Why Washington doesn’t tax the food you buy at the grocery store.

Food for thought—Ever wonder why you do not have to pay taxes on most food you buy at the grocery store? Most food purchased for your family to eat is not taxed. This exemption comes from a 1977 initiative to the people which passed with a vote of 54%. The thought behind a tax exemption on unprepared food, like the majority of food you find at the grocery store, is that it eases the financial burden for families. It is an attempt to make Washington’s tax structure less regressive and make it easier for families to buy food for meals. The only time the tax exemption on food was lifted since 1977 was for a little over a year in 1982.

While the intent is to lessen the burden on grocery costs for families, food taxes make up a large portion of the tax base for states. By offering food tax exemptions, states take in less money, suffer large losses, and are less stable during any fluctuating economic cycles.

Washington, along with 27 other states, offers tax exemptions on groceries. Washington’s exemption does not cover every item you could potential buy at the grocery store, a general rule to follow is that it applies to unprepared foods. The exemption does not include carbonated beverages, dietary supplements, and food that is prepared by vendors (think delis, pizza, subs sandwiches etc.).
During the 2010 Legislative Session, state lawmakers passed 2ESSB 6143, sponsored by Senator Prentice who represents the 11^th District which includes parts of Renton and Tukwila. 2ESSB 6143 included multiple tax modifications, a few of which related to food and beverages. As a part of the bill, candy and gum would now be charged the state’s sales tax rate. Carbonated beverages would be temporarily taxed an additional 2 cents for every 12 ounces. This temporary tax would be in place for three years—starting in June of 2010 and going until July of 2013. A condition of this bill allowed the first $10 million in sales of carbonated beverages to be exempt from the tax. Currently, soda is charged the state’s sales tax rate.

On May 19, 2010, an initiative was filed with the Secretary of State’s Office that would repeal the candy, gum, and soda tax that became law with 2ESSB 6143. Initiative 1107 became one of the most funded initiatives in Washington State history.

According to the Public Disclosure Commission, Stop the Food & Beverage Tax Hike, the group supporting the initiative, raised and spent $16,042,628.67. This money was put towards television commercials, flyers, radio ads, etc. to urge citizens to vote for the initiative and repeal the candy, gum, and soda taxes. Out of the over $16 million that was raised, over $15 million of it was donated from the American Beverage Association. The group against the initiative, Citizens to Protect our Economic Future, raised and spent $426,828.81 which went into urging citizens to vote down the initiative. Initiative 1107 was adopted on November 2, 2010, and took effect on December 2, 2010.
Something to keep in mind is that food stamps are not charged sales tax in any state.

Have you ever thought about how your grocery shopping would change if you were charged taxes on certain items?

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How much of your gas prices are going to Washington State in taxes?

As gas prices continue to climb, Washington’s commuters may be surprised to find out how much of each gallon they drive goes back into maintaining the roads and highways they use every day. Fuel tax information is not broken down on any type of payment receipt when you fill up your tank. Let’s take a look at how the taxes are distributed for each gallon of gas in Washington State.

The gas tax that is collected is split amongst counties, cities, and state accounts. About half of the fuel tax goes to support the Washington State Department of Transportation’s ferry system and highway programs. Any highway repairs or construction projects come from this money.



Source: WSDOT



The other half of the state fuel tax is given to cities and counties within the state. This money is put towards maintenance and construction of roadways that are not highways in the state. Either way, the fuel tax money collected from the state gets distributed directly back into Washington’s roadways.

During the second half of 2011, Washington state ranked 7^th in the nation (and the District of Columbia) for amount of state and federal fuel tax charged per gallon of gas. Washington’s current tax rate is 37.6¢/gallon. While this is higher than the national average of 27.6¢, some states like New York and Illinois charge upwards of 50¢/gallon in fuel tax. Alaska charges the least in state fuel tax at just 8¢/gallon.





Source: Citizen's Guide to the Senate Transportation Budget

 

 

All states are charged a federal fuel tax in addition to their individual state’s fuel tax. The federal rate is set at 18.4¢, which has not increased since 1993. When you add the federal fuel tax to the state’s fuel tax, Washingtonians pay 56¢ on every gallon of fuel.

The fuel tax is a regressive tax since all income levels pay the exact same in taxes. Poorer families that still have to commute to work, often traveling long distances, have to pay the same amount in taxes as the most well-off commuters who have more flexibility to move closer to their workplace. As a percentage, the less economically stable you are, the more of your income is paid in taxes when you fill up the tank. For the middle and higher classes, a smaller percentage of their overall income is paid in fuel taxes.

While prices at the pump fluctuate based on crude oil prices per barrel, the state and federal taxes you pay do not account for the bump.

The Revenue act of 1935

The Revenue Act of 1935 is the origin of our contemporary tax code.  Passed by the legislature and signed into law by then Governor Clarence Daniel Martin, the act introduced dramatic tax reform.  With concerns about the stability of the previous revenue system, proponents of reform looked to develop a tax code that was in pace with the changing economy. The legislature at that time, had to wrestle with a dramatic economic downturn, a highly engaged citizenry, and a number of difficult state supreme court decisions. 

