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Committee to StudyCommittee to StudyWashington State’s Tax StructureWashington State’s Tax Structure
(ESSB 6153, Section 138)(ESSB 6153, Section 138)
““... to determine how well the current tax system ... to determine how well the current tax system functions and how it might be changed to functions and how it might be changed to better serve the citizens of the state in the better serve the citizens of the state in the 21st Century.”21st Century.”
Due November 30, 2002Due November 30, 2002
Governor appointment• William Gates, Sr.
Caucus appointments• Sen. Lisa Brown• Gary Strannigan• Rep. Jim McIntire• Rep. Jack Cairnes
Committee AppointmentsCommittee Appointments
;;
Academic appointments • John Beck
Gonzaga University School of Business Administration
• Neil BruceUniversity of Washington Economics Department
• Dick ConwayConsultant, Governor’s Council of Economic Advisors
• Lily KahngSeattle University School of Law
• Debra SandersWashington State University School of Accounting
• Hugh SpitzerAttorney, University of Washington
Lower income households pay a higher percentage of their income in state and local taxes than do higher income households.
Problems with our current tax structureProblems with our current tax structure
RegressivityRegressivity
0%
2%
4%
6%
8%
10%
12%
14%
16%
Up to$20,000
$30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $100,000 $130,000 over$130,000
Household Income
Total Excise and Property
Property Tax
Excise Tax
Pe
rce
nt o
f In
com
e P
aid
in T
ax
Source: Washington Excise and Property Tax Microsimulation Model
State and local taxes are more burdensome because the retail sales tax paid by households is not deductible from federal income taxes.
ExportabilityExportability
Problems with our current tax structureProblems with our current tax structure
It is politically difficult to build and maintain adequate reserve funds during good economic times.
Initiatives have impacted long run adequacy.
AdequacyAdequacy
Initiatives and state-imposed reductions in tax bases have impacted local adequacy.
Problems with our current tax structureProblems with our current tax structure
19711971 19731973 19751975 19771977 19791979 19811981 19831983 19851985 19871987 19891989 19911991 19931993 19951995 19971997 19991999 20012001100100
300300
500500
700700
900900
11001100
13001300
Percent of Percent of 1971 value1971 value
RevenuesRevenues(excluding tax base and rate (excluding tax base and rate
changes)changes)
The Economy The Economy (Personal Income)(Personal Income)
Problems with our current tax structure - AdequacyProblems with our current tax structure - Adequacy
Source: Office of Financial Management
Excluding tax base and rate changes, over the past 30 years Excluding tax base and rate changes, over the past 30 years General Fund revenues have grown more slowly than the General Fund revenues have grown more slowly than the economy (personal income).economy (personal income).
VolatilityVolatilityWashington’s mix of taxes causes revenues to increase more than personal income during good economic times and less than personal income in economic downturns.
Problems with our current tax structureProblems with our current tax structure
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
Gro
wth
Ra
tes
Personal Income Retail Sales Tax
Sales Tax is more volatile than the Sales Tax is more volatile than the economy (personal income). economy (personal income).
Inflation and other trends have been eliminated. Growth rates are due only to volatility .Inflation and other trends have been eliminated. Growth rates are due only to volatility .
The increasing share of services in consumer spending, along with increased opportunities for making purchases out of state, result in taxable retail sales growing more slowly than the economy as a whole over the long run.
Individuals can avoid sales tax by shopping in bordering states with lower sales tax rates or by making remote purchases.
Erosion of the Tax BaseErosion of the Tax Base
Problems with our current tax structureProblems with our current tax structure
Some Washington firms are able to avoid the B&O tax by shifting their income generating activities (such as manufacturing) to other states.
B&O tax pyramiding (at least 2:1) results in non-neutralities between different industries and between vertically integrated and non-integrated firms
B&O taxes are not neutralB&O taxes are not neutral
Problems with our current tax structureProblems with our current tax structure
To the extent that business taxes are passed on to consumers, business taxes are not transparent.
