Washington is one of only seven states without a personal income tax, but a new initiative introduced by a coalition of liberal activists including Bill Gates Sr. would change that by introducing an income tax on the state’s “high earners.” Gates is the father of Microsoft Corp. cofounder Bill Gates Jr.
Individuals earning more than $200,000 and couples earning more than $400,000 would be subject to a two-level graduated income tax of 5 percent or 9 percent, depending on how much they earn above the initial income tax threshold.
Despite legislative approval of tax hikes on cigarettes, bottled water, candy, soda, beer, service businesses, and other things during Washington’s 2010 legislative session, supporters of the income tax (Initiative 1098) argue it is long overdue.
To win popular support, the initiative includes a 20 percent reduction in the state portion of the property tax and a $4,800 business and occupation tax credit. That tax carrot would leave 97 percent of Washington’s taxpayers the same or better off, while only 3 percent would feel the pinch of the new income tax. For this reason, initiative backers believe it will qualify for the ballot and has a strong chance of passing in the November election.
Promises Easily Broken
Under I-1098 a trust fund for education and health services would dedicate income tax revenues almost exclusively to those priorities. In practice however, legislators routinely raid dedicated accounts in order to balance the general fund or redirect funds to priorities they consider more important at the time. Budget crises tend to exacerbate this behavior.
Another problematic claim concerns the property tax cut. Taxpayers who believe they will experience a 20 percent reduction in their property tax bill will receive a rude awakening: The state portion of the property tax accounts for only 21 percent of a property owner’s bill, meaning the real property tax cut amounts to only a 4 percent reduction.
Withholding System Planned
One of the most contentious parts of I-1098 sets up a new withholding system nearly identical to federal withholding, where individuals subject to the tax must pay throughout the year. Initiative authors believe the withholding system would allow a graduated income tax to pass a constitutional challenge.
The withholding system is an attempt to evade a 1933 State Supreme Court decision striking down a graduated income tax based on Article VII, Section 1, of the Washington Constitution, which requires that all property taxes be uniform. Property is explicitly defined in the same section as “everything, whether tangible or intangible, subject to ownership.”
Critics of the initiative say that’s enough to cast serious doubt on the measure’s constitutionality.
Legal Challenges Expected
Mike Reitz, general counsel for the Evergreen Freedom Foundation in Olympia, Washington, believes the initiative will face steep constitutional hurdles if passed.
“The initiative’s proponents want to erase 75 years of case history by claiming the income tax does not tax one’s property but merely taxes the act of receiving property. This is not a constitutionally significant distinction,” Reitz said.
If the initiative does pass constitutional muster, detractors claim the strict bracket limits would soon be ratcheted down to include lower-income earners. Initiative authors attempted to address the issue by including a clause requiring a majority vote of the legislature and of the people to change tax brackets or rates.
Lawmakers May Override
Under Washington’s Constitution, however, a simple legislative majority may override or modify any portion of an initiative after two years. Taxpayers are still smarting from the legislature’s recent suspension of another popular initiative’s two-thirds requirement for tax increases after its two-year limit was up earlier this year. The suspension serves as a reminder that initiative provisions are hardly binding.
One of the primary claims of state income tax supporters is that the tax would remove volatility from Washington’s revenue system, but Joe Henchman, tax counsel for the Tax Foundation, points out income taxes are less stable than sales and property taxes. He says income taxes on high earners are particularly volatile, making sound budgeting difficult.
Income Taxes Can Swing Hard
“In good times, income taxes grow faster than sales or property taxes; in bad times, income taxes fall more than sales or property taxes. For instance, from 2008 to 2009, state individual income tax collections fell 12.5 percent, while sales tax collections fell 5.5 percent and property tax collections actually grew 3.6 percent,” Henchman said.
Evergreen Freedom Foundation Senior Fellow Bob Williams, who is also director of Statebudgetsolutions.org, argues a state income tax would cause Washington to lose one of its primary competitive advantages over other states.
“Washington routinely ranks among the most highly-taxed states in our existing categories of taxation—whether sin taxes, the gas tax, sales tax, or worker’s compensation rates. Our state’s primary saving grace is that we are among the elite few without an income tax,” Williams said.
He says higher earners who are fleeing high-tax states such as New York, New Jersey, and California will no longer seek refuge in Washington, which hurts investment and economic growth.
“As a state, we would do well to profit from other states’ poor policy choices, not emulate them,” Williams said.
Amber Gunn ([email protected]) is director of the Economic Policy Center at the Evergreen Freedom Foundation in Olympia, Washington.