Let's put a state income tax back on the table

And let's debate that canard that our lack of an income tax is a stimulus for business.
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Washington State Capitol

And let's debate that canard that our lack of an income tax is a stimulus for business.

These are tough times for those who search for hard evidence to support public policy, especially fiscal policy. As anyone who studies economic reports and looks for reliable numbers knows, the challenge is to separate fact from unsubstantiated opinion and, too often, outright fiction.

This has been a long-standing concern of those who follow the civic debate. A comment sometimes attributed to Daniel Patrick Moynihan, sums up the problem: “Everyone is entitled to their own opinions, but they are not entitled to their own facts.” President Obama invoked it when he met with congressional leaders in 2010 to go over the costs of health care reform.

But it isn’t necessary to engage in the national level policy debates to experience the problem. During the 2010 state Initiative 1098 campaign, a Seattle Times editorial made the strong assertion, that “I-1098 also takes away the most important tax-based advantage Washington has in attracting business and jobs.” This supplemented the slippery slope argument: The Legislature could and would extend the initiative’s income tax on high earners to everyone. The job loss claim was echoed in another Times editorial that cited reasons some in Seattle’s biotech opposed I-1098. It quoted the CEO of biotech Dendreon that “having no state income tax is an attractive (recruiting) tool for us.”

As an aside, there are other important factors in addition to tax burden, just one cost of doing business, that dictate a company’s success. Dendreon for example has hit a rough patch and has had to scale back its Seattle footprint. Its drug Provenge, approved for prostate cancer therapy, has had disappointing sales.

The Times again invoked the job loss argument when it recently endorsed Rob McKenna for governor, inferring that Jay Inslee is a closet taxer who might turn to an income tax to fund basic education. According to the Times editorial writers, “Some suggest a state income tax is the answer, but that would remove one of the state’s competitive advantages, and scare away investment in technology companies.” It’s unlikely that the Times newsroom, which fact-checks candidate statements, will do the same for its editorial board. So this shouldn’t be the end of discussion.

Although it’s plausible that some investors would be put off by a state income tax, to what extent? Would potential investors in Washington’s growing technology sector, whether in-state or out-of-state residents, look elsewhere for profitable opportunities? Would companies seeking to locate or expand here instead settle in other states to avoid a corporate income tax? Would highly skilled and compensated scientists choose to take jobs in other states to avoid paying a state personal income tax?

Regardless of how one views a state income tax, these are questions that deserve an answer — to the extent they can be answered with some assurance. The reason is that the income tax may again be on the table for discussion as we  — citizens, legislators, and the next governor, whether Inslee or McKenna  — confront the need to find several billion in biennial budget funds to meet the state Supreme Court’s K-12 education mandate. And, as some have suggested, to roll back college tuition increases.

There are also other important issues that should be included in any discussion of a revision of the state’s tax system. These are the principles of taxation  — stability, equity, economic vitality  — in addition to revenue adequacy. The Washington State Tax Structure Study Committee, chaired by William Gates, Sr., addressed these principles and several income tax options in its 2002 report. It also looked into other key elements such as the ease of reporting and costs to administer the tax.

Then there are side benefits to take into account such as federal tax deductibility, which for the sales tax has proven problematic politically.  And, just as the federal income tax allows credits for economic losses, so can a state income tax.

Even if more revenue isn’t the goal, an income tax can be an option in the context of tax system restructuring that is revenue neutral. A corporate income tax could replace the B & O tax dollar-for-dollar and eliminate numerous problematic business tax breaks that have been adopted to soften the impact of the B & O's tax on gross income.

But whatever the goal, it’s essential that the best facts be applied. That’s difficult to do in the heat of a political campaign, as was the case in 2010 when I-1098 was under consideration. Enter Arthur Laffer. In a Seattle Times op-ed Laffer, proponent of supply-side economics who popularized the Laffer tax-rate curve, threw a curve at I-1098. He suggested its passage would be “economic suicide” for Washington state. His argument was based on a comparison of the gross state product and personal income of states with and without an income tax. Washington, he said, would join the ranks of the slowest-growing states in economic returns if it voted in an income tax. Also in 2010, Laffer predicted an economic collapse in 2011 as a result of federal, state, and local tax increases.

Laffer, whose work is underwritten by the American Legislative Exchange Council (ALEC), a limited-government organization that seeks to influence state as well as federal legislation, continues to beat the drum for lower state taxes and no income taxes. His analyses often appear in the Wall Street Journal as well as in ALEC reports.

As one might expect, there is a contrary viewpoint. The Institute of Taxation and Economic Policy (ITEP), which describes itself as a non-profit, non-partisan research group with a focus on federal and state tax policy, has rebutted Laffer, calling his work “junk economics.”

The ITEP says that Laffer’s commits a fundamental mistake by ignoring state population growth that is unrelated to states’ tax structures. It suggests that “high rate” income tax states have experienced economies “at least as good, if not better, than states lacking a personal income tax.”

The ITEP finds that nine non-income tax states including Washington have performed worse than the average as measured by economic growth per capita.  And Washington along with five others has had higher than average unemployment rates.

Naturally, dueling economic and tax readings have contributed to widely divergent state policy prescriptions for dealing with the lagging economy. Some states are pursuing lower income tax rates, while others think it’s time to boost rates, especially on high earners, and thereby avoid budget cuts.

There is neither time nor space here to sort through the conflicting data and claims to arrive at a direction for our state as we deal with what will be a significant revenue shortfall in the next several budget cycles. A deliberate and fact-based conversation involving our elected leaders and the public is clearly needed.

However, one starting point might be to compare our experience with Oregon’s. Two states with very different tax structures but similar in many other respects. Oregon has both a personal income tax and a corporate income tax. Its highest bracket (over $250,000) for individual taxpayers is 11 percent. Oregon, along with Hawaii, has the highest rate of 43 states that tax personal income. Corporations pay 6.6 percent on earnings less than $250,000, and 7.6 percent at and above that amount.

High-income earners do not seem to have abandoned Oregon but they are somewhat less common there than in Washington. IRS data for 2010 indicates that Oregonians with annual incomes greater than $500,000 account for 0.37 percent of all Oregon federal tax returns compared with 0.53 percent in Washington.

Another indicator of economic health is business startup data. The Kauffman Foundation, which tracks entrepreneurial activity, found that Oregon’s startup index in 2011 was slightly higher than Washington’s, 0.25 percent to 0.23 percent. Oregon’s index has exceeded Washington’s since 1997.

There are other rankings, indices, and data sets that bear on the question of how tax structures and tax rates impact the economies of states. They should be explored.

Let the discussion begin.


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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.