Business taxes are “hidden”Business taxes are “hidden”
Problems with our current tax structureProblems with our current tax structure
Menu of Major AlternativesMenu of Major Alternatives
Flat Personal and Corporate Income Tax
RegressivityRegressivity
Problems AddressedProblems Addressed
Business Value Added Tax (VAT) NeutralityNeutrality
Goods and Services Tax (GST)NeutralityNeutrality,
TransparencyTransparency, ErosionErosion
“Progressive” VAT (low-income relief)Neutrality,Neutrality, TransparencyTransparency
RegressivityRegressivity
Flat Rate Personal Income Tax
Graduated Personal Income Tax RegressivityRegressivity
RegressivityRegressivity
Representative PackagesRepresentative Packages
Value Added Tax AlternativesValue Added Tax Alternatives
Goods &Services Tax
Existing Taxes ReducedExisting Taxes Reducedor Replacedor Replaced
Revenue NeutralRevenue NeutralVAT Tax RateVAT Tax Rate
#1 BusinessVAT
Replace B&O tax 2.2%
#2 Replace sales/use andB&O taxes
9.0%
#3 Progressive VAT
Reduce sales/use taxfrom 6.5% to 3.5%Replace B&O tax
3.9%
#1 Subtraction Method VAT at 2.2% #1 Subtraction Method VAT at 2.2% Replaces B&OReplaces B&O
NO CHANGE IN REGRESSIVITYNO CHANGE IN REGRESSIVITY
0%
5%
10%
15%
20%
Household Income
Per
cent
of
Inco
me
paid
in
Tax
Up to
$20,000
$40,000 $60,000 $80,000 $130,000 Over$130,000
$100,000 $70,000 $50,000 $30,000
Current Law
Replace B&O
Initial Tax Burden on HouseholdsInitial Tax Burden on HouseholdsMajor State and Local TaxesMajor State and Local Taxes
Source: Washington Excise and Property Tax Microsimulation Model
#2 Goods and Services Tax#2 Goods and Services Tax
0%
5%
10%
15%
20%
Up to
$20,000
$40,000 $60,000 $80,000 $130,000
Household Income
Per
cen
t of
Inc
ome
paid
in T
ax
Current Tax System
Replace RST and B&O
Over$130,000
$100,000 $70,000 $50,000 $30,000
Initial Tax Burden on HouseholdsInitial Tax Burden on HouseholdsMajor State and Local TaxesMajor State and Local Taxes
#3 “Progressive” VAT#3 “Progressive” VAT
Replace B&O & Reduce RST
Up to
0%
5%
10%
15%
20%
Household Income
Per
cent
of I
ncom
e pa
id in
Tax
Current Law
$20,000
$40,000 $60,000 $80,000 $130,000 Over$130,000
$100,000 $70,000 $50,000 $30,000
Initial Tax Burden on HouseholdsInitial Tax Burden on HouseholdsMajor State and Local TaxesMajor State and Local Taxes
Percent Reliance on Major State and Local TaxesPercent Reliance on Major State and Local Taxes#2 Goods and Services Tax#2 Goods and Services Tax
25%
49%
49%
11%
13%
13%
29%
30%
30%
27%
0% 20% 40% 60% 80% 100%
U.S. Average
Alternative TaxSystem
Current TaxSystem
General Sales Taxes Selective Sales Taxes Property Income
Percent Reliance on Major State and Local TaxesPercent Reliance on Major State and Local Taxes#3 “Progressive” VAT#3 “Progressive” VAT
25%
43%
49%
11%
13%
13%
29%
30%
30%
27%
6%
0% 20% 40% 60% 80% 100%
U.S. Average
Alternative TaxSystem
Current TaxSystem
General Sales Taxes Selective Sales Taxes
Property Income
#4 Flat Rate Personal Income Taxes#4 Flat Rate Personal Income Taxes
Existing Taxes Reduced or ReplacedExisting Taxes Reduced or ReplacedRevenue NeutralRevenue NeutralIncome Tax RateIncome Tax Rate
A Reduce state sales/use tax from6.5% to 3.5%
2.6%
B Reduce state/use sale tax to 3.5%and replace state property tax
3.8%
C Replace state sales/use tax 5.5%
D Replace state sales/use tax andstate property tax
6.7%
#5 Graduated Personal Income Taxes#5 Graduated Personal Income Taxes
Revenue Neutral Rates for Joint ReturnsRevenue Neutral Rates for Joint ReturnsExisting Taxes Reduced or
Replaced$0 to
49,900$49,900 to
120,650$120,650and over
A Reduce state sales/use taxfrom 6.5% to 3.5%
1.0% 2.7% 4.5%
B Reduce state sales/use taxfrom 6.5% to 3.5% andreplace state property tax
2.2% 3.5% 6.0%
C Eliminate state sales/use tax 2.7% 5.7% 8.7%
Note: The income break points for single filers are $0 to 24,950, up to $60,325 and over $60,325.
