Guest Editorial: Washington State Has a Morally Bankrupt Tax System, and Here's Why

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Rep. Reuven Carlyle (D-36) is the chair of the House Finance Committee in Olympia. He says we're on our way to being a "a low tax, low service state" with a "morally bankrupt" way of funding our government.

There is a public narrative that is so accepted it floats along unmolested by facts on the ground. It has become almost religious in its conviction and unquestioned among elected officials attuned to the public’s frequency: Washington is a high-tax state.

The evidence is overwhelmingly clear that this was the case... in 1995.

Today, we are on the march toward being a low tax, low service state. Of course the public feels as if Washington is a high-tax environment because we are irrationally nickeled-and-dimed in a fashion that doesn’t track with how people live their lives.

The real measure of whether a state’s revenue is too high, low, or just right is whether it meets the needs of its residents. The people, through their voices in government and votes, determine the answer to that statement.

On the revenue side of the ledger, however, it’s useful to unwrap the neatly crafted political rhetoric and look at the data. Not that the data can survive the campaign season’s flamboyance, but it is worth examining if for no other reason than esoteric truth let loose in the world.

The General Accountability Office (GAO) recently released a jolting bit of news, well presented in the Washington Post’s GovBeat, suggesting that tax revenues as a percentage of gross domestic product will not return to the historical high reached in 2007, just before the recession hit, until 2058. Few states show the dramatic change of the “systems issues” identified by the GAO more than Washington.

In 1995, Washington state ranked 11th in the nation in the combined level of all state and local taxes based on personal income, the most commonly used metric by economists to measure tax burden, according to the US Bureau of Economic Analysis, the US Census, and the state Department of Revenue. State and local taxes include state property, sales, vehicle, liquor, and other excise taxes as well as taxes imposed by cities, counties, and special purpose districts and every other category combined.

In 2011, the most recent year that data is available and released in 2014, Washington ranked 35th in the nation in the combined level of all state and local taxes, according to the bureau.

As House finance chair, I am in no way arguing that any one ranking is perfect—neither 11 nor 35—but rather want to make the policy and political case that our 19th-century tax structure is so economically inefficient and unfair that it does not map to our modern economy. The goal is not to be an outlier state at the high or low ends—this is one area where average is a smart target—but rather to be more intelligent by designing a modern system that grows and breathes with the taxpayer’s reality and our economy’s structure.

I maintain my personal philosophical conviction that the best state tax structure is low rates, broadly and fairly applied to everyone with few special breaks. We have the diametric opposite with high rates, narrowly and unfairly applied with hundreds of special tax breaks. It’s unfair to those without lobbyists and campaign cash. Washington’s reliance on a high sales tax, state property tax, and gross-receipts business tax is, without qualification, unique in the nation and not in a handsome way.

How did Washington migrate from 11th in the nation to 35th in less than 20 years?

While many anti-tax crusaders argue that government spending is wildly out of control—and there is much legitimate criticism of how tax dollars are spent—the real issue behind the rhetoric is that four structural factors united in the past two decades to erode the state’s main tax base.

FIRST, the sales tax has been carved out by the economy itself. This means, simply, that in today’s service-based economy about 66 percent of what consumers in Washington purchase is not touched by the sales tax, while only about 33 percent is directly taxed. In 1950, those numbers were reversed, and around 1970 it was 50 percent to 50 percent (services to goods). And there is the small problem of online shopping, where many sales tax bills are avoided.

SECOND, the people as the final arbiters of democracy have limited property tax growth to 1 percent by initiative. Property taxes—initially designed to fund public education—are tactically off the table as a source of revenue growth without genuine structural reform, and each year they continue to be a smaller and smaller portion of overall state taxes as larger economic growth occurs in other areas.

THIRD, the legislature has essentially carved out and shifted the state’s main business tax—the gross receipts-based business and occupation tax (B&O)—by creating hundreds of tax breaks for influential corporations, organizations, industries, and economic sectors. In 2013, the state collected a total of $3.0954 billion in B&O taxes. Of this amount, the aerospace sector paid a total aggregate amount of B&O taxes of $71.8 million after all of the credits. The technology sector paid a total aggregate of $28.2 million in state B&O taxes after credits. The entire agriculture, timber, and mining sectors in Washington—combined—paid $14.6 million in state B&O taxes after credits, according to the state Department of Revenue.

