Earlier this week, lawmakers in the House passed HB 2038, a responsible measure that would narrow tax breaks and extend a small tax increase on business services in order to fund court-mandated improvements to schools while preserving health care, public safety, and other investments that create jobs.

The passage of HB 2038 represents the final component of the two-year spending plan put forward by House leaders. That plan follows the path laid out by Governor Inslee earlier this year, but is very different from the budget proposal from leaders in the State Senate.

Unlike the responsible and balanced approach championed by Governor Inslee and members of the House, the Senate’s approach would only make matters worse by subjecting health care, child care, and other investments that help middle class families prosper and kids learn to yet another round of severe cuts.

As the regular 2013 legislative session draws to close, and as lawmakers begin planning for a special legislative session, the stage has been set for a dramatic show down between these two fundamentally different visions for our state. Which direction will they go? Stay tuned to schmudget as events unfold.

Opponents of legislation that would close wasteful tax breaks to build a better education system for all of Washington state’s children are using flawed arguments to try to derail the effort.

House Bill 2038, which passed the House Finance Committee yesterday, would invest about $900 million in schools and expand opportunities for generations to come. To generate the resources needed to modernize our schools, the legislation would close or narrow about $400 million in tax breaks and continue a tax increase on business services that is scheduled to expire at the end of June.

Investing in education is one of the most effective ways of creating middle class jobs and a vibrant, competitive state economy. Yet, at a recent public hearing on HB 2038, a range of corporate special interests erroneously claimed that if they were required to pay the same tax rates as most other businesses in Washington state, they would be forced to fire some of their workers and not hire others. They ignored several facts:

• Education is key to building a strong economy: Consistently, businesses cite an educated and skilled workforce as a primary factor in deciding where to locate and create jobs. Investing in high-quality schools fosters  economic growth and creates an economy capable of sustaining a strong middle class with well-paying jobs. Unfortunately, per student funding has been consistently cut since the start of the recession, while spending on tax breaks has remained virtually untouched. 
• Demand for goods and services creates jobs: Washington state’s economy is not struggling because there are too few tax breaks on the books. If tax breaks created jobs, the economy ought to be booming with 640 tax breaks currently in place. Ultimately, businesses hire workers when they expect an increase in demand for their products or services. Consumer demand remains very weak in wake of the Great Recession, which is a big reason businesses in Washington state are not hiring. Tax cuts for businesses, broad or narrow, do little to spur demand among consumers.
• Public investments bolster demand for goods and services: Investments in education, health care, and other public services can help stimulate local demand during hard economic times. State and local governments purchase many products and services from local businesses, hire local workers who spend their money at local stores, and contract with local businesses to provide essential services and to build roads, bridges, and other vital economic infrastructure. All of these things help sustain economic demand during tough economic times while laying the groundwork for a more prosperous state economy in the long run.
• Many tax break dollars subsidize jobs and shareholders in other states: It is very difficult to ensure that tax break dollars, and their benefits, stay in Washington state. Rather than creating jobs in local communities, a significant portion of tax break dollars pad the profits of corporations and corporate stockholders in other states. That is very likely the case for a number of tax breaks that would end under HB 2038 – such as a high-tech research and development credit claimed by many large software companies, which created few jobs at a very high cost to the state; a complete business tax exemption for importers; and a preferential business tax rate for prescription drug wholesalers that is available to both in-state and out-of-state businesses.
• Most tax breaks under consideration have failed performance evaluations or serve no purpose: Of the 11 tax breaks that would be eliminated or narrowed under HB 2038, seven have been reviewed by state auditors. In four of those cases, the auditors found that the tax breaks should be repealed because they failed to create jobs or serve any other valid public purpose. Auditors were unable to measure the performance of the remaining three tax breaks because they could find no measurable purpose for them whatsoever.
• Most tax breaks don’t create jobs: State taxes represent a tiny fraction of business’ overall costs. Nationwide, all state and local taxes combined represent between 2 percent and 3 percent of total operating costs for the average corporation and have only a marginal impact on business investment decisions. Moreover, the resources used to finance these poorly designed tax breaks would be far more effectively used to fund education and other public priorities that have a much larger return on investment.

