Along with the many legislative proposals we're considering to reform, cut, and raise new revenue to patch the current $1.5 billion gap between revenue and expenditures in the current two-year cycle, we're also contemplating long-term options to correct our instable, inadequate and regressive revenue system.
I’ve long supported reforming our state’s outdated tax code. Our current system depends far too much on sales tax, an extremely regressive and undependable revenue source. Our revenue system is the most regressive in the nation because people with low to middle incomes pay a much higher percentage of their income than wealthy folks. In a state economy that has shifted from manufacturing to services, our current revenue system no long reflects the best or most equitable way of maintaining critical public investments upon which we all depend.
The HOPE Act and a state tax on capital gains are two possible long-term reforms that I’ll discuss below. Neither of these tax reforms would resolve our immediate revenue deficit, but they would both go a long way to ensure the long-term stability and adequacy of our revenue system. Along with going a long way to prevent future revenue crises like the one we’re currently experiencing, these revenue strategies would make our revenue structure more progressive – people with higher incomes would pay a fairer share of taxes.
The Higher Opportunity Promise for Education (HOPE) Act (HB 2486, Rep. Chris Reykdal) would institute a constitutionally-capped one percent tax on personal income and corporate gross profits. The bill would also eliminate our state’s Business and Occupation tax completely and lower the state portion of sales and use tax by 23 percent. That means the state portion of sales tax would go from 6.5 cents to 5 cents on the dollar.
If the HOPE Act were to pass, Washington would join at least 42 other states in stabilizing its revenue stream through the use of both an income tax and a sales tax. I’ve long been a supporter of an income tax, and have sponsored legislation to that effect. My preference would be to institute an income tax similar to the one proposed in Initiative 1098 in 2010 that would have established an income tax only on income above $200,000 for individuals (or $400,000 for married couples or domestic partners who file jointly). The sponsors of the HOPE Act may also support a similar graduated income tax, but I think they have decided on the 1 percent across-the-board income tax in order to bypass a possible constitutional challenge by people who would maintain that a graduated income for corporations or individuals disputes with the uniformity clause of our state constitution.
All told, the HOPE Act would generate an estimated $500 million in new revenue each year. The sponsors propose that all of these funds be dedicated to the Education Legacy Trust Account to be used solely for higher education. This comprehensive overhaul of our tax system wouldn’t go into effect until 2015, with the goal of preventing further crises like the one we’re currently experiencing. The bill includes a referendum clause, which will ensure that voters have a chance to weigh in on the proposal. I definitely support this legislation, although I think it’s sadly unlikely that we’ll be able to pass it.
Taxing Capital Gains. The federal government taxes capital gains, which are the profits from the sale of stocks, bonds, real estate and other financial instruments. As I’m sure you know, the G.W. Bush administration decreased federal capital gains taxes as part of their gracious largesse toward the wealthy.
Our state, unlike at least 43 other states, doesn’t charge a state capital gains tax. Most states have a 3-11 percent capital gains tax. In 2010, according to Forbes magazine, our neighbor Oregon had the highest capital gains tax at 11 percent. Depending on how it is structured, a modest capital gains tax could potentially generate $500,000 - $5 million a year in new revenue from people with disposable income who currently pay a lower percentage of their income in taxes than do the rest of us. For example, a 5 percent state capital gains tax with some of the exclusions I discuss below could reap about $700,000 each year.
We would have to structure our state capital gains tax so that only those with the most amount of disposable income would have to pay. It would be wise for our state code to mirror the federal capital gains definitions such that ordinary home sales, retirement savings and income, and inherited income are exempt. Mirroring federal tax code would mean that retirement savings through 401k and pension plans would not be taxed; nor would retirement income or inherited assets.
As for houses, under the federal tax code the first $250,000 (or $500,000 for married couples) in profit from the sale of a primary residence is exempt from taxation. Selling our primary residence for more than $250,000 or $500,000 above what we paid for it is out of reach for the vast majority of us. Nationally, less than 3 percent of homes sold in the US in 2007 were subject to any federal capital gains tax.
At the peak of the last economic cycle (2001-2007), only 21 percent of federal income tax returns filed in Washington state reported any taxable capital gains. Eighty-one percent of capital gains that were filed under federal income tax returns were held by the wealthiest 3 percent of households. For our state tax, we could exclude the first $10,000 of capital gains for joint filers from taxation ($5000 for singles). This would mean less than 3.5 percent of Washington households would pay any additional taxes. This tax would narrowly affect the wealthy folks who can truly afford it and who are currently paying a lower percentage of their income towards state revenue.
Rep. Laurie Jinkins recently introduced House Bill 2563, which proposes a capital gains tax similar to the one I’ve described and would go into effect on January 1, 2013.