A special session of Washington’s state legislature kicked off today with a debate on whether or not to offer a multi-billion dollar incentive package that Boeing claims it needs to set up production for its new 777X in Washington State. This taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. incentive is nothing to sneeze at: $9 billion. According to Washington’s Department of Revenue Fiscal Note on the incentive package, those incentives would come from between 0.29 percent and 0.9 percent reductions in the Business & Occupation tax, extra credits against that tax, and sales tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s, extending all these preferences through 2040.
The Business & Occupation (B&O) tax is a distortive and destructive tax. Washington State has the highest gross receipts taxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. of the five states that have these taxes, with a top B&O tax rate of 3.3%. This tax, like all gross receipts taxes, creates tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. as the revenues of businesses at each level of production are taxed, rather than their net income, or profits. This causes a tax-on-a-tax, and creates incentives for businesses to vertically integrate, even when doing so might not make economic sense without the tax.
The fact that Washington State is debating 30-year long incentive packages worth billions of dollars, crediting those incentives directly against a tax that is unique in its distortionary effects, should be a red flag for state legislators. If they’re already willing to enact billions of dollars of long-term revenue reductions, why not just lock in broad, principled tax reform for everyone, not just one major employer that has been moving away from Washington for a while.
Washington has many great features of its tax climate that help companies like Boeing: no income tax, so they can recruit talent and save on wage costs; no corporate tax, so they enjoy bigger after-tax profit margins; moderate property taxes, so that fixed investment is not prohibitively expensive. For all these reasons, we rank Washington the 6th best tax climate in the nation in our 2014 State Business Tax Climate Index. But the B&O tax is a major blemish on Washington’s otherwise sound tax climate, much like Texas’ destructive margin tax, on which Texas is wisely decreasing its reliance.
Big tax incentives serve as implicit acknowledgments of structural flaws in the tax code. But especially when the tax incentives are as huge and long-term as those proposed in Washington, legislators could as easily just consider broad-based reforms: they’d cost the same, but apply to more people.
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