New, Higher Tax Proposals Floating Around Olympia

By Joe Wallin

In 2010, Washington voters resoundingly rejected adopting an income tax (I-1098) on individuals earning more than $200,000 per year, or couples earning more than $400,000. However, the issue is once again potentially alive.

Tucked deep in Governor Gregoire’s revenue proposals, titled Revenue Alternatives For Building A Better Future, is the idea of repealing the B&O tax (business and occupation tax) exemption on wages earned in excess of $250,000, and collecting tax at the “services and other” rate of 1.8%. You can find the text of the proposal here, but the graphic below shows the full text.

Also potentially on the table is a 5% excise tax on net capital gains on Washington residents. My partner Dick Giseburt says these taxes would arguably be unconstitutional income taxes under the Washington state constitution.

The Status Quo

If you are not familiar with Washington’s tax system, as it stands, the state doesn’t have an “income tax” as that term is traditionally understood. Instead, Washington State has a gross receipts tax, at several different flat rates depending on the business, with generally very limited exemptions, deductions or credits. This gross receipts tax applies to businesses and certain occupations.

For example ~ if you are in the business of providing independent contractor services outside the construction industry, you pay the B&O tax on your gross receipts from those services at the current “services and other” rate of 1.8%. Thus, it is not entirely true to say that Washington does not have an income tax. It has something very similar to an income tax that applies to persons in business. And it is easy to forget that this tax would apply to employee wages but for a carveout from wages specifically set forth in the statute in RCW 82.04.360.

That statute provides:

(1) This chapter [the B&O tax] does not apply to any person in respect to his or her employment in the capacity of an employee or servant as distinguished from that of an independent contractor. For the purposes of this section, the definition of employee includes those persons that are defined in section 3121(d)(3)(B) of the federal internal revenue code of 1986, as amended through January 1, 1991.

Theoretically, ignoring the potential constitutional defects, all the legislature would have to do is repeal RCW 82.04.360 to impose our “B&O” tax on all employees in this state.

For years, many directors serving on boards “forgot” that they owed the B&O tax on non-employee director fees. But the legislature reminded them in the 2010 legislative sessions about their obligations by passing specific amendments to RCW 82.04.360 that resolved any doubt about this issue.

Exercising the Excise

It will be interesting to see how the legislature responds to these two ideas, if at all, given the defeat Initiative 1098 took at the polls not too long ago. One of the arguments last year made against Initiative 1098 was that the tax would not have been deductible for federal income tax purposes because “excise” taxes are not deductible for federal income tax purposes. This argument would seemingly apply with even more force to the Governor’s new proposal–because her proposal is clearly an excise tax.

How would imposing the gross receipts tax on wages in excess of $250,000 affect startups? Arguably, very little, in the sense that most employees in most startups don’t receive wages greater than $250,000. But perhaps the income and the proposed capital gains tax would affect Washington startups by crimping the supply of capital available to invest in startups. Imposing an income tax might also cause companies that are considering relocating here not to. Of course, all of these arguments make great debate material, especially because it is so hard to find hard empirical data on the impact of taxes like these on things like startup formation and job creation.

The great thing about the Seattle community is that we have public debates about these matters. Last year, we hosted a forum about I-1098 where Bill Gates Sr., Nick Hanauer, Matt McIlwain and Lew McMurran vigorously debated the pros and cons of an income tax in Washington, from the effects on revenue to the effects on business and job creation.

Nick Hanauer is still concerned about this issue and just penned a great editorial in Bloomberg where he says:

“I can say with confidence that rich people don’t create jobs, nor do businesses, large or small. What does lead to more employment is the feedback loop between customers and businesses. And only consumers can set in motion a virtuous cycle that allows companies to survive and thrive and business owners to hire. An ordinary middle-class consumer is far more of a job creator than I ever have been or ever will be.”

Two Cents Worth of Sense

It will be interesting to see how these potential tax proposals play out in Olympia and throughout the state. I am sure if these proposals advance, we will have many great debates about them.

Read more on B&O and excise taxes:

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