Washington has made some progress recently toward making sure that special-interest tax breaks face the same level of scrutiny and accountability as education, health care and other public investments.
Based on our proposals, two measures that would have improved tax break accountability in our state advanced in the Legislature this year and it’s crucial for that momentum to continue.
House Bill 2762 would have required a review of hundreds of narrow tax breaks to see if they earn their keep. Senate Bill 6088 would have required that all newly created or re-enacted tax breaks be subject to regular evaluations by policymakers, the public, and state auditors.
Narrow tax breaks cost billions of dollars each year. It only makes sense to ensure the beneficiaries are delivering as promised – for instance, by creating more jobs and increasing investments in Washington’s economy.
Together, HB 2762 and SB 6088 would have ended the practice of automatically renewing tax breaks. Instead, existing and newly proposed tax breaks would include a “sunset” date – a date when they would automatically expire unless action is specifically taken to renew them. Transparency and accountability can be significantly improved by applying routine expiration dates to most state tax breaks.
Sunsets force policymakers to consider the costs and benefits of tax breaks when deciding whether to renew them. And, large profitable corporations would have to routinely justify and demonstrate the benefits of their tax breaks at public committee hearings. Our representatives would have to balance the tax breaks against other public priorities – such as educating our children and providing adequate care for seniors.
This approach was lauded in a recent study of state tax break evaluations by the nonpartisan Pew Center on the States. It cited Oregon’s practice of applying routine sunset dates to most state tax credits as an effective way to improve transparency and accountability over narrow tax breaks.
Yet, as shown in the graph below, only 10 percent of the tax breaks on the books in Washington have an expiration date.
The fact that even useless tax breaks can’t be eliminated without a two-thirds majority vote of the legislature aggravates the situation. While investments in health care, education, and public safety have been cut by some $10.6 billion since 2009, spending on tax breaks has grown.
This year, SB 6088 (sponsored by Senator Craig Pridemore) was approved by the State Senate and HB 2762 (sponsored by Representative Reuven Carlyle) passed out of the House Ways & Means Committee.
Going forward, policymakers should build on this momentum and enact comprehensive sunset dates for state tax breaks.
For more information, check out our policy brief “Every Dollar Counts: Why it’s Time for Tax Expenditure Reform.”
Part four in a series on Washington’s long-term fiscal challenges.
Washington’s outdated tax system is starving our state of vital resources desperately needed to invest in what it takes to create jobs and build a strong economy.
The amount taken in from state taxes, measured as a share of our state economy, has been steadily falling for the past couple of decades. In fact, since 1995 there has been a 30 percent drop. Without changes in the tax system, this downward trend won’t subside.
The major reason behind this decline is that Washington’s tax structure has not kept up with the changes in the state’s economy. It was built for a different time. For example, increasingly, the wealthiest Washingtonians make their money from capital gains, which the state doesn’t tax. In addition, the state sales tax – Washington’s largest revenue source – doesn’t reflect the massive shift in consumer spending patterns. When the sales tax took effect in 1935, people spent more on things than services. Today it’s the other way around, but the sales tax isn’t applied to most services – many of which didn’t exist when the sales tax began.
Elimination of the motor vehicle excise tax (MVET) through approval of Initiative 695 in 1999 made the decline even worse. Replacing the MVET with a flat, $30 vehicle licensing fee costs the state more than $800 million in annual resources.
In an era of so much social and economic upheaval maybe it’s natural to gravitate toward things that are traditional and familiar. But Washington’s 1930s-era tax system is making things worse. Difficult as it may be, we must acknowledge that Washington faces 21st century economic challenges that our quaint tax system simply can’t handle.
We can create a sustainable tax system that meets the demands of the 21st century global economy. Key reforms that would put Washington on the right path include modernizing the sales tax to include more consumer services and adopting a tax on rapidly-growing capital gains. These two options would help reverse the downward spiral of economic resources. In the coming year, adopting these changes would increase available state tax revenues by at least $800 million -- all of which could be invested health care, education, and other necessities proven to create jobs and promote prosperity.
The Pew study found that overall Washington ranks among the 13 states that are “leading the way” on tax break evaluations. Washington’s evaluation process was praised for evaluating the majority of state tax preferences over a 10 year period. However, our state received lower scores for the quality of its tax break audits.
Tax break evaluations don’t answer key economic questions
The report finds that effective audits should evaluate how tax breaks impact a state’s economy and the extent to which they create jobs. Many of the audits in Washington don’t provide such an assessment, which is why Pew gave Washington a lower score in this area. It’s important to note that answering these questions isn’t easy. As the study states:
Even so, other states have found ways to tackle the “but for” question. Oregon received high marks for both the scope and quality of its tax break evaluations. The study cited creative approaches taken by that state to assess the economic and jobs impact of several large state tax breaks.