The bottom line is that HB 2038 is a modest but smart step toward creating middle class jobs and a state economy that works for all Washingtonians. Those who claim that tax breaks are needed to create jobs overstate their effectiveness and fail to recognize the economic benefits of investing in better schools for our children.

Part 2 in a series on revenue options under consideration in the 2013 Legislature
Following Governor Inslee’s lead, last week leaders in the State House of Representatives sensibly proposed to end costly and ineffective tax breaks to generate additional resources for schools and other investments that grow the economy and help middle class families prosper.

Both the Governor and House leaders propose to rein in preferential business and occupation (B&O) tax rates, many of which have remained in place for decades at the expense of investments in education, health care, and safe communities.

There are 31 special B&O tax rates on the books in Washington state that give an advantage to certain businesses, costing hundreds of millions of dollars each year (see graph below). For example, while most wholesale businesses pay the standard B&O rate of 0.484 percent, companies that sell prescription drugs at wholesale pay less than one-third of that.

Governor Inslee wants to generate about $70 million in additional resources for the state by increasing most of these preferential tax rates by 25 percent, except those for aerospace firms and businesses that clean up toxic waste. That means, for example, the tax rate for prescription drug wholesalers mentioned above would increase to 0.1725 percent, still far below the standard wholesaling rate.

House leaders want to take a slightly different approach. Instead of trimming the tax breaks by the same amount, their plan would eliminate the B&O tax breaks that fail to create jobs or that no longer make sense in the modern economy. Here’s what they propose and the amount of revenue that would be generated in the 2013-15 budget cycle:

• Travel agents and tour operators ($15 million): The standard B&O tax rate for service businesses is 1.8 percent, but in 1975, policymakers gave a lower tax rate to travel agents and tour operators of 0.275 percent. Although the preference was intended to make sure travel agents weren’t paying higher taxes than airlines on ticket sales, changes in the travel industry and state and federal policy changes since 1975 have corrected the underlying problem. Because of this, a Citizen Commission that reviews tax breaks recommended that this preference be terminated, as it is no longer needed.
• Insurance agents ($46 million): Real estate agents, stock brokers, and other service providers are subject to a 1.8 percent B&O tax rate, but in 1983, policymakers gave a lower rate to insurance agents and brokers and have further lowered it over the years to just 0.484 percent, less than a third of the standard rate. State auditors recently found that there is no justification for this tax break.
  
• Prescription drug wholesalers ($29 million): In 1996, to encourage prescription drug wholesalers to build warehouses in Washington state, policymakers gave these businesses a B&O tax rate of 0.138 percent, compared to the 0.484 percent paid by other wholesale producers in the state. However, this preferential rate is poorly targeted since it is available to all prescription drug wholesalers that do business in Washington state, whether they have warehouses located here or not. As a result, this preference is not helping to increase the number of prescription drug warehouses located in Washington state and should be repealed.
• Stevedoring ($28 million): Businesses engaged in stevedoring (loading or unloading cargo from ships) are given a B&O tax rate of just 0.275 percent, which is far below the tax rate of 1.8 percent paid by most other service businesses. State auditors found no evidence that it makes Washington state ports more competitive with those in other states. Furthermore, no competing West Coast ports provide a tax break for stevedoring services. Because of this, the Citizen Commission recently recommended that the state end this tax break.

House leaders should move forward with closing these ineffective tax breaks that are making it hard for our state to invest in the building blocks of Washington state’s economy. These small but sensible changes are the responsible thing to do.

Check out part 1 of this series,  which explains proposals to make two temporary tax increases on service businesses and breweries permanent.

Up next, an overview of sales tax breaks that would eliminated under proposals from the Governor and House leaders. Stay tuned to schmudget.

Part 1 in a series on revenue options under consideration in the 2013 Legislature.

Yesterday, leaders in the House  introduced a sensible budget plan that would preserve investments that are vital to creating jobs and helping middle-class families thrive while taking needed steps toward improving K -12 education.

Unlike the unbalanced budget passed last week by the Senate, the House  proposal  would ensure there are enough resources  to pay for these investments.

Today we examine the proposals from Governor Inslee and the leaders in the House to permanently extend two temporary tax increases enacted three years ago. Later posts in this series on legislative revenue options will examine proposals to narrow or terminate wasteful tax breaks, actions to plug legal loopholes created by State Supreme Court rulings, new tax breaks that have been introduced, and proposals to foster a more transparent and accountable process of scrutinizing tax breaks during the budget development process.

