Gates panel's value-added tax a dud, users say

John Gillie and Joseph Turner; The News Tribune

12/15/02

Olympia, WA - Michigan business leaders can't believe Washington state may soon consider imposing a new business tax like one Michigan is dumping.

"The tax that they want to replace had better be one bad tax," said Barry Cargill, vice president of government affairs for the Small Business Association of Michigan.

Cargill was referring to news that a high level tax study committee created by the Washington Legislature is recommending Washington replace its business and occupation tax with a value-added tax similar to Michigan's.

"The Single Business Tax (Michigan's name for its value-added business tax) taxes all the wrong things," Cargill said. "It punishes all the things the state should want businesses to do.

"If you give your employees a raise, you'll pay more taxes. If you hire more employees, you'll pay more taxes. If you want to pay your employees' health care cost, it'll raise your taxes."

Cargill said the tax also scared away companies considering moving in.

"Our SBT was absolutely the worst thing we could have imposed if we wanted to attract new businesses," he said. "When consultants advise companies about places to expand, the SBT is always in the negative column."

Michigan is scheduled to phase out its SBT by 2009.

But the Washington State Tax Structure Study Committee, headed by William H. Gates Sr. (father of Microsoft's co-founder), says the value-added tax would be an improvement over Washington's 70-year-old business and occupation tax.

That tax was first imposed by the Legislature in 1933 as a stand-in for the graduated income tax while the income tax was undergoing state Supreme Court scrutiny.

Ever since, it has been consistently criticized by businesses as burdensome and unfair, particularly for new and struggling businesses.

Indeed, when the Legislature imposed the business and occupation tax during the depths of the Depression, lawmakers never contemplated the tax would play a permanent role in Washington's taxation plan.

B&O tax gets poor reviews

The business and occupation tax, a tax on the gross revenues of Washington businesses, was to be a temporary money raiser that would be replaced by an income tax.

But when the state Supreme Court said the income tax was unconstitutional, the B&O tax became a permanent fixture of the state's tax structure.

Over the years, the B&O tax has regularly earned poor critical reviews, but every effort to replace it with a more stellar tax has failed.

The committee's report recounts again the B&O tax's numerous problems:

•The tax unfairly burdens new, unprofitable companies because it taxes the business' revenues, not its profits.

•The B&O tax hits high volume, low margin companies more heavily than low sales, high profit companies.

•Vertically integrated companies, which produce and market what they sell, bear a smaller tax cost burden than companies that buy from others the goods they sell.

•The B&O taxes pyramid (that is, businesses pay taxes again on goods already taxed) as goods move from raw materials to consumers.

•B&O taxes are invisible to consumers because businesses raise their prices to pay them, but don't specifically itemize the taxes in the prices of goods they sell.

"Washington state imposes one of the heaviest business tax burdens in the nation," claims the Evergreen Freedom Foundation in a special report on taxation in Washington. "Our onerous business and occupation tax discourages the creation of new jobs, and may even be the cause of losing them."

The Legislature could simply abolish the B&O tax, but doing so would leave an additional $2 billion-a-year hole in Washington's already overstressed state budget.

And simply raising other taxes to compensate for the loss of the B&O isn't realistic or desirable, the committee said.

"The business and occupation tax is the second largest source of state tax revenue, and it would be difficult for the state to raise this revenue by increasing the unpopular state property tax or increasing the retail sales tax rate, which is already one of the highest in the nation," the study said.

The study, in fact, recommends a flat rate personal income tax to replace part of the sales tax and eliminate the state portion of the property tax.

The case for VAT

The committee's recommended alternative, the value-added tax, or VAT, would tax businesses not on their gross revenues, but on the value they added to goods they purchased.

A value-added tax would require businesses to pay taxes only on the incremental value they add to a product. Under the existing B&O tax, taxes are compounded because each company pays taxes on the total value of a product as it moves through the production or service chain.

For instance, the company that harvests timber pays tax on the value of trees; the company that turns the timber into lumber pays a tax on total value of the product; a cabinetmaker pays tax on the total value of the wood cabinet.