#4 Flat Rate Personal Income Taxes#4 Flat Rate Personal Income Taxes
0%
2%
4%
6%
8%
10%
12%
14%
16%
Up to$20,000
$30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $100,000 $130,000 Over$130,000
Household Income
Per
cen
t of
Inc
ome
paid
in T
ax
Current Tax System
Sales Tax at 3.5% and Replace Property Tax
Replace Sales Tax
Replace Sales and Property Taxes
Initial Tax Burden on HouseholdsInitial Tax Burden on HouseholdsMajor State and Local TaxesMajor State and Local Taxes
0%
2%
4%
6%
8%
10%
12%
14%
16%
Up to$20,000
$30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $100,000 $130,000 Over$130,000
Household Income
Tax
Pa
id a
s a
Per
cen
t of
Inc
ome
Current Law Tax System
Sales Tax at 3.5%
Sales Tax Replaced by Personal Income Tax
Sales and Property Tax Replaced by Personal Income Tax
#5 Graduated Rate Personal Income Taxes#5 Graduated Rate Personal Income Taxes
Initial Tax Burden on HouseholdsInitial Tax Burden on HouseholdsMajor State and Local TaxesMajor State and Local Taxes
21%
Percent Reliance on Major State and Local TaxesPercent Reliance on Major State and Local Taxes#4 and #5 Flat and Graduated Income Taxes#4 and #5 Flat and Graduated Income Taxes
General Sales Taxes Selective Sales Taxes Property Income Taxes
14%
34%
25%
54%
39%
11%
20% 40% 60% 80% 100%
27%
39%
53%
12%
14%
14%
32%
33%
33%
30%
14%
0%
OREGON
Replace Sales and Prop Tax
U.S. AVERAGE
Sales Tax at 3.5%
WA TAX SYSTEM
21%
100%
150%
200%
250%
300%
350%
400%
450%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Gro
wth
Per
cen
t
Flat Rate Personal Income Tax at 5.5%
Sales Tax (Constant Base & Rate)
Personal Income (Economy)
Long Term AdequacyLong Term AdequacyPersonal Income Tax v. Sales TaxPersonal Income Tax v. Sales Tax
Improvements to the Current SystemImprovements to the Current System
Continue to impose an estate tax.Continue to impose an estate tax.
• Tax in the amounts of the state credit allowed under Tax in the amounts of the state credit allowed under prior federal law.prior federal law.
• Adequacy - Prevents an increase in regressivity by Adequacy - Prevents an increase in regressivity by
maintaining an existing tax on high-income maintaining an existing tax on high-income
households.households.
• No change. Current yield estimated at:No change. Current yield estimated at:
FY 2005FY 2005 $114.8 million $114.8 million
Extend the sales tax to consumer services.Extend the sales tax to consumer services.
Adds beauty shops, amusement, recreation and cable Adds beauty shops, amusement, recreation and cable TV to definition of retail sale.TV to definition of retail sale.
Adequacy - extends the base to a growing area of Adequacy - extends the base to a growing area of consumption not subject to tax.consumption not subject to tax.
