On Monday, the Seattle City Council unveiled a much-anticipated draft ordinance proposing a municipal income 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. . The ordinance, crafted by Mayor Ed Murray (D) and Councilmembers Kshama Sawant and Lisa Herbold, would impose a 2 percent tax on income above $250,000. The council estimates that less than 5 percent of Seattle households would pay the tax, which would generate a projected $125 million in annual revenue.
The council also estimates that there could be some litigation, and little wonder. A municipal income tax faces some serious legal hurdles.
- The Constitutional Uniformity Clause. Article VII of the Washington constitution stipulates that all taxes must be “uniform upon the same class of property,” and adopts an unusually broad definition of property that has been held to include income. The constitution also imposes a maximum combined rate of 1 percent. Seattle officials do not deny that their ordinance conflicts with current caselaw; the municipal income tax is seen as a test case to challenge the current interpretation of the uniformity clause.
- A Ban on Local Net Income Taxes. Further compounding the city’s challenges, there is a statutory prohibition against Washington localities adopting taxes on net income. The “net income” terminology was likely to exclude the local B&O 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. from the prohibition. But advocates of a Seattle municipal income tax argue that by imposing the tax on gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” rather than adjusted gross income, it cannot be said to fall on net income. This is arguably a strained interpretation of the statute. Net income is undeniably a subset of gross income, and thus subject to tax under the proposed ordinance.
- Restrictions on Creating Local Taxes Not Expressly Authorized. The courts have held that localities must have an express grant of authority to levy a given tax, and of course, nothing in statute specifically authorizes a local income tax. The Seattle City Council justifies the proposed income tax under statutory authority to establish licenses and permits, which may be too novel for the courts, not least because it is unclear that a right of residency could be subject to a licensing process.
The preamble to the draft ordinance contains two findings worthy of comment. The first is the claim that Washington’s tax code is the most regressive in the nation. We have previously critiqued the methodology of the study from which this claim is drawn, but of particular note, the state’s high-rate gross receipts tax is wrongly classified as a sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. under the study, contributing greatly to Washington’s poor ranking. The second is the claim, citing one of our own reports, that local income taxes are widespread. While it is true that almost 5,000 local jurisdictions impose an income tax, the majority of these jurisdictions are concentrated in just two states. Pennsylvania and Ohio account for 2,961 and 774 of local income tax jurisdictions respectively, representing 76 percent of all jurisdictions levying a local income tax.
Washington, moreover, is in a unique position, as it does not impose a statewide income tax. Six other states forego a statewide income tax, and none of these states permit income taxation at the local level.
Seattle’s municipal income tax ordinance, if adopted, faces an uphill legal battle. If it can survive the earlier rounds, however, it could emerge as a test case on the constitutionality of income taxes in Washington state. The voters and the courts have rejected income taxes many times, but the issue isn’t going away any time soon.
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