Extending current taxes

To help fund Court-mandated improvements to K-12 education and other important education investments, like early learning and higher education, both Governor Inslee and leaders in the House have proposed permanently extending a pair of temporary tax increases that are currently set to expire at the end of June.

In 2010, facing enormous revenue shortfalls, policymakers enacted these tax increases to help maintain core investments in health care, education, and public safety during the worst part of the recession. Given the sluggish economic recovery and the mandate to fund improvements to schools in Washington state, making these small tax increases permanent is a sound way to generate the resources needed to support middle class families. These two tax increases and the amount of revenue they are projected to raising in the coming 2013-15 budget cycle include:

A 0.3 percentage-point B&O surcharge applied to business services ($534 million):

Prior to 2010, the standard business and occupation (B&O) tax rate applied to range of services, such as legal, accounting , and cosmetic services, was 1.5 percent of gross business income. The surcharge enacted in 2010 raised the B&O rate applied to these services to 1.8 percent. It’s important to note that this rate is still quite low by historical standards, in the mid-1990s the rate was 2.5 percent.

It also makes sense to apply a higher B&O rate to many of these services because, unlike companies that sell appliances, tools, and other tangible goods, these services are not subject to the much higher 6.5 percent state sales tax rate. As we’ve written previously, that’s a problem because consumers now spend much more of their incomes on services than they do on tangible products. And, this shift in consumer spending habits over the last few decades is a major cause behind the decline of state tax revenues relative to the broader state economy.

A surcharge on breweries and beer distributors ($58.7 million - $128 million): 

Also in 2010, policymakers adopted a temporary, 50-cents per gallon increase in the beer excise tax applied to breweries and beer distributors in Washington state. The surcharge only applied to beer sold in Washington state by large, multistate breweries – those producing more than 60,000 barrels of beer annually.

The Governor proposed making the 50-cent per gallon surcharge permanent while extending it to include microbreweries, which would raise about $130 million in the coming budget cycle.

House leaders proposed a slightly different approach that would generate about $60 million in the coming budget cycle. Their proposal would also permanently extend this surcharge, but would lower the rate to 25-cents per gallon for larger breweries (14-cents per six-pack) and apply a smaller, 15-cents per gallon (8-cents per six-pack) surcharge to microbreweries. It’s important to note that beer that is exported from Washington state is not be subject to the surcharge, meaning extending the tax to local microbreweries would have no impact on their competitiveness in the national and international beer markets.

On deck: eliminating outdated preferential B&O tax rates.  Stay tuned to schmudget.

By Andy Nicholas and Kim Justice -- A plan that State Senate leaders recently revived to fund education at the expense of all other vital services continues to be the wrong approach to fully funding our schools and poses a grave danger to Washington state’s economy. It would lead to deep cuts in investments beyond education that create jobs and help the middle class prosper.

Beginning in 2015, Senate Bill 5895 would attempt to fund court-mandated education reforms by limiting public safety, health care and all other areas of state investment to the rate of inflation plus population growth.

This rigid formula, which was the cornerstone of Rob McKenna’s education funding proposal when he ran for Governor in 2012, ignores the real-world costs of maintaining important investments from one year to the next.

For example, health care costs grow considerably faster than the general rate of inflation. And the aging of our state’s population means that the number of seniors needing health care and other services grows more rapidly over time than the population at large.

As a result, the arbitrary population plus inflation formula would force huge cuts to a range of important non-education investments. But the cuts don’t stop there. The measure would also eliminate Initiative 732, a law requiring annual cost-of-living adjustments (COLA) to teacher salaries. However, policymakers would be required to transfer an amount of funding equal to the cost of these COLAs to education from other areas of state investment, forcing even deeper cuts non-education spending.

The graph below shows the combined impact of the population plus inflation formula and the mandated COLA transfers, had SB 5895 been enacted in 2005. As the graph shows, the Senate proposal would have forced more than $4 billion in cuts to non-education investments between 2005 and 2008.

During the 2005-07 budget cycle alone, SB 5895 would have forced $2.5 billion in cuts to important priorities in Washington state. That’s more than all of the combined funding for public safety ($1.5 billion) and services that support foster children and families in crisis ($500 million).

