Think Washington is Unstable Now? Just Wait for the Income Tax

New Research Council Report Challenges Long-Held Belief – A Wobbly Leg for the State Stool

By Erik Smith

Staff writer/ Washington State Wire

OLYMPIA, June 10.—One of the best-loved arguments for a Washington-state income tax is that it would make the state’s tax system more stable. But a new report from the Washington Research Council says there’s a serious flaw in that thinking, at least when it comes to a proposal that could come before voters this fall.

            The high-earner income tax proposed by Initiative 1098 would make the state even more vulnerable to economic downturns, it says. That’s because it’s a soak-the-rich measure that would apply only to those who make more than $200,000 a year.

            Who makes that kind of money? Real-estate developers, entrepreneurs, high-end salespeople, software jillionaires. Those are the same people who suffer the most when the economy tanks, said economist Kriss Sjoblom. “This is going to be a really, really volatile tax,” he said. It’s going to create all kinds of problems. The Legislature will face a tremendous amount of pressure to spend all the money as it gets it. The Legislature wants to be responsible, but the political pressure will be difficult to resist. So you’ll see revenue and spending yo-yo in good times and bad times.”

            Challenges Article of Faith

            The argument from the business-oriented think tank challenges one of the most cherished beliefs about a state income tax. Washington has been arguing about the matter for the last 77 years, ever since the state Supreme Court tossed out a Depression-era income tax passed by the Legislature. Every ten to 20 years, the issue is raised anew, and the effort has fizzled every time. Today Washington is one of only seven states that does not impose its own income tax.

            The basic idea is that an income tax would allow the state to raise more money from taxpayers to pay for government programs. The proposals are never truly revenue-neutral. But that’s usually not the way the argument is presented. Instead, it’s almost always an argument about stability. 

            The idea is that if the state had another revenue source – an income tax – the state would be less vulnerable to trouble the next time the economy goes into the toilet.

            That argument doesn’t work very well even with an ordinary income tax, Sjoblom said. But when it comes to a high-earner tax, it’s exactly the opposite. The state would become even more vulnerable to economic problems, he maintains.

            And that points up the irony of I-1098, which is being backed by a coalition of social-service organizations, labor groups, and certain influential members of the business community – Bill Gates, Sr. in particular. The very element that may give the measure the best chance of passage in nearly eight decades is the fact that 100 percent of the population will be asked to pass a tax on three percent of the population.

            If things go as Sjoblom suggests, the state would find itself in heap big trouble the next time the economy crashes. That could mean the Legislature would feel pressure to extend the tax to the entire population.

            The Four-Legged Stool

            The easiest way to explain the argument is to use a metaphor that comes up every time an income tax is considered. The state right now has a three-legged stool. Its tax structure is supported by property taxes, sales taxes and Washington’s one-of-a-kind business and occupations tax, which is levied on gross receipts.

            If you add a fourth leg – the income tax – the stool is supposed to be more stable.

            But what if that fourth leg is really, really wobbly?

            That’s what it amounts to, Sjoblom said. The tax is supposed to raise $1.7 billion a year – about 10 percent of the amount the state receives each year in taxes.

            That money is supposed to come from those who are most dependent on the economy’s rise and fall, and whose incomes are most volatile. The Legislature will feel pressure to spend every dime that comes in – that’s what happens every year. Now suppose the economy crashes again – as it did in 2008 and 2009, and as seems to happen once every decade. What’s going to happen if a big chunk of that 10 percent goes away?

            “If it drops as we’ve seen, say 50 percent in a year, that translates into a five percent decrease in revenue,” Sjoblom said.

            Add that to all the other problems the state faces in a downturn and he says dependence on a high-earner income tax would make the state’s economic problems even worse.

            The funny thing is that if the tax was extended to the entire population – the other 97 percent – it would be a more stable source of income, Sjoblom said. Exactly how stable is a matter for economists to debate – and of course, a thousand other economic arguments enter the picture if that happens. But it illustrates one of the strangest things about this year’s proposal.

The argument that an income tax would make the state’s tax system more stable has been sounded so many times over the years that it has become a matter of folklore. There are reams of dusty reports and studies that have been produced over the years, and of course they go both ways. But until now everyone has been talking about a tax that hits everybody.

            That’s not what’s on the table this time, Sjoblom said. People seem to forget that.

            Stability is Big Selling Point

            It might seem an obvious argument, but until now, no one has raised it – and that’s what seems so striking about the Research Council report. Every time proponents have talked about the latest income tax proposal, stability has been one of the big advantages.

            For instance, Senate Majority Leader Lisa Brown, D-Spokane, wrote in her blog earlier this year that a tax on high earners would “bring more fairness and stability to our sales-tax-dependent tax structure.”

            And at the kickoff news conference for the income-tax initiative, Gates declared, “Our tax code is unfair. It harms our economy and fails to provide the stable revenue we need for important state services, particularly priorities like education and health care.”

            Queried about the Research Council report, Sandeep Kaushik, spokesman for the I-1098 said of course the income tax would bring greater stability. But exactly how is an argument for the economists.

            “The answer to that is that a more diversified tax structure in our state will make our state tax structure more stable,” he said. “The tax structure we have right now was put in place in the 1930s, and there have been a lot of changes since then. We’ve moved away from a manufacturing economy and we have seen growing disparities of wealth. The tax structure is proving itself to be increasingly incapable of dealing with our economy. Adding greater diversity to our revenue stream over time is going to add greater stability to our tax revenues and allow us to maintain our core services.”

            More Work Needed

            To be fair, the Research Council’s argument isn’t fully fleshed out. For instance, the report doesn’t examine how the state might have fared, if the high-earner income tax had been in place when Wall Street collapsed in 2008 and the state found itself $12 billion short. Would the problem have been worse?

Sjoblom’s gut feeling is yes, but a detailed analysis of the numbers will have to wait until after I-1098 makes the ballot. “Assuming they collect the signatures, this will be a five-month dialogue,” he said.