Washington State's Broken Tax System

by John Stafford

Washington State has a dysfunctional tax system — arguably the nation's worst. It is critical to understand the mechanisms by which this flawed tax system adversely impacts progressive public policy development in our state.

Washington is one of just seven states with no personal income tax. This leads to an excessive reliance on the highly regressive sales tax. It is also one of just three states that tax corporations based on their revenues (the business and occupancy, or "B&O" tax) rather than their profits. This penalizes unprofitable firms (often start-ups), who would not pay taxes until they were profitable in other states. And Washington is the only state in the nation that uses both of these inferior approaches.

This taxation system has numerous drawbacks. First, as is commonly known, Washington has the most regressive tax system in the country. Washington's poorest 20% pay 16.9% of their income in state and local taxes, compared to 2.8% for the top 1% — a ratio of six, the worst in the nation (source: Institute on Taxation and Economic Policy). The business tax is regressive as well. The conservative Washington Policy Center writes: "The problem is that the base includes unprofitable businesses, so if you readjusted the base to exclude unprofitable businesses, those who are profitable would see their tax rates rise." The business tax structure also contains numerous exemptions, whose benefits are skewed toward large, profitable firms with lobbying clout. Second, it is the regressive nature of Washington's tax system that precipitates the ongoing stream of voter initiatives to limit tax increases (e.g., I-695, I-747, I-960, I-1033, I-1053, etc.) as lower and middle class citizens seek to limit the burden placed on them by the regressive system. Even though some initiatives fail and others are overturned, the movement-at-large is influential. The Economic Opportunity Institute comments on this connection between regressivity and tax reduction: "…the disproportionately high tax burden placed on middle and low income families by Washington's regressive tax system has led many to support tax cutting initiatives that hobble state and local government." Third, and consequently, Washington State has become a low taxation state. Higher income states tend to have higher state and local taxes per capita. But this is no longer true in Washington State. Despite being a high income state (13th in the nation), Washington fell from 11th to 37th place in state and local taxes as a percentage of personal income between 1995 and 2011 (source: Washington State Office of Financial Management).

This decline in tax position is hindering the state's ability to adequately fund its most important obligations — a recurring phenomenon that is on constant display in our daily news. Washington's K-12 education spending per pupil as a percent of personal income is 44th in the nation. This has brought forth the State Supreme Court's McCleary decision, calling for a significant increase in spending. Predictably, Washington's legislators are having a difficult time complying with this decision. Washington is 49th in the nation in mental health treatment capacity. This has also triggered a judicial intervention. Higher Education suffered major reductions in state funding during the Great Recession, which gave rise to the second highest tuition increases in the country. State employees and teachers have forgone cost-of-living wage increases for years. And so on.

Washington State is generally seen as one of the most progressive states in the nation, and yet it has the most regressive tax structure in the nation. It becomes important to ask: is this merely an ironic dichotomy, or is there more to it than that? Here, it is worth noting a loose parallel between national and state tax dynamics. In Washington D.C., a common conservative tactic is to reduce taxes in order to deprive the government of the funding needed for liberal programs ("starving the beast"). In a more roundabout way, Washington State's tax structure engenders a similar dynamic. A poorly designed tax structure drives intense regressivity, which foments efforts to constrain taxes, which has contributed to a decline in Washington's rank in tax revenue as a percent of personal income, which has led to a series of institutions to be underfunded. To address this challenge, legislators, with progressive taxation options off the table, are forced to consider additional regressive taxes. In this manner, Washington's tax structure forces the progressive agenda to work in opposition to itself. That is, there is the desire on behalf of liberals to fund progressive priorities — K-12 education, mental health, higher education, cost-of-living wage increases, etc. But to do so, they must decide whether to inflict further financial burden on the lower and middle classes — the very classes that these programs are intended to support.

In Washington, our dysfunctional tax system frustrates the progressive policy agenda — to the detriment of the state. Indeed, it is hard to imagine the state successfully meeting its basic institutional funding obligations over the long term without fundamental tax reform.

John Stafford is a substitute teacher for Seattle Public Schools and a former management consultant in corporate strategy. He recently completed a run for State Senate in the 37th District. He will be writing a monthly article on public policy for the South Seattle Emerald