Why Washington’s tax system is the worst

By Josh Kelety

Originally published in the December 2014 issue.

Marilyn Watkins has been a Policy Director at the Economic Opportunity Institute for 15 years, and she knows a ton about topics such as Washington State tax policy and gender pay equity issues. The Central Circuit called her up to get a run-down of Washington State’s highly regressive tax structure.

So where does our tax money go? What services are we all paying for?

The [state] general fund budget is what we are really talking about here … half of that goes to the K-12 public education system, roughly 10% goes to pay for the whole system of higher education including the community and technical colleges as well as the four year universities. There’s some social and human services, children services, health services for seniors, services for disabled people … and then of course there is the whole justice system, prisons [courts, etc.]. That’s not a huge part of the budget … we’re getting down to more like 5% … so those are some of the big buckets of things that our general fund supports.

How do we pay for all of that?

About half of that money is raised through the sales tax … we pay a sales tax (on items besides food) and 6.5% goes to the state, and the other, about 3%, goes to city and county governments to fund local services like the police and fire and public transit. But … about two thirds of the sales tax, goes to the State. So that’s the biggest source of money that goes to pay for all the education and human services and other kind of stuff that the state does.

That’s half. The next biggest chunk of the state budget comes from the business & occupation tax (B&O). Washington’s business tax is a little different from most other states in that instead of taxing corporate profits we tax gross receipts. So it’s kind of almost like a sales tax, but it’s at a very low rate … it’s [around]1.5% that a business will pay on its total revenue without being able to deduct stuff.

And then about 12% of the State budget comes from property taxes … most of that money actually stays and funds local services. But a small percentage of the property tax also goes to the state … there are the sin taxes … cigarettes, alcohol, now marijuana … there is lottery proceeds … but all of them add up to the rest of the budget.

So what makes our tax system so backwards?

The reason our system is so regressive compared to other states is that most other states have a income tax … other states have all of those same taxes that we have plus they also do a personal income tax … it’s graduated … the higher your income, the higher percentage you pay … in most states people are paying 3% or 4% or 5% or 6%, or if you’re a millionaire in California you’re paying more like 10% of your income to the state … they [other states] can then have much less reliance on sales tax and that business tax – which businesses of course have to pass on to their customers.

Sales tax ends up being really regressive … if you’re low income or even middle income … every paycheck, most of it goes out to buy the stuff you need. But if you’re really wealthy … you’re not spending anywhere near all your income … it goes into savings and other kinds of investments … when you [a wealthy person] do spend it, often times what you’re purchasing is not goods, but services, and services don’t typically have a sales tax on them … you buy your own cleaning supplies and clean your own apartment or house if you’re a low or moderate income person. But if you’re a high income person you can hire someone to come and clean for you. So high income people don’t have to pay [tax], even if they are spending a lot of their money … low and moderate income people are paying … a much higher percentage of their overall income into supporting state and local services than are the highest income people.

What kinds of income would be subject to an income tax?

There are various kinds of income … earned income [is] where you go out and get a job and you get your wages. But for very wealthy people, a big part of their income comes from investments … in our federal tax code and in most state income tax codes, capital gains are taxed along with wage and salary income … Washington lacks that basic income tax, we’re not taxing either wage or salary income … or capital gains … one of the proposals that is out there … would be to add a tax on capital gains … it’s not going to be a tax on what you have in your savings account at the local bank … it really would be the top 4 or 5% of [wealthy] people that would be subject to that kind of a tax.

For example Bill Gates and his wife no longer earn salaries at Microsoft but they have lots of income coming in every year from their 86 billion dollars of investments … that money makes money. That’s what their source of income is.

What about Corporate income tax? Is that different from our current B&O tax?

Basically it’s [a tax] on profits … [it] would be on what the company makes after it pays its employees and after it has bought the stuff it needs to buy in order to sell or make whatever it is selling or making. The B&O tax in contrast doesn’t allow for those kinds of deductions in most cases. So it doesn’t allow you to deduct what you pay for your employees, or what you pay for the goods that you buy to resell or to manufacture, your cost for property and vans, and computers, you don’t deduct any of that … for smaller companies especially, it’s another expense that they have to include and pass on to their customers.

Unfortunately … the larger, more influential companies have been able to find ways to get special tax preferences passed through the State legislature. I think everyone has heard about the Boeing tax breaks that have passed … but other corporations like the Microsoft corporation have found ways to basically legally avoid paying taxes in the state of Washington … but your locally owned little restaurant or locally owned little business, they don’t have the resources to either get their own special tax break passed through the state legislature or to find ways to avoid paying Washington State taxes. So they’re paying a little more than their fair share as well.

What’s the history of our mess of a tax system?

