On March 9th, the House approved a package of revenue enhancements needed to maintain core public services like health care and education.  The House package includes a measure that would broaden the sales tax to include purchases of customized software. Like many of the other tax increases proposed by state policymakers, this has already been done in other states; according to CCH Incorporated, 11 states and the District of Columbia currently levy sales taxes on custom software.

Under current law, sales of prewritten or “canned” software are subject to the state sales tax while sales of custom software are exempt.  Prewritten software includes typical off-the-shelf products such as Microsoft Office, Windows, video games, and other mass marketed consumer software products.  Custom software is not mass marketed or sold in retail stores.  In its purest form, custom software is developed from scratch for use by a single user or business. 

The current House proposal would extend the sales tax to custom software and to prewritten software that has been heavily customized for a specific user.  If approved by the State Senate, this action would generate some $77 million in coming fiscal year and more than $180 million in the FY2011-13 biennium.

Based on the findings of a new analysis by the Center on Budget and Policy Priorities (CBPP), last week the Budget & Policy Center reported that many of the actions currently under consideration in Olympia have already been enacted in other states.  Of the 33 states that have enacted tax increases to maintain services during the current downturn, 11 have restricted business tax preferences; five have enacted business tax surcharges; nine have eliminated sales tax exemptions; and eight have increased the sales tax rate – all of which are currently under consideration in Washington State.  Click here to read our full summary.

Lawmakers in Olympia are considering placing a limit on a B&O tax preference that primarily benefits large banks headquartered outside of Washington State.*  Capping the “first mortgage deduction” would generate about $67 million in badly needed new resources, while leaving in place a sizable tax benefit for smaller local banks and mortgage lenders.

Since 1980, banks and mortgage lenders have been granted a B&O tax deduction for interest earned on investments tied to first home mortgage loans.  This deduction costs Washington State taxpayers nearly $100 million in foregone revenue each year and has not been vigorously reviewed to ensure that it fulfills a valid public purpose.

This year, lawmakers are considering a measure that would scale back the first mortgage deduction in order to preserve essential services like health care and education.  The current revenue package (SB 6143) under consideration in the Washington State House would place two limits on the deduction:  

1. Fixing the “Homestreet Case”:  The current proposal would clarify that the deduction only applies to interest earned on first home mortgage loans and first home mortgage-backed securities.  A recent State Supreme Court ruling (Homestreet Inc. v. Washington State Department of Revenue) expanded the deduction to apply to previously unintended streams of business revenue, such as fees charged for servicing loans sold on secondary markets.  If enacted, this clarification would save the state about $9 million in the current fiscal biennium.
2. Enacting a $100 million cap:  The current legislation would place a reasonable limit of $100 million on the amount of interest earnings any bank or lender could deduct from their B&O tax liability each year.  Under such a cap, small lenders and community banks (those with less than $100 million in interest earnings) would be held harmless.  While large banks would no longer be able to deduct all of their interest earnings from first home mortgages, they would still be able to deduct a sizable portion – up to $100 million per year.

In total, clarifying and capping the home mortgage deduction as described above would generate some $67.1 million in the current biennium.  Given the depth of the current economic crisis, Washingtonians cannot afford to squander scarce public resources on unnecessary tax exemptions, credits, preferential rates, or special deductions.

*After the recent demise of Washington Mutual last year, there are no longer any large banks headquartered in Washington State.

A new report from the Center on Budget and Policy Priorities (CBPP) finds that at least 33 states have raised revenue to meet public needs in the present downturn.  Many of the types of actions being considered by Washington State lawmakers have already been enacted other states.  

As part of a balanced approach to our economic problems, lawmakers in Olympia are considering a range of responsible revenue enhancements needed to preserve essential services like health care, education, and child care while the economy recovers.   Raising state taxes to maintain these services is a reasonable and economically sound approach that has been adopted by majorities of states in past recessions. 

State tax increases in 2008 and 2009 have already generated some $30 billion in new resources to help close recession-induced budget shortfalls.