To be clear: These sectors and industries—and the companies they comprise—also pay various sales, excise, property, unemployment insurance, worker’s compensation, and other taxes and fees, so calculating their true effective tax rate requires integrating all of the data. Still, the B&O remains our state’s primary business tax, and for many of the most profitable global companies the combined state effective tax rate is generally in the very low single digits or even negative range.

To put the corporate taxes in perspective on the spending side, five of the major industries listed—aerospace, information technology, agriculture, timber, and mining—in the state paid a total of $114.6 million in state B&O taxes while the base budget from taxpayers to fund the University of Washington alone is $270.9 million. The state general fund budget is $16.9 billion a year or $33.8 billion on a biennial basis.

When a tax break (i.e., tax preference, tax exemption, or tax incentive) is adopted by the legislature for a given company or industry, it is essentially a “tax shift” more than an actual reduction, and in most cases the real losers are small businesses—the vast majority of our state’s 345,961 total registered businesses that earn $250,000 per year or less in revenues that don’t receive the preferential treatment.

The cost of granting the tax breaks also disappears into the political mist. In the decade of the 1990s, for example, the legislature created 103 new tax preferences of the combined 655 total we see today. The total fiscal impact today in lost revenues is $1.5 billion from those preferences alone. Nowhere does that cost show up on the books. We have created a system where tax breaks are “off-budget” until and unless they are set to expire, and only during the political process of renewing the tax break does the “opportunity cost” of how those dollars are spent surface in the budget process.

FOURTH, the legislature has directed increasing state tax dollars to local governments during this period using a variety of tax instruments that have the net effect of shifting dollars to the local level. Also, nearly 1,800 special purpose taxing districts, such as fire, library, cemetery, flood control, hospital, and transit districts, have been created at the local level, so local governments in aggregate now account for a larger portion of revenue growth than the state general fund. This is the policy equivalent of a tax preference for local governments when those dollars would previously have been dedicated to the state’s general fund budget. In many cases, city and county governments are acting as agents of the state, so the transfer of taxing authority is naturally commensurate to the new service obligations. Irrespective of the degree of merit, however, it has taken a major toll on general state revenues.

In all four of these categories there are frequently rational policy reasons for the actions taken. This is art, not science, and there is no one mystical answer. The challenge arises with the convergence of the four long-term, structural problems, causing us to face a perfect storm of nearly 20 years of tax erosion of the state’s main budget.

The result? A court order to increase funding for public education; a court order to increase funding for mental health services; disastrous cuts to foster youth and children’s services; the doubling of tuition for college students; poorly paid teachers; insufficient investments in Puget Sound cleanup; and so much more.

All of these dense policy issues fail to capture the human impact of our morally bankrupt tax system. By any standard, our tax system has become the most unfair to middle-class and low-income citizens in the nation. According to the Institute of Taxation and Economic Policy, the lowest 20 percent of income earners in Washington—making an average income of $11,500 per year—pay 16.9 percent of their income in state and local taxes. The national average for this group is 11.1 percent. The top end—the proverbial 1 percent, earning average income of $1.1 million per year—pay 2.8 percent of their income in combined taxes in Washington, dramatically less than the 5.6 percent national average.

We can no longer continue down the same path of tinkering with a broken, unfair, and economically inefficient tax system that is divorced from our economy and fails to serve our communities. The 20-year trend shows absolutely no signs of relenting. In a handful of years we are likely to be 40th in the nation in the combined level of state and local taxes based on personal income. And a few years beyond that we can expect to reach 45th. Is that our vision for ourselves? Are we so caustically anti-tax that we would close the doors of our colleges to our own children? Would we close foster homes for our most vulnerable? Would we allow traffic to suffocate our industrial economy and our quality of life?

In an era of divided government, let’s put labels aside and design a modern tax structure that drives us into the future. When it comes to taxes, let’s move toward the national average by building a healthy system that grows with our real economy, not our tainted politics.

It’s time for a tax reset of our antiquated, outlier system so that it becomes responsive to our community needs and built for a 21st-century economy. That’s not a veiled euphemism for an income tax or a shallow retreat into old rhetorical battles. It’s a call for courageous honesty both to raise sufficient revenues and to demand rigorous, authentic, and fierce accountability for how those hard-earned tax dollars are invested.

We are an educated, entrepreneurial, innovative state. We are also coasting on fumes from a time when our tax system mapped more intelligently and capably to our role in the global community.

We are so much more than what we’ve become.