Analyzing The Claims About I-1107

Proponents of Initiative 1107 are making a number of claims about the recent taxes on candy and other non-essential products that were enacted earlier this year to prevent deeper cuts in state priorities. In this post, we analyze these claims:

• The claim that the definition of candy is too complicated and is harmful to businesses is misleading and out of context;
• The argument that the legislature applied new taxes to meat and vegetable products, but didn’t apply these taxes to similar products from other states or countries, ignores key facts; and
• The claim that the taxes enacted earlier this year harm Washington’s economy runs counter to mainstream economic theory.

The claim: The definition of candy is too complicated and is harmful to businesses.

Analysis: Misleading. Proponents fail to put the issue in context.

Proponents of I-1107 claim that the definition of candy, used to administer the sales tax in Washington, is too narrow and is difficult for businesses to comply with.  They note that the current definition of candy excludes products with flour resulting in some sweets not being defined as candy.  Proponents fail to mention a number of positive aspects about the way candy is defined – including the fact that the definition arose from a multistate effort to reduce tax compliance costs for businesses.

• The definition of candy is part of a broader effort to reduce costs for businesses:  For sales tax purposes, the definition of candy used in Washington was developed by businesses and state tax policy specialists from around the country as part of the Streamlined Sales and Use Tax Agreement (SSUTA). Under SSUTA the 23 participating states (including Washington) have agreed to adopt a uniform set of sales tax base definitions and to develop statewide sales tax databases, containing comprehensive information on taxable products and state and local tax rates by zip code. These provisions, among others, are designed to help large Internet and mail-order businesses collect and remit state and local sales taxes.

• SSUTA helps small in-state businesses compete with large out-of-state businesses: Small in-state businesses are required to charge sale taxes on taxable sales in Washington, putting them at a competitive disadvantage to out-of-state mail order and internet retailers that are able to avoid collecting sales taxes. The SSUTA helps level the playing field between in-state and out-of-state retailers by making it easier for the larger businesses to charge sales taxes on Internet and mail-order purchases from in-state customers. See here for more information on the Streamlined Sales Tax Agreement.
  

• Washington is hardly alone in using the SSUTA definition of candy: At least eight other states – Iowa, Kentucky, Minnesota, North Carolina, North Dakota, New Jersey, Rhode Island, and Tennessee – currently tax candy under the SSUTA definition.
• The SSUTA candy definition prevents taxation of non-candy products:  By excluding products that contain flour, the SSUTA definition of candy ensures that bakery products and confections -- like scones, cookies, rolls, and other products that are generally not considered to be candy – are not subject to state sales taxes.
• Actions are being taken to help small businesses comply with the new taxes:  To help small businesses identify taxable candy products, the Department of Revenue (DOR) has developed a searchable on-line database containing over 12,500 different products.  The database is available on the DOR website.
  

The claim: The legislature applied new taxes to meat and vegetable products, but didn’t apply these taxes to similar products from other states or countries.

Analysis: Misleading. The legislature simply clarified two small business tax preferences earlier this year to ensure they achieve their intended purposes.  Under state and federal law, Washington cannot levy state business taxes on out-of-state manufacturers that have no physical presence here.

Proponents of I-1107 argue that the legislature placed new taxes on meat and vegetable products this year.  They further argue that these taxes are unfair because they only apply to businesses located in Washington State.  This ignores or misrepresents the following factors:

• No new taxes on processed foods were enacted this year:  Early in 2010, the legislature clarified and narrowed two Business & Occupation (B&O) tax preferences, originally intended only for meat packers and companies that can or preserve fresh fruits and vegetables.  Due to vagaries in the law, businesses whose products contained only minor amounts of meat or preserved fruits and vegetables were able to claim these preferences, even though the intent of the preferences was not to benefit these businesses. The expanded preferences cost the state more than $4 million per year in foregone tax revenues. To reclaim these resources, this year lawmakers clarified and narrowed both preferences.  As a result, a small number of businesses will no longer be able claim these preferences (often referred to as “tax subsidies” by economists) and will be required to pay the same B&O tax rates that similar businesses pay.  For more information on these preferences read the following schmudget post.
• The U.S. Constitution prohibits Washington State from levying similar taxes on out-of-state manufacturers:  Under state and federal law, Washington is barred from levying B&O taxes on firms that do not have nexus (a firm connection) with the state.  State law mandates that out-of-state manufacturing firms must own property or have employees or agents working here in order to be subject to taxes on activities conducted in Washington.   This means that the state cannot levy taxes on a meat or vegetable processing business located in another state if that business has no employees or property in Washington. That does not necessarily mean out-of-state manufacturers of processed foods have an advantage over in-state business, however. That’s because:
• Products from out-of-state businesses are still subject to wholesaling and retailing B&O taxes in Washington:  While Washington cannot tax businesses located in other states, products from these businesses are subject to wholesaling and retailing B&O taxes here.  Additionally, out-of-state businesses are subject to state taxes in the state(s) in which they are located. It’s also important to note that other states are similarly prohibited from taxing production activities that occur exclusively in Washington.

The claim: The taxes enacted earlier this year harm Washington’s economy.

Analysis:  False.  The modest revenue package enacted earlier this year prevented economically-damaging cuts to essential public services.

Proponents argue that the taxes targeted by I-1107 should be repealed because they are harmful to Washington’s economy.  Again, they fail to place this issue in the proper context.  Mainstream economic theory indicates that state tax increases enacted during a recession prevent further economic damage by preserving core public services vital to the state’s overall well-being.

• Budget cuts are more harmful to state economies than tax increases during a recession:  When budget shortfalls occur, mainstream economic theory suggests that a “cuts-only” approach is the most economically-damaging choice state policymakers can make.  During the recession of the early 2000s, Nobel Prize-winning economist, Joseph Stiglitz, and Peter Orszag, former Director of the Congressional Budget Office and the Office of Management and Budget, wrote that large budget cuts produce the most drag on state economies during a recession – reducing overall demand in the economy on a dollar-for-dollar basis.  At the same time, Stiglitz and Orszag found that state tax increases reduce economic activity by a lesser extent because some of the money used to pay the additional taxes comes from residents’ savings or from out-of-state taxpayers.   As a result, tax increases used to preserve public services – as was done in Washington – is the most sensible course of action for state policymakers.  This view has been endorsed by more than 20 economists and public policy experts here in Washington. For more information, read the 2000 report from Stiglitz and Orzsag.