Governor Clarence Daniel Martin

Prior to the Revenue Act of 1935, Washington funded its core functions through property tax collections. Being that Washington was a predominately agricultural state, this provided the most reliable and consistent form of revenue.  However, this was proving inadequate, inequitable, and economically unsound as manufacturing increased and agriculture declined.

The notion of dysfunction in the state’s tax code carried far and wide and had largely populous support.  The reform discussion sprung from the successful passage of People’s Initiative 69 on November 8, 1932.  This initiative brought in sweeping revenue reform in Washington State, including a graduated income tax.  However, the initiative was challenged in court resulting in the removal of the income tax section.  As the economic situation continued to worsen, the legislature capitalized on the populous sentiment and put forth many of Initiative 69’s reforms in the legislative process.

The 1935 legislature introduced HB 237 with 17 titles and nearly 200 sections!  Within those titles were provisions for a B&O tax, a cigarette tax, a radio tax (that was vetoed at signing), a highly controversial sales tax, and much more.  In addition, the 1935 legislature introduced a second bill that instituted a graduated income tax with a 3% tax on all income over $4,000 and up to a 4% surtax on additional amounts. Reform proved to be difficult, creating more obvious divides between urban and rural communities. This divide played out in the legislature and discussions were difficult and controversial.

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The income tax portion of the sweeping reform went on to be struck down by the Washington State Supreme Court because of its lack of uniformity (it wasn’t a flat tax), but other reform components still remain today. Only through intense and informed discussion was the Revenue Act of 1935 passed by the legislature.  Despite the difficulty of the discussion, the legislature and the people of Washington State pressed forward towards the changes that had to take place.

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What is the B&O tax?

Chances are you’ve heard of the Business and Occupation (B&O) tax if you own a small business or do taxes for a business in the state of Washington. The B&O tax is a gross receipts tax, which means the State collects taxes on the total amount of money a business earns from products sold or services provided. This means companies can’t subtract expenses like labor, materials, taxes, or other costs from the amount that the taxes are collected from.  The Department of Revenue (DOR) says that the B&O tax is measured on the value of products, gross proceeds of sale, or gross income of the business.  This tax is pretty complex and my goal over the next few posts is to provide you basic information regarding this tax, its origins, and where to find resources that can give more detailed answers to B&O questions. I’ll also briefly talk about opinions of the tax and alternatives that legislators and other groups are discussing.

So, basic information: Aside from the definition above, it’s important to know that with this tax not all businesses are taxed at the same rate. For example, the tax rate for retailers is 0.471 % while real estate brokers are charged a rate of 1.5 %.  DOR has a list that covers tax classifications for common business activities including everything from accounting to yard maintenance. When doing your business taxes, it’s important to know which group you belong to or know if your company fits under multiple groups so you’re paying the right rate. Also, I won’t go into detail about these but you should know that there are quite a few exemptions and other parts for this tax and businesses in Washington. When looking at the chapter of Washington State law that covers the B&O tax, there are 75 exemption sections, 34 deduction sections, and 20 credit sections of the tax that the legislature applied to specific parts of Washington State’s economy.

What does this all add up to for state government? During the biennial budget for 2009 to 2011, the B&O tax brought in $5.6 billion for the state’s general fund. This equals 19.9 % and was the second largest contributor behind the sales tax that collected $13.1 billion. The B&O tax provides an important revenue source and is used to fund agencies and services that state government provides. Also, the B&O tax is somewhat unique when compared to taxes collected by other states. Ten years ago, the legislature authorized a study of tax alternatives for Washington State that was chaired by Bill Gates, Sr. (also known as the Gates Commission). In the Commission’s final report, they talk about what other states use:

The truly unique element of Washington's tax system is the B&O tax: a gross receipts tax levied on businesses. Forty-five states impose a traditional corporate net income tax, similar to the federal tax. Of the other states, Michigan levies a form of value added tax, Nevada relies on taxes on the gaming and entertainment industry, South Dakota utilizes special taxes on contractors and banks, and Wyoming receives significant revenues from severance taxes (e.g. taxes on oil and minerals).

Next week we’ll talk about why Washington went against the grain compared to other states when taxing businesses and look at a few perspectives on the B&O tax.

Quick recap on the history of the B&O tax and why Washington hates it so much

When people think about the 1930’s they usually reference the Great Depression, FDR’s New Deal, or the build up to and beginning of World War II.  While it might not be ranked as high in terms of historical significance, this time period was pretty turbulent when looking at Washington State tax policy. In other entries, you’ve read information about the sales tax and our State’s numerous attempts to create an income tax.  Along with these, another outcome of this era was the creation of Washington’s B&O tax, which was supposed to help offset the failure of income tax proposals and help the State, which needed to find a revenue source that the State Supreme Court wouldn’t overturn.

