This is the first in a 3-part series on tax reform in Olympia.
If success in the legislative process is measured by the number of bills filed, and by interest group support — including marches and demonstrations at the state capitol — the 62nd state legislature that adjourned in April should have made substantial progress in rolling back costly and ineffective tax breaks. But some legislative issues prove very intractable in spite of well-intended proposals by lawmakers and the energy of citizens.
Neither tax breaks nor the process that produces and evaluates them, was substantially reformed this year and the lack of success suggests the need for a new approach. An approach that should involve a close look at how billions in public funds are used to spur economic development and job growth.
By the end of the second special session on April 11, only one tax break of any significance had been modified, while several others had been extended or resurrected. And only a small start was made to improve the factors used to measure the efficacy of tax breaks that benefit businesses.
Senate Bill 6635 sponsored by Senator Ed Murray (D-Seattle) passed on the last session day, the only one of about 40 bills that addressed reform in various ways. It ended the B & O tax deduction allowed for out-of-state banks on interest earned on first mortgages while continuing it on in-state banks. The modification is expected to generate $15 million in FY2013 and $32 million in the next two years.
Moving in the opposite direction, the same bill extended to July 1, 2015 the sunset date for B & O tax exemptions received by processors of fruit, vegetables, dairy and seafood. After that date they'll get a preferential B & O tax rate of 0.138 percent — less than one-third of the 0.484 percent manufacturing rate. The cost to the state of that adjustment: $15 million between 2013 and 2015.
The bill also extended the time for data centers to qualify for the sales and use tax exemption on server equipment and power infrastructure. A cluster of data centers have been constructed at Quincy in Grant County to take advantage of cheap electrical power rates offered by Grant County PUD, which operates two Columbia River dams. State taxpayers will be out $7 million for that one between 2013 and 2015.
Earlier, in the regular session, SB 5539 sponsored by Senator Jeanne Kohl-Welles (D-Seattle) resurrected the B & O tax credit for motion picture production. The credit, which is available to firms that support the state’s film industry, had been allowed to sunset on July 1 of last year. The bill extends the credit until 2017, caps it at $3.5 million annually, and requires data to allow the state to better measure the effectiveness of the program.
These are not large tax breaks. Collectively the net impact on state revenues over the next two years will be only about $4 million on the positive side. And the legislature did show restraint by controlling the urge to spur the economy through additional tax incentives. Several bills were introduced but not enacted.
But also left on the cutting room floor – more precisely, in the House and Senate Ways & Means Committees — were numerous bills that would have curtailed a range of current breaks and captured a more significant sum of revenue. These included breaks for private airplanes, elective cosmetic surgery, sales to non-residents, intangible property, high-tech research and development, fuel spilled in handling and agricultural producers. Some would have funded social safety net programs currently being cut.
Proponents of reform encountered a hostile environment even when the purpose was seemingly meritorious. House Bill 2532 sponsored by Representative Rueven Carlyle (D- Seattle) to limit and redirect the B & O tax credit for high-tech R & D spending provides an example. It would have allowed companies to continue to receive the credit if they contribute to the Opportunity Expansion Program designed to increase the number of baccalaureate degrees in high demand employment areas including STEM (science, technology, engineering, and math).
Although HB 2532 was supported by UW President Michael Young and UW students, it was opposed by the Association of Washington Business and the biotech and interactive media industries. The AWB suggested that the measure was really a tax bill and would require a super majority to pass. Microsoft broke ranks and spoke for it. After hearing testimony, the committee took no action on the bill.
The B & O credit, which is capped at $2 million per recipient per year, has been on the books since 1995 and costs the state about $30 million annually. It was adopted with another high-tech break that allows a sales tax exemption for buildings and equipment used in several categories of R & D. The two breaks together will reduce general fund revenues by an estimated $114 million between 2013-15.
From 1995 to 2012, Microsoft built 98 separate R & D centers in Redmond and at other sites in the Seattle area. It received the sales tax exemption for these facilities at an estimated total cost to the state of $296 million. When the B & O credit is added, state taxpayers paid Microsoft about $20 million per year over that period.
Neither of the R & D breaks requires a showing of financial need, so even wealthy and well-established corporations such as Microsoft qualify. Microsoft, in 2011 had reserve funds totaling $53 billion available for investment, so it’s a safe bet that it would have made R & D investments without these breaks.
The Department of Revenue’s several reviews of the R & D breaks have failed to find that they are effective economic development tools.
Most recently the Joint Legislative Audit and Review Committee (JLARC) commissioned an econometric review of the B & O credit by independent consultants. The reviewers, from the Upjohn Institute, reached no definitive conclusion as to whether the credit should be continued. But they did indicate that its costs likely exceed benefits to a substantial degree based on their earlier study of a Michigan credit program:
Bills to improve the tax break review and accountability process mostly fared no better than those directed at curtailing specific breaks. They included:
- A requirement that a tax expenditure report be produced every two years as part of the Governor's budget. It would include recommendations on tax breaks set to terminate in biennium.
- A requirement that an expiration date and statement of legislative intent accompany every new tax preference.
- A requirement that there be a showing of a net benefit to the state in order to claim a tax break.
Still there were a few baby steps. One bill that did pass, SB 5044, provides more flexibility in conducting reviews by permitting consideration of factors other than the tax break's date of enactment.
Tax preferences can now be grouped by type of industry, economic sector, or policy area, when reviews are scheduled. The Citizen Commission for Performance Measurement of Tax Preferences used this new authority in their 10-year review schedule by grouping health industry preferences for action in 2013.
here are currently 640 tax breaks on the books that have been enacted since 1854 when the state was still a federal territory. The Citizen Commission and JLARC are scheduled to review 569 of these over the next 10 years, including more than 100 that fall into the "business incentive" category. The evaluation process they use needs to be improved so that all breaks, but especially those designed to enhance the state's business climate, are cost-effective.
Tune in next week for part 2 of the series, where we'll look at the ways existing business tax breaks are evaluated.