Capital gains tax alternative proposed

We’ve talked about how regressive Washington’s tax structure is and how people in higher income brackets contribute a smaller percentage of their money to funding public services.  One solution to this discrepancy was proposed by Representative Laurie Jenkins during the 2012 Legislative Session that would have helped to correct this imbalance. 

On February 29, 2012, Representative Jenkins, and 26 other Democrats, introduced House Bill 2563 - Establishing a state tax on capital gains – which would have applied a 5% tax on capital gains over $10,000 per year. For those of you who don’t know, capital gain is the profit from investing in capital assets (like stocks, bonds, or real estate), which exceeds the purchase price.  So if you buy a stock for $100, then sell it later for $150, you have a capital gain of $50.  It’s important to note that one of the exemptions for this tax removed any collection of capital gains from the sales of homes.  Also, the collection of this tax would mirror the federal model, which would make it easier for citizens during tax season.

It was projected that, if implemented, this bill would bring in over $1.4 billion during the 2013-15 fiscal biennium.  Also, 42 other states have a similar tax on capital gains, 31 of which are higher than the proposed 5% for Washington.  Representative Jenkins said,  “We should join 42 other states in making sure everyone pays their fair share for public schools and universities, prisons and parks. Capital gains is a big step toward tax reform and fairness.”  Lastly, according to the Washington State Budget and Policy Center, 96% of capital gains go to those with an annual income over $1 million.

This bill seems like a good way to even the tax burden in Washington. So, what happened? Two things killed the capital gains proposal. The first was time.  When this bill got it’s first hearing with the House Ways and Means Committee, it was day 52 of a 60-day legislative session and the cutoff for fiscal committee bills was two days earlier. This meant that Jenkins’ bill needed to be included in a proposed budget to survive, but this didn’t happen. The second thing that would have killed this proposal is Initiative 1053 and the supermajority requirement on the Legislature for any revenue increase.

It’s unfortunate that this bill fizzled in the legislature and with any luck it will progress further when lawmakers return to Olympia next year.  This was a good example of addressing our regressive structure without trying to implement an income tax.  It’s also a popular revenue source for a majority of states and the federal government.  If this concept is to survive the legislature or the initiative process, people will need to be more aware of the discrepancy in tax contributions for people with low and high levels of income. People who are better off enjoy capital gains without paying taxes at the state level. Others who are less fortunate shouldn’t have to give up a higher portion of their money to fund government.

Taxes and the Internet

Other posts about economic nexus and the use tax talked about how the Internet changed the way we interact and buy or sell goods and services. Electronic commerce is an emerging issue for states and local jurisdictions who deal with taxation of digital and out of state products. One of the main reasons governments haven’t had more dialogue on this issue is because of federal law.

The Internet Tax Freedom Act (IFTA) (Public Law105-277, Section 1100) was passed by Congress and signed by President Clinton in 1998. The purpose of the ITFA was to give the Internet some time to develop and to protect users from multiple and discriminatory taxation due to its decentralized architecture. The ITFA imposed a moratorium on state and local taxes for Internet access and banned multiple or discriminatory taxes on electronic commerce.  The law also created the Advisory Commission on Electronic Commerce, which analyzed Internet taxation and provided recommendations on dealing with this issue.

Two of these ideas included establishing “bright line” nexus standards for American businesses and placing the burden on states to simplify their own complicated telecommunications tax systems as well as sales and use tax systems to ease burdens on interstate commerce.  To address the issue of tax simplification, the National Governors’ Association and the National Conference of State Legislatures created the Streamlined Sales and Use Tax Agreement, which established a common set of definitions and tax laws regarding electronic commerce for government and businesses.  Currently, there are 24 states that have passed laws conforming to the agreement. Washington joined in July 2008 with the passage of Senate Bill 5089 - Conforming Washington's tax structure to the streamlined sales and use tax agreement.

Scott Peterson, Executive Director of the Streamlined Sales Tax Governing Board (Board), said that the consortium is recruiting mores states and seeking bill sponsors in Congress to create a national system for online sales tax collection and remittances. Remittance means sending the taxes collected to the jurisdiction of the buyer.  Businesses also like the agreement and 1,400 online retailers have volunteered to collect state sales tax. In return, Washington promises not to sue them for back taxes they might have owed.

While the Agreement is a step in the right direction, in order for there to be significant change the answer will need to come from the other Washington.  According to the Board, some studies estimate that states lose billions a year in uncollected sales tax and it could reach as much as $23 billion by this year.  Only Congress has the authority to let states require collection of this revenue.  The Agreement simplifies the complexity of this issue and as more states join, it applies pressure on Congress to act.

Unfortunately, in the current political climate in D.C. where lawmakers are willing to default on our nation’s debt for political purposes, change won’t come easy or quickly.  However, this change needs to happen. Even though the sales tax is regressive, it’s Washington’s primary source of revenue.  By fixing this issue it will help to modernize the state’s tax collection authority for a 21^st century economy.

