular session, efforts to curb overly generous and ineffective tax breaks appear to be going poorly. Proponents of reform are taking widely disparate approaches.

Some reformers want to couple tax-break elimination with shoring up budgets for essential programs. Others, perhaps motivated by recent voter disapproval of taxes, seem inclined to take a longer-term approach to fixing the problem.

In the meantime, expanded breaks are moving forward. One proposal (SB 5539), would double the B&O tax credit for contributions to a fund intended to attract film makers to Washington, at a biennial cost to the state of $10 million. Another bill (SB 5735), would remove the 2015 sunset date for the B&O credit for R&D expenditures by high-tech firms, with a cost estimated at $65 million. Neither of these breaks have received close scrutiny for need and cost-effectiveness.

In an earlier Crosscut article, I described the Legislature’s current process for reviewing tax “preferences,” which involves the Joint Legislative Audit and Review Committee. JLARC reviewed the film program last year and recommended it be continued based primarily on competitiveness considerations — British Columbia and Oregon have somewhat more generous programs.  However, the committee stopped short of suggesting a higher level of support, which the current bill seeks.

JLARC, however, didn’t look at economic studies that conclude state programs to attract film makers are ineffective. The Center on Budget and Policy Priorities (Link 2), after reviewing 43 state programs, puts it in blunt terms: “State film subsidies are a wasteful, ineffective, and unfair instrument of economic development.”

The R&D credit, established in 2005, is scheduled for JLARC review next year. A close look would find that the lion’s share of the credit flows to a relatively small number of firms distinguished by having large amounts of cash reserves — billions in many cases — available for investment. Public disclosure data indicates that just 42 of 484 firms receiving the credit in 2009 garnered a total of $17 million, or about two-thirds of the total payout.

One tax break that JLARC reviewed and recommended be terminated may be on its way to elimination. Currently motor vehicle fuel distributors can take a deduction for fuel spilled in transfer operations. Ending the deduction from the motor vehicle fuel tax would recapture $5.5 million for the state in 2011-13.

The tax break issue has received little exposure in the print media, while excellent in-depth reports, especially in The Seattle Times, have looked at the impact of budget cuts in higher education, K-12 education, and social services that comprise the state’s safety net.

The governor and legislative leaders have not publicly addressed tax breaks at length. So this reading of the current status of reform efforts has to be gleaned from recent comments made by the governor and legislators during taped presentations.

KCTS 9's Enrique Cerna interviewed Gov. Chris Gregoire on the state’s budget problems. In response to a citizen's question about professional services as a source of revenue, the governor explained how the shift from a manufacturing to a services-based economy has impacted the tax base. She volunteered to Cerna, “I think we need to have that debate.”

"That debate" would presumably entail a close look at the exclusion of personal and professional services from the retail sales tax base. The Department of Revenue estimates that “taxpayer savings” — to the purchasers of legal, financial and other services — from this break alone reduced state revenue by $4.2 billion and local government revenue by another $1.3 billion in the current biennium. This significant exclusion explains in part why Washington state ranks 30th in total state and local tax collections per $1,000 personal income.

Austin Jenkins at TVW has done the best job so far in probing the politics of tax breaks, having interviewed two legislators, one Democrat and one Republican, and two think-tank representatives on opposite sides of the debate. (Link 4)

The Republican spokespersons expressed no concern for program cuts that could be funded if tax breaks were eliminated. Their mantra: We’ll support elimination of a break if it’s used to lower the general tax rate dollar-for-dollar, but not to fill the budget gaps.

TVW also recorded remarks of labor lobbyists and several legislators at the Washington State Labor Council’s annual legislative conference. State Sen. Jeanne Kohl-Welles, D-Seattle, described a bill, SB 5857, she introduced that takes a longer range approach to the “systemic problem.”  The bill incorporates several ideas to improve “transparency and accountability,” including proposals by Rep. Reuven Carlyle, another Seattle Democrat.

The Kohl-Welles bill would sunset about 275 sales tax exemptions and B&O tax exemptions, credits, deductions, and preferential tax rates. It would incorporate state “tax expenditures” into the state budget process. It would modify JLARC’s review process by allowing the committee to group tax preferences by type of industry, economic sector, or policy area. And it would permit review of all but a handful that are constitutionally required.

The breaks run the gamut from large to small. One of the largest is the sales tax exemption for machinery and equipment used in manufacturing available to an estimated 25,000 manufacturing firms. If eliminated it would produce “taxpayer savings” of about $600 million per biennium.

Sunsetting is phased over four biennia from FY 2013 to FY2019. And sunsetting, of course, is not the same as elimination. The legislature could, after review, continue or modify a break.

The bill also requires the governor to be directly involved in the review process as a part of the biennial budget process. Based on a tax expenditure report developed by the Department of Revenue, the governor must make recommendations as to whether expenditures set to expire in any coming biennium should be allowed to terminate, continue, or continue with modification. And it encourages the governor to submit recommendations to the legislature with respect to the repeal or modification of other tax expenditures.

The Kohl-Welles bill contrasts sharply with one introduced by Rep. Eileen Cody, D-Seattle, which targets four specific tax breaks for the purpose of generating dollars immediately to bolster the state’s basic health program. The breaks benefit mortgage lenders, private airplane owners, cosmetic surgery, and coal burned at the Centralia power plant. Since Cody’s bill, HB 1847, goes into effect on April 1 of this year, it would produce a $8.2 million revenue gain in the current biennium. And it would generate $121 million in the next biennium.

Another bill introduced by Rep. Larry Seaquist, D-Gig Harbor, would establish a multi-biennium process for identifying tax breaks for modification and elimination to support “strategic” investments in education.

Although there has been negligible public discussion of these proposals (no hearings have been scheduled), Kohl-Welles mentioned to the Labor Council that talks are going on behind the scene; that “progressive” senators are meeting weekly. Whether these discussions include progressive Republicans is unknown. None of the three bills have Republican co-sponsors.

So here’s the perspective of one observer who believes that long-term systemic reform is crucial, but the most important immediate concern is short-term revenue.

Long-term reform should include changing the factors that JLARC must take into account in its reviews. Interstate competition needs to be revisited, a means test should be applied generally to business-tax incentives, and independent economic analyses should be considered when deciding how the state can best spur economic development.

Regarding the short term, Republicans appear to believe they are in the catbird seat following passage of Tim Eyman’s Initiative 1053, which requires a two-thirds majority to raise a tax or eliminate a tax break. Some Democrats appear wary of challenging that assumption and want to take a longer-range approach to reform. Other Democrats, particularly House members, want to challenge specific breaks in an effort to reduce the impact on essential programs.

Both reformers and opponents of reform need to take into account some realities. There’s nothing on the record to suggest that voters who supported I-1053 did so because they wanted the elimination of tax breaks to require the same super-majority that new taxes need. And one post-election poll indicated that a large plurality of voters believe that legislators should close loopholes before cutting spending.

So it’s possible that, if a two-thirds vote of both houses is not attainable, voters might respond positively to a referendum that targets the least defensible tax breaks and dedicates the revenues to essential state services. For example, how would voters respond to a reform proposal that applies a means test to high-tech businesses that are flush with cash and who can obviously fund investments in R&D without the help of the state, and thereby funds education or health care?

This might be something for legislators on both sides of the issue to consider before time runs out.


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About the Authors & Contributors

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Dick Nelson

Dick Nelson is a former Washington State legislator. He currently contributes to the public debate on state and local fiscal issues through research and commentary. As when he was in the legislature, he prefers the Democratic Party.