We’ve had this same basic structure since the middle of the 1930’s … it was a tax structure that worked pretty well for that early 20th century economy when a urban middle class was just emerging and you had more and more consumption taking place … our economy has changed a lot since the 1930’s … people are spending an ever smaller percentage of their income on stuff that is subject to sales tax. We’re spending more on services [healthcare, education].

And … for the last 30 years, we have seen this growth of income inequality. So people at the top end of the income spectrum are getting richer and richer and richer … that means that incomes have been really squeezed in the middle and the bottom … the fact that the highest income people don’t spend all their income means more and more of our state economy is not being taxed in a very efficient way. We’re just not taxing the people and the businesses that have the most money. We’re asking the people and the businesses with lesser income to shoulder the bulk of the responsibility for paying for public schools and universities and whatnot.

There was actually a tax structure study commission that was set up by the State legislature to look at our state tax structure … and they determined that our system was too regressive … and that it had this structural deficit: that our sales tax [revenue] is a shrinking part of our overall [state] economy, [and] as our economy is growing and changing  sales tax is a capturing less and less of that economic growth. That results in a structural deficit where we have more people coming in, demands for more and better educational services … our revenue structure just naturally doesn’t produce enough.

Why has sales tax revenue declined?

Over the last 40 and 50 years, people have been spending more of their income on services and less on goods … the kinds of services people are spending more of their income now, includes healthcare services and educational services … we don’t all buy and make our own stuff anymore … but the other big part of it is … is income inequality, [which] in of itself is reducing revenues coming into state government because rich people don’t spend all their money. The more income that is going to people at the top end who aren’t spending their money on stuff that is subject to sales tax, you’re just getting less of money that is out there … if the only way you are capturing it is through sales tax.

States that have … an income tax, they’ve seen their state revenues since the great recession go back up again. They’ve been able to hire more school teachers and not ask students at community colleges and universities to continue to pay 10% more in tuition every year like we’ve been doing here … in Washington, over the last 20 years … the percentage of our state economy that comes in as revenue, has gone down.

Why hasn’t the system been changed?

We had an initiative in the early 1930’s that would’ve passed a progressive income tax here in Washington State … but the supreme court that year ruled that that [income tax] was unconstitutional.. Since then there have been several attempts to do a constitutional amendment to allow an income tax to go into effect. And basically the people of Washington State since then have always turned it down, have always voted against it. [They] have said “Well, no, we may not love the system we have, but we’re familiar with it and we’re just going to keep it”. So that has made the Legislators very wary of trying to change the system in any major way.

What will happen in the near future if we don’t fix our tax structure?

If nothing changes in our tax structure than the future holds ever rising college tuition. It [the future] holds ever larger class sizes in our K-12 system … continuing disparities and unevenness in providing public services … continued cuts in the level of public services and asking public servants to do more … have bigger caseloads, have more foster children under their care, more assistance to low income disabled folks, and just a really continued downward spiral.

What can students do to fight for a fair, no-nonsense tax code?

One of the big thing students can do is talk about their own experience and talk about the challenges of paying tuition and paying their other bills … that’s important for our state legislators to continually hear … [to] get involved in the process and to vote is one of the key things … we have a much lower rate of voting among younger people than we do among older people. And that’s especially true in this last election … it’s important to actually turn out and vote and try to remember the ways it does directly impact your own life.

It’s important for students to actually be talking to legislators themselves … so figuring out … who’s representing you in Olympia … sending them emails, calling up their offices, weighing in on why it’s really important to continue to support public education and particularly higher education. It’s important for legislators to hear that and know that somebody is not going to be criticizing them for trying to raise revenue but is going to be supporting them because they support the services that that revenue is going to be paying for.

A final tidbit from Marilyn

Our economy is not just like the weather … It’s something that we actually make the rules that control how the economy works and how the benefits of the economy and how benefits of economic growth are distributed.

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2 thoughts on “Why Washington’s tax system is the worst

  1. Reblogged this on Casey Jaywork and commented:
    Josh Kelety has an illuminating interview with Marilyn Watkins of EOI on Washington state’s regressive tax system.

    Here’s some food for thought: The WA supreme court found a progressive income tax to be unconstitutional in 1933’s Culliton v. Chase because taxing higher incomes at a higher rate would violate Article VII, Sect. 1’s uniformity clause: “All taxes shall be uniform upon the same class of property.” Seems reasonable. But if it’s unconstitutional for the state legislature to create a progressive income tax that applies to everyone, then how can it be constitutional for the legislature to create line-item tax breaks to individual businesses? If the state supreme court wants a rigid interpretation of ‘uniformity,’ then it seems like *any* individualized tax breaks must violate the constitution.

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