Sunset dates necessary for transparency
Oregon was also praised for applying systematic expiration or “sunset” dates to most state tax credits. Sunset dates are important because they force state policymakers to balance the costs and benefits of state tax breaks against competing public health and education priorities on a routine basis -- an area where Washington needs improvement.
While audits provide useful information regarding the performance of tax breaks, policymakers in Washington state are not required to act on that information. As Bill Longbrake, Chair of Washington’s Citizen Commission for Performance Measurement of Tax Preferences, states in the report:
“It is a great process in terms of depoliticizing it, it is a great process in terms of providing really high-quality analysis and information, it is a great process in terms of involving public stakeholders and getting their views on the table, but it stops at that point […] There is nothing that requires the legislature to do anything other than receive the report and hold one hearing on it.”
As we’ve argued previously, applying sunset dates to most tax breaks in Washington would push lawmakers to act on the findings of state auditors.
The report, co-authored by Jeff Chapman, the Budget & Policy Center’s former Research Director, shows that Washington has made great strides in recent years toward better evaluation of tax breaks, but more needs to be done. Going forward, policymakers should apply routine sunset dates to most tax preferences and should give auditors the tools they need to provide more comprehensive assessments.
For more information read the entire Pew report.
Also check out our policy brief, “Every Dollar Counts: Why it’s Time for Tax Expenditure Reform.”
Yesterday’s state budget agreement might have left some with the impression that lawmakers eliminated scores of tax breaks, raising millions upon millions of dollars to preserve public health and education priorities. That simply isn’t the case.
All told, tax increases resolved only $250,000 of the more than $6 billion in revenue shortfalls encountered since the current budget took effect in July 2011, even taking account of what the Legislature did yesterday. During the same period, public investments in schools, health care, transportation, and other things that promote job growth and economic prosperity have suffered some $5 billion in harmful cuts (see graph below). (1) This lopsided approach has only worsened Washington’s long-term economic challenges.
Wait, didn’t policymakers just curtail a wasteful tax break for out-of-state banks? Yes they did. Limiting eligibility for that break to small banks (those that operate in fewer than 10 states) will generate about $14.5 million in the fiscal year that begins this July. They also closed a tax loophole for businesses that sell roll-your-own cigarettes, which will raise about $12 million.
Yet, since January 2011 lawmakers have also created or extended a number of other tax breaks for specific industries – ranging from fruit and vegetable processors ($6.7 million per year) to real estate firms ($1 million per year) to movie production companies ($3.5 million per year). They also established a permanent tax break for newspapers worth about $7,000 per year.
When all of the tax giveaways enacted since early 2011 are accounted for, net tax increases raised less than a quarter of a million dollars for the current budget, leaving important economic investments without desperately needed funding. In fact, if you drew a line to represent the proportion of new revenue over that period, it would be one inch long. A line representing spending cuts would stretch the length of five-and-a-half football fields.
To build a state that can compete in the 21st century economy, policymakers must support first-rate schools, affordable colleges and universities, and a healthy, productive workforce. Doing so will require us to generate new resources by eliminating wasteful tax breaks, modernizing our sales tax by including more consumer services and enacting a new tax capital gains.
1. Net tax increases resolved only $250,000 of about $6.3 billion in budget shortfalls encountered since the start of the 2011-13 fiscal biennium. Going forward, total tax actions enacted since early 2011 will result in a net annual increase of about $3.5 million.
The Legislature concluded its second special session by passing a budget that spares kids and vulnerable populations from deeper cuts, but takes no steps to rebuild our economy.
Since 2009, the Legislature has cut over $10.5 billion from investments in health care, education, and resources people need to remain economically secure through a recession (see graph). This is the opposite of what is necessary for our economy to recover. While the worst of the cuts to these investments were avoided this time around, little progress was made to ensure future economic prosperity.
Actions taken by the Legislature at the close of special session include:
- $295 million in cuts: Almost half ($127 million) of the reductions came from unspent funds in the Temporary Assistance to Needy Families program, which provides families with child care support and help finding a job. This funding could have been used to help families hardest hit by the recession, but instead it was mostly used to balance the budget.
- Funding preserved: K-12 and higher education, support for people with disabilities, women’s health, and food assistance were spared further cuts.
$238 million shift in payments to local governments:
By waiting until the end of each month to distribute tax revenues to local jurisdictions, the state budget gets a one-time $238 million boost.
Miniscule revenue increases:
- Actual tax increases amounted to about $26 million, from closing a tax breaks for out-of-state banks and sellers of roll-your-own cigarettes.
- Policymakers also cut taxes by about $20 million. Tax breaks were renewed or extended for companies that process fruits and vegetables, server farmers, film companies, and shipping businesses.
- Administrative actions -- such as selling the state’s liquor distribution center and offering an amnesty program for taxes owed on personal property – amounted to about $27 million in additional resources.
