Legislature considers limiting costly tax preference for banks

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.