That compounding of taxes is called pyramiding, and the task force estimates the total taxes collected increase 2.5 times as a product moves through the chain to market.

If a value-added tax is to raise as much money as the existing B&O tax, the tax rate would have to be adjusted upward because the goods and services will only be taxed once, not several times as under the present scheme.

That means the tax bite would be redistributed among existing businesses. Some businesses would pay less tax, others more.

The committee's proposal has not been sufficiently detailed for most businesses to know whether a change would put them on the winning or losing side.

"They've got to do a lot more work and a lot more study," said Carolyn Logue, state director of the National Federation of Independent Business. "There's a great fear of an unknown tax. That's something we should not leap lightly into."

The federation has about 17,000 members in the state, with an average of six employees and annual gross income of $300,000 to $350,000, Logue said.

Logue said the NFIB has not surveyed its members to see how they feel about a value-added tax, noting such taxes exist primarily in European counties.

Boeing didn't like VAT tax

Former legislator Dan Grimm of Puyallup is well aware of the political complications of proposing new taxes, particularly unfamiliar ones like value-added taxes.

As chairman of the House Ways and Means Committee, Grimm proposed replacing the B&O tax with a value-added tax in 1985. The measure passed the House, but failed in the Senate, Grimm recalled.

Grimm said he was motivated to propose replacing the B&O because of the uneven cost to businesses of the B&O tax.

"We figured that with some high volume, low margin retailers like grocers, they were paying the equivalent of a 25 or 30 percent tax on profits," he said.

But the B&O tax was preferable to some companies like The Boeing Co. that produced much of their own components.

"If they paid a tax based on the value they added by turning a piece of aluminum sheet into an airliner, their taxes would have been much higher," Grimm said.

Boeing told Grimm's committee that if it had to shoulder higher taxes, it would be uncompetitive with its out-of-state and foreign competitors.

"Boeing lobbyists pointed out that grocers generally were competing only with other local grocers who had to pay the same taxes, while Boeing was competing with companies who didn't," Grimm said.

Faced with the prospect of losing high-paying Boeing jobs or keeping high tax burdens on high volume retailers, the Legislature elected to stay with the status quo, Grimm said.

Boeing spokesman Chuck Cadena said the company is still studying the tax committee's new report.

"We appreciate the effort they made in making the study," he said. "We're still studying its recommendations."

Logue said that the B&O tax is not without some redeeming qualities.

"The B&O is not a great tax, but it certainly is simplistic for a lot of businesses. The paperwork is easier than it would be under a VAT or a state income tax."

In Michigan, the complexity of the Single Business Tax was one of the reasons for its demise, said Tricia Kinley, director of tax policy and economic development for the Michigan Chamber of Commerce.

Little momentum for change

Though the Washington tax study committee's report has enjoyed extensive media exposure, there's no stampede in Olympia to implement its recommendations.

"This is probably not the year to upend our tax system," Logue said. "Let's get through this recession and work at ways to get the (state) budget under control, then have a very needed discussion."

Don Brunell, president of the Association of Washington Business, agreed much more study needs to be done before changing the state's tax structure.

The association has about 3,700 members, including 80 chambers of commerce, 120 professional organizations and 3,500 businesses. They include Boeing, Microsoft, Safeco, Bank of America and other large employers.

"We're going to be meeting in the next couple months to bring our tax people together - folks in the tax departments of major corporation and tax attorneys," he said. "Whether the value added tax is a better tax, we don't know yet."

The task force said Washington businesses pay 46 percent of state and local taxes, in contrast to the 30 percent average paid by businesses in seven Western states.

State Sen. Jim Honeyford (R-Sunnyside), who will become chairman of the Senate Commerce and Trade Committee next month, said he's sure the Legislature will look at changes to the state's tax structure.

"Replacement of the B&O tax is possible, but I don't know if we can get any traction on that," he said. "It may get discussion, but I'd be surprised if any legislation is pass on that.

"We've got enough headaches."

John Gillie: 253-597-8663
john.gillie@mail.tribnet.com

Joseph Turner: 253-597-8436
joe.turner@mail.tribnet.com