This year, lawmakers in Olympia have proposed to generate additional resources by eliminating a number of costly business and sales tax preferences.  The study found other states have taken similar steps. The first table below shows that 11 states restricted business tax credits, deductions, and exemptions or have taken actions to reduce tax avoidance.  Another five states -- Connecticut, Delaware, Nevada, North Carolina, and Oregon – have enacted business tax increases or surcharges.  (Both the Washington State House and Senate revenue proposals include temporary B&O surcharges on a range of business services.)

Legislators in Olympia are also considering measures that would eliminate wasteful sales tax exemptions.  The second table below shows that nine states have expanded their sales taxes to include previously untaxed products and services.  Notably, two states (Tennessee and Wisconsin) extended the tax to certain types of software – an action that is included in the current House revenue package here in Washington.

The current revenue proposal in the Washington State Senate includes a temporary 0.3 percentage-point increase in the state sales tax.  So far, the sales tax rate has been increased in eight states during the current downturn.  California, Indiana, Massachusetts, and North Carolina increased the sales tax by one cent (1.0 percentage-point) or more.  Even Nevada’s 0.35 percentage-point increase is larger than the current proposal in Washington State.

Finally, both the current House and Senate revenue proposals here in Washington include measures to increase the cigarette tax and taxes on other tobacco products.  According to the CBPP report, 20 states increased tobacco taxes in 2008 or 2009.  

To view the entire report, click here.

The headline in The Seattle Times "State spending on track to rise, despite budget cuts" is a misleading way of looking at the state budget situation. If you’ve been following the budget debate, you know that both the Senate and House budgets propose deep cuts to education, health care, economic security, and so on.

State spending – from money the state collects --would actually fall under the two budget proposals. The article adds anticipated federal aid to state spending in order to reach the conclusion that the budget would increase.

However one treats the federal aid, the budget proposals would result in deep cuts across the budget, cuts that would come on top of the $3.6 billion in cuts made last year.

There are increases in spending in some areas. Most (over 70 percent) of the increases are maintenance-level changes. These are changes that are due, not to the creation or expansion of new programs, but to just adjusting to changing costs. When the Governor signed a balanced budget into law last year, it included assumptions about the number of people who would need health care coverage, the number of kids who would be enrolled in schools, the price of providing various services, and so on. Some of those assumptions turned out to be incorrect, primarily because the economic outlook has been worse than expected. Adjusting for those changes is generally considered as part of the maintenance-level budget and is not considered budget cuts or increases.

Aside from the maintenance budget changes, there are modest spending increases in both budgets. The largest items include a mandated correction in how the state calculates clinic reimbursements and reversals of cuts to nursing homes and adult day health in response to lawsuits.  The Times article points out one of the few areas where budget changes represent a significant change in the state’s commitments: sending unemployed workers to train at colleges for jobs in high-demand fields. This is spending that is both badly needed and woefully inadequate when compared to the demand. That’s a policy choice, but one that’s hard to argue with.

The bottom line is that neither the federal dollars nor the revenue increases are enough to fully offset the effects of the Great Recession. However, these sources of funding will help stave off other disastrous cuts such as those contained in the Governor’s first budget – the ones she said she didn’t have the conscience to adopt.

Both chambers of the State Legislature have now passed revenue measures needed to maintain basic public services like health care and education while the economy recovers.  

While these packages are an important step toward addressing our economic problems, both are insufficient given the scale of the current crisis.  The current Senate proposal would generate about $890 million in new resources while the House proposal would increase revenues by $680 million -- $70 million less than the earlier version approved by the House Finance Committee.  It's important to note that even under the larger Senate proposal, revenue increases would account for only 10 percent of total actions taken to close the $11.7 billion shortfalls in the FY2009-11 biennium.

The proposals

The Senate approved its proposal, SB 6143, last Sunday (March 7th).  Last night, the House passed a completely different version of SB 6143.  The table below provides an overview of the Senate and House proposals. To view a pdf of the table, click here.

