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Sunday, June 06, 2004 - Page updated at 12:00 A.M.

Guest columnist
Washington state's upside-down tax system

By Hugh D. Spitzer
Special to The Times

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Governments often devise tax systems to influence behavior and support public policy. For example, cigarette and liquor taxes intentionally reduce consumption as they raise revenue. High-tech industry tax breaks are meant to stimulate new jobs. This is an accepted, though debated, practice.

But the reverse — a tax system that drives public policy — is backwards and causes distorted behavior by governments as they hunt for revenue to provide public services: for example, converting residential and open space to retail development, specifically to generate more sales-tax dollars.

The universally accepted ideal — a balanced system of several local taxes at low rates — remains elusive.

Now, our state's backwards tax system, with its heavy reliance on the sales tax, is facing more difficult challenges, with local governments currently in a fight over Washington's role in a national proposal to tax Internet and interstate catalogue sales. If enacted, the proposed system could shake up decades of local policy decisions that were made to increase revenue under our existing sales-tax system.

First, some history: Bellevue, Lynnwood and Tukwila, among other cities, made key choices to accommodate and enable the expansion of regional shopping centers because of the sales taxes they bring in. There is nothing wrong with encouraging retail commerce, but the three cities might not have made the same land-use, environmental and traffic-impact decisions if they were not keeping an eye on those giant tax engines.

Likewise, when construction of Safeco Field hung in the balance, the Seattle City Council was poised to kill it because of public opposition to what was perceived as an oversized subsidy of the Mariners. Then a study demonstrated how much sales-tax revenue would be generated by fans streaming into Pioneer Square, and the council voted to support the project. Those of us who are Mariners fans are thrilled with Safeco Field. But it is still fair to ask whether new sales-tax revenue should have had such a large effect on the City Council's policymaking.

In Kitsap County, many Silverdale residents want to incorporate to better control their destiny. But the county government has fought incorporation because it would wipe out 30 percent of the county's sales-tax revenue, much of it from Silverdale Mall.

This has been repeated across the state as revenue-starved counties battle to maintain revenues to pay for services residents demand. But counties should not have to make decisions about incorporations and annexations based on "profit and loss."

Internet sales taxes

Washington's local tax system is based on sales taxes, property taxes and, for cities, business gross-receipts taxes. Because of property-tax cuts by voter initiatives, and widely varying sales-tax revenues, most jurisdictions are without the funds to adequately support local services. This frustrates both public officials and the taxpayers they serve.

The defects of our upside-down local tax system that drives policy instead of the other way around were highlighted in an intense dispute in Olympia this past session.

The battle involves Washington's decision to comply with a uniform sales-tax process for all states, which Congress has required before it will permit taxation of interstate catalogue and Internet sales. The proposal is to make state sales-tax definitions similar from state to state (so that "seller" means the same thing nationally); to make tax bases uniform (so similar activities are defined similarly for tax purposes); and to direct sales-tax revenue to the jurisdiction where the purchaser resides (to prevent double taxation, once by the jurisdiction where the product is purchased or shipped from, and once by the jurisdiction where the buyer lives).

This interstate tax-reform project has wide support. The private sector wants a consistent system nationwide, and many local enterprises want to stop the loss of business to the "tax-free" Internet. Governments welcome the added revenue from everyone paying their fair share of taxes, regardless of where or how they buy products.

Winners and losers

But change means winners and losers.

The states involved in the sales-tax-uniformity project voted to "source" sales to the point of delivery. That means when someone buys a shirt over the Web from Wisconsin and takes delivery in Seattle, Washington state and the city of Seattle (not Wisconsin) share the sales tax. Good news for Washington and Seattle.

But Washington has historically sourced taxes to the place of shipment. Under our old system, if someone ordered a sofa at Tukwila's Southcenter that was shipped from a Kent warehouse to a Seattle home, Kent would get the local sales taxes. When Washington switches to the new system and taxes go to the buyer's hometown, Seattle will receive the taxes. Good news for Seattle. Very bad news for Kent.