Asahel Curtis, Courtesy UW Special Collections (Neg. CUR1641)

The current reliance on capped property taxes was becoming more inefficient as people moved to the cities. To fix this, the State passed the Revenue Act of 1935, which included the B&O tax. This law completely changed how State government collected money from Washington citizens and according to DOR, in Fiscal Year 2008, Revenue Act taxes generated more than three-quarters of all state tax receipts supporting the State general fund.
Over the next several decades, the Legislature authorized seven studies to analyze Washington’s taxes and recommend adjustments if necessary.  Most of these recommended reducing the B&O tax rates, however, these proposals weren’t enacted by the Legislature or were shot down by the voters. The lone exception was in 1993 when the State increased the tax rate for certain businesses to 2.5 percent but this was later repealed.
Fast-forward to present day and reactions to the B&O tax usually reference its complexity and desired change for reforming the current system. In 2010, the Seattle Times published a piece about the issues with the tax and quoted Governor Gregoire as saying "If you want to come forward with an alternative to the B&O tax system in the state of Washington, the welcome mat is out from me." This sentiment is pretty common across the political spectrum. For example, the conservative organization, the Freedom Foundation, said “The B&O tax is harming our state. Washington has a proud history of ranking near the top of the nation in terms of new business startups. And yet, unfortunately, it also has a history of being on the wrong side of the national average for business failures. Undoubtedly this is due, at least in part, to the state’s onerous Business & Occupation (B&O) tax.”

Arguably, the largest issue with the B&O tax is what folks call the pyramiding of the tax as a product moves through the production process. For example, with wooden furniture, there are several steps in its production that involve multiple businesses that pay taxes. You have people who cut the wood, others who mills the lumber, companies that produce the furniture, and in some cases a fourth that sells it. Each company pays a tax at each step. This doesn’t negatively impact companies that control all aspects of production but it hampers many others.
While all sides agree that the current system for B&O taxes is flawed, there are a wide variety of answers on what the best options are to replacing the status quo would be. Next time I’ll discuss some of these options, their impacts, and which groups are advocating for them. Stay tuned…

Alternative proposals to the B&O tax, Part I

So what are some alternatives to the B&O tax in Washington? I’ll discuss some of the alternatives that came out of the latest study on Washington taxes, the Gates Commission report.  Their major recommendations included two around the idea of a Value Added Tax (or VAT) and a goods and services tax. A quick example of VAT is to use the wooden furniture scenario from last week. Instead of taxing the entire item at its different stages in production, VAT would only tax the ‘value added’ at each step, which would reduce the amount of taxable business revenue.

The first option that the report looked at was called a ‘subtraction method business VAT.’  This alternative included completely eliminating the B&O tax and replacing it with a 2.2 percent subtraction method business VAT. The main benefit of this included the removal of any pyramiding. However, some of the downfalls are that it would have been harder to administer than the B&O tax and would probably be easier for businesses to evade the tax. Also, Michigan use to have a VAT in place but ended up phasing it out in 2009.  In 2002, The News Tribune asked business organizations in Michigan to comment on the Gates proposal. Some comments included: "The tax that they want to replace had better be one bad tax," and "The Single Business Tax (Michigan's name for its value-added business tax) taxes all the wrong things." Also the complexity of the Single Business Tax was one of the reasons for its demise, said Tricia Kinley, director of tax policy and economic development for the Michigan Chamber of Commerce. The Commission ended up endorsing this over the other VAT model, the progressive VAT.

For the progressive VAT, the Commission’s alternative was to institute a 3.9 percent tax, reduce the sales tax to 3.5 percent, and eliminate the B&O tax. A progressive VAT is similar to an income tax, since employed citizens would pay a tax on their wages (the study described employees as value-adding entities in their own right), companies would also pay the same rate as employees. The benefits are the same in terms of pyramiding and leveling the playing filed, however, this idea hasn’t been tried in the United States. Combined with appearing as an income tax, it’s likely that gaining traction for implementing this would be a tough battle.

The last proposal discussed by the Commission was a goods and services tax (or GST), which they didn’t end up endorsing.  For this option, there would be a 9 percent GST and no sales or B&O tax. The tax base would be equal to sales at every stage of production, including wholesale and retail transactions, with a credit for taxes paid on intermediate goods and services purchased by registered taxpayers. The biggest benefit of this choice would be the streamlining of Washington’s tax system. However, there is no example of this being done by a sub-national government and considering how connected we are to other states, there would most likely be problems implementing this and dealing with cross-border and online transactions.

Even though this report was widely discussed upon its release, it did not lead to any tax policy changes in the Legislature or the ballot box. As you’ve read in numerous entries on this site, changing our tax code has been a slow process that usually ends up in dead ends for ideas like the three listed above. Next time, we’ll look at some recent proposals that have been discussed in the Legislature regarding the B&O tax and also mention how the cities use this tax.

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