A single-rate income tax system would be simple, fair and transparent and negate the need for any other tax.
THE state Legislature is in a fiscal bind. Can it find billions of dollars for education and transportation without exacerbating Washington’s notoriously regressive state and local tax system? The answer is no, not without tax reform.
A 2014 study I wrote,“Washington State and Local Tax System: Dysfunction and Reform,” compares our tax system with all other states, focusing on five characteristics: fairness, adequacy, stability, transparency and economic vitality. The findings indicate that Washington has the worst tax system in the nation.
• Fairness: The Washington State Tax Structure Study Committee found that in 1999 the state’s lowest-income households paid 15.7 percent of their income on state and local taxes, while the highest-income households paid just 4.4 percent. This meant that the lowest-income households had to work 8.2 weeks out of the year to pay their tax bill, while the highest-income households had to work only 2.3 weeks. In 2013, the Institute on Taxation and Economic Policy concluded that Washington’s sales-based tax system was the most unfair in the nation.
• Adequacy: This is the ability of a tax system to generate sufficient revenue to meet our public needs. The state and local effective tax rate of all states (tax revenue as a percent of personal income) has averaged 10.6 percent and been quite stable since 1970. In contrast, the Washington effective tax rate fell from 11.4 percent (the 12th highest in the nation) in fiscal year 1995 to 9.4 percent (the 37th highest) in fiscal year 2012. By taxing at a rate below the 10.6 percent national norm from fiscal year 2005 to fiscal year 2012, Washington forfeited $17.1 billion in tax revenue, enough to pay for the 520 bridge, the Alaskan Way Viaduct replacement and the state Supreme Court’s education mandate.
• Stability: This refers to the stability of the effective tax rate over the course of economic cycles. Due to the inadequacy and volatility of the sales-tax base, Washington had the 47th most stable tax system between fiscal years 1995 and 2011.
• Transparency: Every household and business should know how much it pays in taxes, a prerequisite for rational tax policy. Individual income taxes are totally transparent, but sales taxes are only partially transparent since few of us keep track of our total tax payments. Without an income tax, Washington has the nation’s second, least transparent tax system.
• Economic vitality: Last year, the Tax Foundation rated Washington as having the sixth best business tax climate. The foundation contends that the lack of an income tax gives Washington an advantage in attracting businesses and jobs.
A statistical test shows that there is in fact no correlation between the business-tax-climate ranking of a state and its job growth. Washington and Oregon have fundamentally different tax systems — Washington has no income tax, while Oregon has an income tax but no sales tax — yet their economies have expanded at identical rates since 1970.
There is no good reason why Washington has to live with its dysfunctional state and local tax system. Indeed, if the state adopted a flat-rate personal income tax with a preferred rate of 10.6 percent, it could have the best — not the worst — tax system in the nation.
Consider the advantages: The single-rate income-tax system would be simple, fair, adequate, stable and transparent and would not adversely affect economic vitality. With a 10.6 percent rate, there would be no need for any other tax.
There is one hitch. Since Washington is currently taxing well below the norm, the 10.6 percent rate implies an increase in taxes, though not for everyone. Low-income households would pay less, middle-income households would pay about the same and high-income households would pay more.