Taxes likely a hot topic in state elections

By Richard S. Davis

No matter how the current budget impasse in Olympia ends — and it should end soon — we can expect to hear a lot more about taxes through the campaign season. It’s the debate that never really caught on during the legislative session. Although for a time trial balloons floated under the dome, they deflated swiftly when a better economy and reduced demand for state services narrowed the budget shortfall to a manageable margin.

There was clearly no public appetite for general tax increases. The governor’s proposed half-cent increase in the sales tax was dead on arrival. A few liberal Democrats pushed for income and capital gains taxes, but quickly found they were pushing a heavy wagon up a very steep hill with not much help from their friends. A sweeping repeal of all statutory tax incentives found favor briefly in the House, but then disappeared.

While it’s unlikely any of these measures will be revived in the special session, interest groups continue to press for more money. So it’s a good time to recall how taxes influence job creation and investment.

The complexities of taxation often force analysts to simplify. One of the best national studies, by the Council on State Taxation, for example, collapses a mountain of data to produce a useful statistic, summarizing business taxes as a share of gross state product — a measurement of the state’s economic output. COST finds that state and local business taxes in Washington amount to 5.4 percent of gross state product, significantly higher than our neighboring states. Business taxes claim just 3.8 percent of GSP in Oregon and 4.3 percent in Idaho. The 50-state average is 5.0 percent.

It can get confusing. In January, the nonpartisan Tax Foundation, based in Washington, D.C., reported that our state had the nation’s seventh best business tax climate. Such rankings inevitably have an “eye of the beholder” dimension.

The Tax Foundation rankings consider five taxes — individual income, sales, corporate, property and unemployment insurance. They’re all weighted differently, reflecting the foundation’s assessment of the tax’s relative importance to business. The income tax receives the heaviest weight, accounting for one-third of the total. The sales tax gets the second heaviest weighting, nearly one-quarter of the total. It’s hard to break into the top tier with an income tax and hard not to look good if you don’t levy the tax.

While policymakers can benefit from close attention to the principles undergirding the COST study and the “best business tax climate” rankings, the two reports share a shortcoming. They’re abstractions that fail to capture how taxes land on different industries at different stages of development.

To provide the additional detail, the Tax Foundation contracted with a tax advisory firm to look at how state taxes fall on different business types: corporate headquarters, research and development, retail, call center, distribution center, capital-intensive manufacturing and labor-intense manufacturing. For each, they considered tax costs for a mature firm and a new business.

The study finds us at a comparative disadvantage for new manufacturing, corporate headquarters and, to a lesser extent, new research and development. For mature operations, we generally rank in the top tier for call centers, distribution centers and retail. The disparity stems from a relative lack of incentives to offer new investors, contrary to what you may hear about a loophole-ridden tax system. Washington has generally opted out of the interstate competition to lure new business with special tax incentives.

Taxes are just one factor in business location decisions. Access to a skilled workforce, proximity to markets or resources, energy costs, school quality and transportation are also key. But among the tools available to legislators, nothing is as immediately responsive as tax policy. It may take years to improve an education system, develop a labor force, or expand a highway system. Taxes, conversely, can change overnight.

Such speed can occasionally be beneficial in clarifying or securing a necessary policy change, but it also creates the potential for mischief and instability. Lawmakers wisely chose not to increase business costs this session by repealing exemptions or introducing new taxes. Ideally, economic growth will eventually ease budget constraints, which is why states will continue to compete aggressively for new jobs and investment. And why taxes will continue to matter.

Richard S. Davis, president of the Washington Research Council, writes on public policy, economics and politics. His email address is rsdavis@simeonpartners.com.