Change to four-year budgeting:
Requiring the Legislature to budget four years out could result in even deeper cuts to public priorities in the future because it fails to address the major reasons why Washington has a hard time meeting growing public needs: spending and revenue are not treated the same in budget decisions, and examining tax breaks is not part of the budget process. Click here to read more on this topic.
The Legislature missed out on the opportunity to enact smart reforms that would help create jobs and put the state on track to compete in the economy.. Key reforms include: extending the sales tax to more consumer services, enacting a tax on capital gains, and systematically reviewing the billions of dollars spent each year on special tax breaks.
More posts to follow.
Part Three in a Series on Washington's Long-Term Fiscal Challenges
Without the ability to address Washington’s flawed revenue system, current proposals requiring the budget to be balanced over four years (instead of the current two year cycle) would force policymakers to cut important public health and education priorities over the long term. A major reason is that long-term revenue forecasts tend to be highly unreliable.
As we noted in parts one and two of this series, balanced state budgets are key to maintaining important priorities in the long run. However, economic uncertainty makes it extremely difficult for forecasters to develop reliable long-term revenue estimates.
The graph below shows that forecasters tend to be overly conservative when estimating revenue growth following a recession and overly optimistic during an economic peak. Following the “dot-com bust” recession of the early 2000s, the state Economic and Revenue Forecast Council (ERFC) under-estimated state tax collections by about $2.8 billion prior to the 2005-07 budget cycle.
Under current budgeting practices, it is entirely appropriate for the ERFC to be extremely cautious when projecting state revenues following a recession. However, under the proposed four-year balanced budget requirements this approach could harm public investments by creating a “ratchet effect.”
That means overly pessimistic forecasts would require policymakers to enact unnecessarily deep cuts to public health and education infrastructure in order to keep the budget balanced within the depressed revenue estimates. And, deeper-than-necessary cuts to these and other vital components of the state economy would greatly harm the state’s ability to recover following a recession.
The “ratchet effect” would be less severe if the legislature were able to raise additional revenues, which would increase the revenue forecast and mitigate the need for excessive cuts. Yet the onerous, minority rule requirement established under I-1053 makes it virtually impossible for the legislature to meaningfully increase revenues under current law.
Without the ability to address Washington’s flawed revenue system, proposals to mandate a four-year balanced budget would simply force policymakers to abandon our commitments to building a robust and vibrant state economy.
A new bill in the state Senate (SB 6635) would generate additional resources to help address the roughly $1 billion revenue shortfall. While this is a positive development, the amount of additional revenue under consideration falls far short of what is needed to sustain basic public investments.
Senate Bill 6635 would narrow two costly tax breaks – a business tax deduction for out-of-state banks and a sales tax exemption on certain telephone services – while extending tax preferences for other industries. No fiscal note has yet been produced, but a rough analysis suggests the measure would generate $40 million to $50 million in additional tax resources in the coming 2013 fiscal year. (In comparison, the current House budget proposal would cut roughly $315 million from Washington’s core health and economic services).
SB 6635 would:
• Narrow a business tax break for out-of-state banks: Under current law, banks are allowed to deduct interest payments they receive from 1st home mortgages from their state Business and Occupation (B&O) taxes. The bill would limit eligibility for this deduction to banks that operate in fewer than 10 states.
• Eliminate a sales tax exemption on certain phone services: Payphones, local residential calls, and calls from cell phones made by out-of-state residents are currently exempt from the sales tax. SB 6635 would repeal this exemption.
• Extend a B&O exemption for fruit, vegetable, seafood processors: A B&O exemption for companies that process fruits, vegetables, and seafood products is currently set to expire on July 1st of this year. These businesses will then be eligible to receive a preferential B&O tax rate of 0.138 percent. The bill would extend the exemption through July of 2017.
• Enact larger B&O tax breaks for newspapers: SB 6635 would provide a preferential B&O rate of 0.365 percent for newspapers. That rate would fall to 0.35 percent after July 1, 2013. Under current law, different B&O rates are applied to various activities related to newspaper publishing. The activity of printing a newspaper currently receives a preferential rate of 0.2904 percent while publishing a newspaper online is taxed at the ordinary rate for service businesses of 1.8 percent. The bill would consolidate these activities into single new category taxed at 0.365 percent, which would then fall to 0.35 percent at the end of the 2013 fiscal year.
• Codify an exemption for shipping and cargo companies: Historically, the state Department of Revenue (DOR) has not collected Leasehold Excise Taxes (LET) from companies that lease publicly-owned cranes and docking facilities to unload cargo. After reviewing this activity, however, the Department recently announced these activities are subject to the LET. SB 6635 would create a LET exemption for these companies.
SB 6635 is a good first step in addressing our flawed revenue structure through closing tax breaks and loopholes. However, with proposed deep cuts to essential public services such as healthcare and economic services, now is not the time to extend and enlarge other tax preferences.