Common Elements

Both versions of SB 6143 would limit or eliminate large exemptions and loopholes.  These include: Repealing the direct sellers' B&O exemption and retroactively fixing the Dot Foods case; adopting economic nexus (for more information see the schmudget post "What is 'Economic Nexus' and Why Do I Care?");giving DOR greater authority to reign-in abusive tax avoidance transactions; repealing the sales tax exemption on bottled water; and repealing a number of smaller exemptions and preferential tax rates.  Both measures would also increase the cigarette tax, though the House version would raise more money by increasing taxes on other tobacco products as well.

Senate Proposal

The Senate proposal would raise a total of $890 million. In addition to the exemptions and loopholes in common with the House version, the Senate proposal includes two temporary general tax increases: a 0.3 percentage point increase in the state sales tax ($313 million); and a 0.25 percentage point increase in the B&O tax rate applied to service industries ($170 million).  

The Senate measure also includes the Working Families Tax Rebate (WFTR) -  a rebate program for lower-and moderate-income families based on the Federal EITC.  (For more information on the WFTR, click here.)  Along with a number of smaller actions, the Senate proposal would also extend the sales tax to include coal used at coal-fired electricity facilities.

House Proposal

Overall, the House approach would generate about $682 million in new revenues in FY2011.  The current House proposal relies heavily on limiting or eliminating tax exemptions and preferences such as capping a deduction claimed by banks on interest earnings from first home mortgages. It would also extend the sales tax to include candy and custom software, and would repeal the exemption for nonresident shoppers.  The measure does not include any general sales tax or B&O tax increases -- a key difference with the Senate proposal.

The House version of SB 6143 largely resembles HB 3191 -- the revenue package that was passed by the House Finance Committee on March 2nd.  The new proposal contains a few important differences with HB 3191, however. Unlike the earlier version, the current House proposal would not limit the B&O exemption on investment earnings from nonfinancial firms.  Nor would it extend the sales tax to janitorial services.  While the new version partially compensates for these omissions by expanding the scope of services subject to the B&O surtax, the current House proposal would raise about $70 million less than the earlier measure.

The Senate Ways & Means Committee passed a revenue package today that would raise nearly $900 million to fund education and health care. While the overall level of the package is similar to the version proposed on February 23rd, there are differences in the components.

Major pieces of the previous proposal not included in the version passed by the committee today include:

1. Repealing the sales tax exemption for trade-ins;
2. Capping the B&O 1st mortgage deduction at $100 million; and
3. Limiting the sales tax exemption for fertilizer to organic fertilizers.

These three provisions were relied upon in the previous version to raise about $168 million.

The package passed by the committee today contains new provisions. The most significant include:

1. A temporary B&O surcharge on service businesses;
2. Extending the sales tax to bottled water.

The B&O surcharge would temporarily raise the B&O on those service business currently taxed at 1.5 percent to 1.75 percent. The proposal would also double the small business tax credit for businesses subject to the surcharge. On net, it would raise about $171 million. (The House revenue package raises $22 million by raising the B&O on a much smaller subset of businesses.)

The proposal also follows the House’s lead by extending the sales tax to water, raising $30 million.

In total, under the Senate proposal, revenue increases would account for only 10 percent of the total solution to the FY2009-FY2011 $11.8 billion shortfall (see below).

The interactive graph below allows you to look up the number of people currently enrolled in Basic Health in your county, the number of people that have been disenrolled since January 2009, and the number of people on the Basic Health waiting list. Simply select your county (or "statewide") from the drop down selector.

Basic Health is the only source of affordable health insurance for 70,000 Washingtonians, most of whom are working but have no access to employer-provided care. While Basic Health is a core part of the state's health care safety net, it falls far short of the need. Over the last year, budget cuts have eliminated coverage for over 35,000 people while a sour economy has dramatically increased the need for the program. As a result, the waiting list for Basic Health has grown by over 90,000 people and is now larger than total enrollment.

While the Governor's Book 2, the Senate, and the House Ways and Means budgets all preserve Basic Health, they all rely on passing revenue increases (and federal funding in the case of the House). Without moving quickly on revenue, Basic Health remains in jeopardy. And none of the proposals deal with the enormous and growing unmet need for the program.