A recent Washington State University study predicted that 187 Washington cities would be "winners" from the change, but 97 would be losers. Seventeen cities would lose more than 10 percent of their sales-tax base. Kent, which actively encouraged retail and warehouse activity, would lose nearly 12 percent of its sales-tax base. Lynnwood and Tukwila, which promoted the growth of their regional shopping centers, stand to lose about 9 percent. The cities that stand to lose tax receipts have forcefully demanded that if Washington conforms to the national standard and sends sales taxes to the point of delivery, the Legislature should redirect some local revenue back to the community that would have received it under the old method. Legislators have been unable to broker a compromise.

Fair Criticism

The losers' vehemence highlights a fair criticism. They argue to lawmakers: "You made the sales-tax rules. We played by those rules. We built our land-use policies around them, encouraging commercial developments that yield tax dollars we can use to serve our citizens. Now, just as voters are slashing local property- and car-tax revenues, you are changing the rules."

That is a fair criticism. But it provokes some questions: How did we wind up with a local tax system that caused cities to make key land-use and investment decisions based on generating more taxes? Taxes are supposed to enable governments to carry out policies our elected leaders make. But is the search for tax money supposed to drive those policies? The business of business is to make money. But is the business of government to make money?

Certain tax principles go back to the 18th century economist, Adam Smith: A tax system should be fair, stable, simple and adequately support government activities. But a tax system should also be economically neutral, meaning that it should not distort business decisions by forcing companies, because of tax consequences, to opt for strategies they would not otherwise choose.

The same goes for local governments, which should not be driven to make distorted land-use, public-investment and strategic decisions to "profit" from more tax collections. Governments are not in the money-making, profit and loss business. They exist to ensure public safety and improve the quality of life. But many public decisions have been heavily influenced by the drive to obtain revenue.

A sensible approach

A sensible local tax system would be based on balance, stability, fairness and adequacy.

Balance and stability come from having several types of local taxes, all at low rates. This ensures that most activities are taxed, but at levels that do not adversely affect business and personal decisions.

A balanced local tax system for cities and counties would include business and occupation taxes, utility taxes, sales taxes, per-employee payroll taxes, property taxes and motor vehicle taxes. Yes — property and car taxes. Those are stable because land and car values do not swing wildly with the economy. They are a proper part of a local tax system so long as the rates are both modest and fair. Furthermore, surveys show that voters are much more supportive of property taxes when the money is used close to home, such as for schools. And business taxes based on the number of employees is a good way to support services to commuters.

Our local tax system will be fairer to individuals if the sales tax does not play too big a role. Sales taxes hit low-income people harder because they must spend almost everything to get by, thus paying a disproportionately high share of their income on taxes. Our local tax system will be fairer to business when local sales and gross receipts tax rates and calculation methods are similar from place to place.

Adequacy comes when governments have enough revenue to do what taxpayers demand. Since the 1980s, governmental revenue and services have not kept pace with the rapid growth of Washington's economy and population. The choice is simple: Either revenue has to keep up with population growth or services must go down. (Certainly, government efficiencies can help, too.) But a broad range of taxes at low rates is the best solution, because the impact is spread and bites individual taxpayers less.

Equalization

Some type of "equalization" should be reinstated so that poorer communities have access to adequate revenues. The motor vehicle excise tax previously funded payments to governments that did not have sufficient commerce to yield high sales-tax revenues. Repeal of the MVET after Initiative 695 destroyed equalization. Although the point-of-delivery taxing mechanism will help these entities, equalization may still be necessary.

Washington's local tax system is broken and needs fixing.

We deserve a system where taxes provide sufficient resources to cities and counties, a system that is stable and fair to taxpayers and business.

And we need a right-side-up system of low rates spread over a range of taxes that enables governments to act based on public safety and quality of life policies the public demands, rather than desperately basing policies on tax profits and loss.

Hugh D. Spitzer was vice chairman of the Washington State Tax Structure Study Committee in 2002. The opinions expressed in this commentary are solely his own, and do not reflect the views of any client.

Copyright © 2004 The Seattle Times Company

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