Funding education at the expense of all the other things that kids need to thrive – strong families, safe neighborhoods, a healthy environment -- is the wrong approach. Instead, Senate leaders should look to generate additional resources for schools by ending unproductive tax breaks, as Governor Inslee proposed, while continuing current taxes that are set to expire and exploring other options, such as a tax on profits from high-end investments and other capital gains.

Not only does today’s budget proposal from the Senate fail to close a single wasteful tax break to help maintain funding for schools, health care, and other important priorities, it deepens state spending on tax breaks, creating 13 new ones.

These new tax breaks will drain available resources by an additional $11 million in the coming 2013-15 budget cycle. Notable highlights include (see full list below):

• A sales tax exemption on the purchase of clay targets by non-profit gun clubs ($29 thousand);
• A sales and use tax exemption for the sale of financial information to qualifying international investment management firms ($747 thousand);
• A sales tax exemption on cover charges for dance clubs ($892 thousand).

At a time when existing state tax resources are projected to fall $2.6 billion short of the amount needed to sustain existing investments and fund court-ordered improvements to Washington state’s education system, it is irresponsible for policymakers create new tax breaks.

Instead, the Senate should follow Governor Inslee’s lead, who, just last week proposed eliminating more than $500 million in wasteful tax breaks to build a stronger education system for Washington state’s children.

Stay tuned to schmudget for additional analysis on the Senate budget.

Budget Beat: Learn more about the Senate budget—and how it compares with Governor Inslee’s budget— at this week’s Budget Beat call this Friday at noon. Register here.

As the Legislative Session progresses all three branches of state government have taken, or are poised to take, actions that could greatly enhance transparency over the hundreds of special tax breaks on the books in Washington state.

Although more needs to be done, there have been several encouraging developments, including:

• Eliminating the supermajority vote barrier: Earlier this month, the State Supreme Court struck down the law that required a supermajority – two-thirds vote - for tax increases. Among other problems, the supermajority law allowed a small handful of lawmakers to block any attempt to rein in special interest tax breaks.
• Unanimous Senate support for greater tax break accountability: Senate bill 5843 would require most new tax breaks to include key transparency requirements – including a sunset date, a clear purpose and policy goals, and specific performance metrics to help state auditors gauge its effectiveness. This bill was passed unanimously by state Senate earlier this year and is waiting for action in the House Finance Committee.
• A Disciplined House Finance Committee: All of the transparency and accountability tools in the world would be useless without a commitment among policymakers to foster accountability. With the newly reconstituted Finance Committee, leaders in the House of Representatives are doing just that. The Finance Committee has shown discipline, passing far fewer tax breaks than the Senate Ways and Means Committee and requiring all newly proposed tax breaks to include sunset dates and performance metrics.
• Governor to propose narrowing tax breaks for education: Governor Inslee has announced that he will unveil a strategy for funding education that includes eliminating or narrowing unproductive tax breaks, which have in the past compromised the state’s ability to invest in schools.

Over the last two decades, policymakers have dramatically increased their use of tax breaks to further various legislative goals. As the graph below shows, the number of tax preferences on books has nearly doubled since 1990, rising to 640 from 333 over the last 23 years.

But, unlike direct spending on schools or health care services, tax breaks don’t have to go through the biennial appropriations process, despite the fact that they cost the state a large amount of money. This makes it easier to enact tax breaks and difficult to balance against competing public priorities.

History has shown that most tax breaks are poor mechanisms for achieving policy goals, but they have remained popular with policymakers. According the Institute on Taxation and Economic Policy:

“Administering spending programs through the tax code allows policymakers to simultaneously claim that they are taking action on an important issue while also taking credit for cutting taxes, shrinking government, or deferring to the private sector. In reality, however, selectively shuffling around tax burdens leaves no less of an imprint on the economy than direct government spending.”

More reform needed

While recent developments indicate progress toward a more accountable tax break system, more aggressive steps will need to be made to ensure true accountability is achieved. Notably, policymakers should apply sunset dates to most existing state tax breaks – a reform that was proposed last year under HB2762. Such a reform would help policymakers evaluate tax breaks and balance their costs against the need to invest in schools, health care, and public safety.