What else can be done about exemptions in Washington State

In a previous post I touched on the number of tax exemptions  and the impact they have on our state’s budget.  I also mentioned some of the complications that arise when trying to close exemptions.  With the increasing number of exemptions on the books and the limitations on the legislature’s ability to close those exemptions, the big question remains: what can be done to mitigate the impact of these exemptions in Washington State?

One interesting proposal, introduced during the 2012 Legislative Session, came in the form of HB 2530, introduced by Seattle Democrat Rep. Reuven Carlyle.  This bill, if passed, would have placed a mandatory sunset (expiration) date for all newly established exemptions.  Every 10 years an exemption would expire if not reviewed and extended by the legislature.  This would require the legislature to review an exemption and take deliberate action to extend that exemption if deemed necessary. 

This legislative proposal was a breath of fresh air in the exemptions debate.  So much of the debate has been characterized by extremes—one side calling for the closure of exemptions and the other refusing to consider any changes to the list of exemptions.  This proposal sits right in the middle by calling for a regular review that is based on sound economic principles, a review that is automatically triggered by a sunset.  This trigger would not be avoidable and would require careful consideration no matter how unpopular that discussion may be. 

Unfortunately, the legislation did not pass into law, but it did garner some media attention and added another facet to the tax reform debate in Washington.  Both Rep. Reuven Carlyle and Rep. Chris Reykdal spoke about this debate on an episode of TVW’s inside Olympia.  (click here for full video). This proposal addressed long term reform and, as written, would not provide immediate relief for Washington’s budget woes.  In this respect, this proposal is doubly refreshing in that it addresses larger long term systemic problems in our tax code.  In tough economic times, it is easy to become consumed with immediate action that provides instant relief.

The problems with Washington’s revenue system spans decades.  An undue obsession with short term solutions only compounds the problem by leaving the larger system failures in place.  If we do not take the lessons learned from the Great Recession to heart by addressing the larger systemic problems in our tax code, we are kicking the can of reform onto the coming generations which may be hit harder by future recessions.  Short term steps must be taken, but long term reform (like that introduced by HB 2530) is necessary.

Property Tax 101: Exemptions, Credits, & Deductions

Part 1

Washington State’s Constitution allows for the legislature to declare certain exemptions for property taxes.  And declare they have!  Over the years, the number of exemptions, credits, and deductions has grown.   There are a number of classifications, too.  For example, there are various entities and types of property that are exempt from property taxes.  It’s probably no surprise that federal, state and local government owned properties are among those exempt.  But did you know that most non-profit organizations and many privately owned properties are exempt, as well?  For a complete list, read the Tax Reference Manual produced by the State Department of Revenue.  In the meantime, here are some examples:

Non-Profit Organizations:

·         Churches, parsonages, convents, and administrative offices of religious organizations

·         Humane societies

·         Assembly halls and meeting places

·         Thrift stores that sell only donated merchandise

Privately Owned Property:

·         Cemeteries

·         Widows/widowers of veterans

·         Property used to produce biodiesel, wood biomass, or alcohol fuel or as an anaerobic digester

·         Senior citizen and disabled homeowners (see below for a more detailed discussion)

As discussed in previous posts, some personal property is also exempt from taxation.  Certain intangible assets such as cash, stocks, and bonds are not included in property taxation.  Also, motor vehicles, farm equipment, commercial vessels, and recreational boats are exempt. 

In the 2012 legislative session multiple bills were introduced to expand exemptions or credits.  Here is a roundup:

·         SHB 1042/SB 5017 – Providing a property tax exemption for property held under lease, sublease, or lease-purchase by a nonprofit organization that provides job training, placement, or pre-employment services.  Did not pass.

·         HB 1385/SB 5628 - Concerning a limited property tax exemption from the emergency medical services levy.  Did not pass.

·         HB 1457 – Encouraging businesses to locate in vacant buidlings through a business and occupation tax credit for property taxes paid. Did not pass.

·         HB 2772/SB 6583 – Creating a property tax exemption for the value of new construction of industrial/manufacturing facilities in target urban areas.  Did not pass.

·         SB 6600 – Extending property tax exemptions to property used exclusively by certain nonprofit organizations that is leased from an entity that acquired the property from a previously exempt nonprofit organization.  Passed – effective 6/7/2012.

For more information on property tax exemptions, read part 2, coming soon.

Property Tax 101: The Limit Factor

In recent years, residents of Washington State would think little of Governor Gregoire calling a special session of the legislature simply because it has become a very common occurrence as of late.  However, in November of 2007, when the Governor called her first special session, it was unexpected. The special session was called for the purpose of reinstating a 1% limit, or cap, on property taxes. 

The first limit on property taxes was passed by the legislature in 1971 and only affected regular property taxes at the local level.  This limit required that any property tax levy not exceed 106% of the highest amount of revenue received from any levy in the preceding three years.  Eight years later, the legislature extended this same provision to state property taxes, as well.

 A couple decades later, Washington State voters passed Referendum 47, which required additional limits on top of the 106% limit.  Beginning in 1997, taxing districts with a population over 10,000 could only increase regular levies by the inflation rate or 6%, whichever was smaller.

