Research & Commentary: Seattle Income Tax Seeks to Bypass the Will of Washington State Voters

Published August 16, 2017

In July, the Seattle City Council unanimously approved a controversial income tax on wealthy residents. The new measure levies a 2.25 percent tax on total income above $250,000 for individuals and above $500,000 for married couples filing their taxes together. The city council estimates the new tax would raise about $140 million per year and cost $10 million to $13 million to set up, in addition to an annual cost of $5 million to $6 million per year to maintain and enforce the tax.

Everyone, including the city council, knows the new tax, as constructed, violates state law. The only reason the council passed the law was to challenge Washington state’s long-held position against the income tax.

The Washington State Constitution specifically states property must be taxed at a uniform rate, and as the Washington Policy Center points out, the state Supreme Court has ruled on several occasions that income is property. Washington voters have also roundly rejected on four occasions efforts made by the legislature to redefine an income tax as an “excise tax.”

The end goal of this tax increase is clear: The city hopes to successfully challenge legal precedent blocking the income tax in Washington state, allowing governments across the state to override the will of the people.

Millionaire taxes, like the new Seattle tax, are an unreliable source of revenue. Scott Hodge of the Tax Foundation notes millionaire status is both temporary and fluid. Many taxpayers achieve millionaire status only once in their lifetime. In addition, the number of millionaires fluctuates based on the business cycle. Before the recent recession, between 2002 and 2007, the number of millionaire tax returns more than doubled to a record 392,220; as a result of the recession, the number fell by 40 percent between 2007 and 2009.

A millionaire tax is likely to discourage both new capital and wealthy taxpayers from entering a city or state.  Higher taxes drive wealthy taxpayers out of the city, taking their income, capital, and tax revenues with them. The revenue-generating results of millionaire taxes have been mixed—many states that increased taxes on the upper brackets, including Maryland, New York, and New Jersey, have allowed their tax hikes to expire.

Relying on a fluctuating tax with a small base like the millionaire tax can lead to larger budget deficits than with broader and flatter tax systems. City based income taxes are even more difficult, as moving out of the tax base only requires a short move. While some supporters of the amendment argue large-scale relocation by wealthy taxpayers is not likely to occur, the negative effect of Maryland’s millionaire tax provide a stark example of what new tax’s effect will be. In 2009, Maryland created a millionaire tax projected to raise an additional $106 million. Instead of providing the expected new revenue, by the next year, the number of people in the state reporting incomes of $1 million or more fell by one-third. Maryland took in $100 million less from millionaire earners than the previous year, and the state allowed the tax to expire in 2010.

According to the Tax Foundation, the Seattle ordinance justifies the tax increase by pointing to the prevalence of local income taxes in cities across the country. This claim is misleading and troublesome. The majority of cities imposing local income taxes are in two states, Ohio and Pennsylvania, and the presence of a disruptive tax in one city is does not mean all cities should adopt it.

While income taxes are often sold to the people as a tax on the rich, like in Seattle, they never remain that way. Income taxes always expand over time to cover increasingly more taxpayers, due to government’s insatiable need for tax revenue, which it uses to fuel out-of-control spending. Instead of increasing taxes on higher earners, Seattle’s elected officials should focus on making the city a more attractive place for businesses and workers, a goal that would best be accomplished by restraining spending, lowering tax rates, and reducing unnecessary regulations.

The documents cited below examine millionaire taxes and their history of failing to shore up budgets and increase revenue.

Seattle Passes Municipal Income Tax; It is Almost Certainly Illegal
Scott Drenkard of the Tax Foundation examines Seattle’s proposed income tax on higher earners. Drenkard argues the tax goes against the will of Washingtonians and is an illegal law that seeks to use the legal system to impose an income tax in Washington. “So, in the textbook sense, enacting an illegal tax violates the public finance principle of stability because you are creating business uncertainty about future tax burdens. But even on a more basic level, this charade invites some head-slapper questions like: if you say you need more revenue for government programs, why would you willfully set yourself up to spend revenue on a legal battle?” wrote Drenkard.

Why You Should Care about Seattle’s Plan to Impose an Income Tax
Jason Mercier of the Washington Policy Center discusses the Seattle income tax and criticizes the city council’s effort to use the city tax as a backdoor challenge to the state’s laws rejecting the income tax. “One thing is certain, if Seattle opens the door to an income tax in our state, we will constantly be hearing from the tax collectors as the income tax expands to target more taxpayers and the tax rate creeps higher and higher,” wrote Mercier.

Ten Principles of State Fiscal Policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”

Taxing the Rich Will Bankrupt Your State
John Nothdurft of The Heartland Institute explains the disadvantages and negative consequences of “millionaire” taxes and overtaxing the top income brackets.

Trend #1: “Millionaires’ Taxes”
Joseph Henchman of the Tax Foundation examines the millionaire tax trend in this Fiscal Fact article. “A number of states have enacted high income taxes on those with large incomes. Although nicknamed ‘millionaires’ taxes,’ they have hit income at much lower levels. The trend seems to have petered out although California and Maryland may see further action,” Henchman writes.

Should We Raise Taxes on the Rich?
Peter Ferrara, senior fellow for entitlement and budget policy at The Heartland Institute, writes in the American Spectator about “taxing the rich” and explains why such policies make no fiscal sense.

Long-run Macroeconomic Impact of Increasing Tax Rates on High-Income Taxpayers in 2013
This report from Ernst & Young conducted on behalf of the Independent Community Bankers of America, the National Federation of Independent Business, the S Corporation Association, and the United States Chamber of Commerce examines the long-term impact of an increase in top income tax rates.

The U.S. Tax System: Who Really Pays?
Writing for the Manhattan Institute, Stephen Moore examines popular conceptions and misconceptions about the impact of tax rates on economic productivity and fairness, addressing these statements and debunking attendant myths. He provides useful information on how the rich are taxed and how much they contribute.

Seven Myths About Taxing the Rich
Curtis S. Dubay of The Heritage Foundation considers seven commonly cited myths about policies to tax the rich. Dubay argues raising taxes on the rich would increase the progressivity of an already highly progressive tax code. It also would damage economic growth by stifling job creation, further slowing already stagnant wage growth. Although some see raising taxes on the rich as a silver bullet for fiscal woes, it actually badly damages the economy, he writes.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.

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