• Equity - resolves inequities in our tax system, e.g., Equity - resolves inequities in our tax system, e.g., video rentals are taxed and movie tickets are not.video rentals are taxed and movie tickets are not.
• Estimated revenue gain:Estimated revenue gain:
CY 2005 CY 2005 $229.6 million$229.6 million
Join other states in enacting streamlined sales Join other states in enacting streamlined sales tax legislation.tax legislation.
• Multistate effort to create simpler, more uniform system for Multistate effort to create simpler, more uniform system for collection of sales tax.collection of sales tax.
• Erosion of the base, equity - leads to collection of retail Erosion of the base, equity - leads to collection of retail sales tax on remote sales.sales tax on remote sales.
• Neutrality - consumers could no longer avoid tax by Neutrality - consumers could no longer avoid tax by shopping on the Internet.shopping on the Internet.
• Economic vitality - would improve the competitive position Economic vitality - would improve the competitive position of WA retailers.of WA retailers.
• Simplicity - uniformity would make sales tax simpler for Simplicity - uniformity would make sales tax simpler for multi-state retailers.multi-state retailers.
Extend the watercraft tax to motor homes and Extend the watercraft tax to motor homes and travel trailers.travel trailers.
• Consider raising existing rate from 0.5% rate to 1%.Consider raising existing rate from 0.5% rate to 1%.
• Equity - motor homes and travel trailers can be Equity - motor homes and travel trailers can be substitutes for vacation homes which are taxed.substitutes for vacation homes which are taxed.
• Regressivity - upper income households spend more Regressivity - upper income households spend more on motors homes/travel trailers as a percent of on motors homes/travel trailers as a percent of income.income.
• Estimated revenue gain:Estimated revenue gain:
1% Rate = $47.5 million in CY 20051% Rate = $47.5 million in CY 2005
Create a constitutionally mandated “rainy day” Create a constitutionally mandated “rainy day” fund.fund.
• Enact a constitutional amendment mandating a Enact a constitutional amendment mandating a “rainy day” fund.“rainy day” fund.
• Volatility - sets aside revenues in years when Volatility - sets aside revenues in years when they exceed income growth.they exceed income growth.
• Adequacy - would help prevent permanent Adequacy - would help prevent permanent decreases in the tax base during good economic decreases in the tax base during good economic years.years.
Exempt construction labor from sales tax.Exempt construction labor from sales tax.
• Only a few states impose a sales tax on labor portion Only a few states impose a sales tax on labor portion of construction.of construction.
• Exempt labor portion of construction contract. Exempt labor portion of construction contract.
• Problems addressed: Problems addressed:
Economic VitalityEconomic Vitality VolatilityVolatility
Tax HarmonyTax Harmony RegressivityRegressivity
SimplicitySimplicity HomeownershipHomeownership
• Estimated revenue loss:Estimated revenue loss:
CY 2005CY 2005 $400 million$400 million
Increase the B&O small business credit from Increase the B&O small business credit from $35 to $70 a month.$35 to $70 a month.
• Increase the small business credit to $70/month.Increase the small business credit to $70/month.
• Raise the reporting threshold from $28,000 to $56,000 Raise the reporting threshold from $28,000 to $56,000 in gross.in gross.
• Economic vitality - new and expanding firms have Economic vitality - new and expanding firms have high tax burdens. This improvement would assist high tax burdens. This improvement would assist new and expanding businesses that start out small.new and expanding businesses that start out small.
• Estimated revenue loss:Estimated revenue loss:
CY 2005CY 2005 $28 million$28 million
Other improvements to current systemOther improvements to current system
Problem AddressedProblem Addressed
Neutrality, economic Neutrality, economic vitalityvitality
Avoid or reduce dedicated taxes (except user fees) SimplicitySimplicity
Periodically review tax incentives to determine if they’ve outlived their purpose.
Simplify local B&O tax
Adequacy, economic Adequacy, economic vitalityvitality