Not long after, in 2000, Initiative 722 (I-722) was passed.  I-722 limited future property tax increases to 2% and rolled back certain property tax increases levied in the year 2000.  The State Supreme Court ruled I-722 unconstitutional because it was not limited to a single subject.

With the help of Tim Eyman, voters were back at it in 2001 with I-747, which restricted property tax increases to the lesser of inflation or 1%, sending legislators a clear message that property taxes were growing too quickly and they wanted that growth curbed.  Six years later, the State Supreme Court overturned I-747 stating that it didn't include proper disclosure to voters.  In other words, the court believed voters didn't fully know what they were voting on.

The legislature and Governor Gregoire disagreed and quickly called a special session in late 2007.  House Bill 2416 reinstated the 1% levy limit established by I-747 and remains intact today.

Washington State’s First Tax Amnesty Program

When the economy’s in the tank and government needs cash without raising taxes, one thing lawmakers can do is create amnesty programs that forgive interest and fines on delinquent tax payments.  In 2009, State Auditor Brian Sonntag released his yearly audit report that showed Washington State was owed $1.6 billion in delinquent payments (at the time) and an amnesty program could be a one-time option for collecting revenue. He also discussed some of the possible cons of these programs such as implementation costs and lost revenue.

The Governor and Legislature agreed with his assessment and unanimously passed Senate Bill 6892 – Establishing a temporary penalty and interest waiver program for certain excise taxes administered by the department of revenue – which created an amnesty program to run from February 1^st to April 30^th of 2011.  At the time, state officials estimated that collections would bring in around $24 million that could be used to help bridge the gap in the budget deficit. 

The Department of Revenue (DOR) set up the application and payment process and ended up spending $381,000 on staff time and outreach efforts.  The result of this program was a huge success that dwarfed the initial collection estimate. In its final report, DOR says the program collected $345.8 million from 5,095 businesses (over 9,000 applied).   This resulted in $284 million for the state general fund, $5 million for other state accounts, and $61.3 million for cities and counties. This did come with a cost of $91 million in waived fees and penalties, but the quick infusion of cash helped to save programs and services that were on the chopping block.

According to DOR’s data, most of the money came from out-of-state businesses and 75% of businesses that were granted amnesty were small businesses that had a gross business income (GBI) of under $1 million. I’m not sure how much of an overlap there is between these two datasets, but it would be interesting to know why these two groups made up large pieces of the whole.  Regardless, this was a win-win for businesses and government.

DOR was also recognized nationally and received the 2012 Taxpayer Service and Education Award from the Federation of Tax Administrators. Citizen outreach is an important piece for any state program and process transparency builds trust between government and the public.  While this program can’t be implemented on a regular basis since it would be rewarding delinquent payments, it’s a good example of addressing a tax problem in the middle of a fiscal crisis.

Tax Discussion Definitions: Revenue Neutral

A popular phrase that comes up when talking about taxes is that “____ policy is revenue neutral.” What does that mean? Revenue neutrality is when tax reforms are made and the end result doesn’t lead to an increase or decrease in revenue for the government.  The ending balance is neutral when compared to what was in place before.  This phrase is really popular, especially if you’re advocating for change without raising taxes.

However, it’s important to know that even with revenue neutrality, there are winners and losers.  If you reform a tax structure by reducing a tax, you’ll have to raise another tax to claim revenue neutrality.  Someone will be better off and another won’t be based on these changes. The Tax Foundation described this balancing act as robbing Peter to pay Paul and discusses a few examples of when states would lower certain income tax rates, but raise excise taxes to cover the difference.

For this term, neutrality portrays a sense of equality and fairness that might fly when looking at the big picture of a budget, but doesn’t pass muster when looking at the changes made to get there.   Even though the overall tax burdens haven’t changed, the variables to keep the neutrality have. 

Also, neutrality doesn’t account for another important aspect of taxation--values. Jason Furman from the Brookings Institute mentioned this when testifying before U.S. Senate Committee on Finance: “In other cases, deviations from a neutral tax system reflect the goals of policymakers. The tax system is designed to encourage home ownership, contributions to charity, health insurance, and higher education and to discourage smoking and drinking alcohol.”  By focusing on the fiscal goal of revenue neutrality, lawmakers might have to change their interpretation of citizens’ values when it comes to increasing or decreasing taxes for certain activities (link to elasticity brief).

That’s a quick synopsis of revenue neutrality. Just remember that neutrality just refers to the total amount of money that government collects, not how it collects it or who’s impacted by potential tax reforms. I’d like to close with a quote from Christopher Bergin’s entry on this issue on tax.com:

“My point is that if we go down the road to tax reform now, we need to chuck the principle of revenue neutrality and replace it with a new principle; call it loser equality. Because if ‘winners’ in tax reform are those who don’t see their taxes go up or actually see their taxes go down, and ‘losers’ are the ones who see a tax increase, and we do the next round of tax reform responsibly, we are all going to need to be losers. We are all going to need to pay more taxes.

Besides, nothing is neutral.”