HOUSE BILL REPORT

HB 1195

BYRepresentatives Wang, Holland, Nelson, Sayan and Brekke; by request of Governor Gardner

Providing major tax reform.

House Committe on Revenue

Majority Report:  The substitute bill be substituted therefor and the substitute bill do pass.  (11)

      Signed by Representatives Wang, Chair; Pruitt, Vice Chair; Appelwick, Basich, Fraser, Grant, Haugen, Morris, Phillips, Rust and H. Sommers.

Minority Report:  Do not pass.  (6)

      Signed by Representatives Holland, Ranking Republican Member; Horn, Assistant Ranking Republican Member; Brumsickle, Fuhrman, Silver and Van Luven.

House Staff:Robin Appleford, Rick Wickman and Bob Longman (786-7136)

AS REPORTED BY COMMITTEE ON REVENUE APRIL 3, 1989

BACKGROUND:

State Taxes

Washington does not levy either a corporate net or personal income tax, and relies on property and excise tax revenues to fund many state programs.  Of the excise taxes, the retail sales and use taxes generate the most revenues.  The retail sales tax is paid on retail sales of most articles of tangible personal property and certain services.  The use tax is imposed on the use of articles of tangible personal property when the sale or acquisition has not been subject to the sales tax.  The sales and use taxes are levied at a state rate of 6.5 percent.

Washington's major business tax is the business and occupation tax.  This tax is levied on the gross receipts of all business activities conducted within the state without deductions for costs of doing business.  Any business with gross receipts of less than $12,000 per year is exempt from taxation.  The business and occupation tax is levied at varying rates, but most businesses pay at rates of 0.484 percent and 1.5 percent.  A similar tax is imposed on public utilities at rates varying from 0.642 percent to 3.852 percent.

The maximum state levy for the support of common schools is $3.60 per $1,000 of assessed value, equalized to the indicated ratio of property assessment to market value.

Fourteen income tax proposals have either been adopted by the Legislature or submitted to the voters through the initiative or referendum process.  Four times, the Legislature approved income tax legislation for direct implementation; one was vetoed (1931) and three were ruled unconstitutional by the State Supreme Court (1929, 1935, and 1951).  Ten income tax measures have appeared on the ballot; two were approved but overturned by the Court (1930, and 1932) and eight were defeated by the voters (1934, 1936, 1938, 1942, 1970, 1975, and 1982). 

State Spending Controls

Rainy day funds and revenue limitations are two mechanisms commonly used by states to control taxes and expenditures.  A rainy day fund is a contingency fund set aside during times of strong economic growth to be spent during periods of weak economic growth.  The Legislature created the budget stabilization account in 1981 to serve as a rainy day fund.  This account has never had money in it because the statutory conditions for transfer of money to the account have never been met.  The Legislature subsequently created the revenue accrual account in 1983, and directed that any balance remaining in the state general fund at the end of each biennium be transferred into this account.  Monies in this account may be used only to reduce unfunded liabilities in the state pension systems.  This account has received all ending fund balances since 1983.

Revenue limitations are usually designed to limit growth in revenues to growth in the economy or population.  Washington has a revenue limitation, Initiative 62, that was approved by the voters in 1979.  Initiative 62 limits the growth in state tax revenues to a three year average of growth in state personal income.  Any revenue collected in excess of the limit is to be set aside for the next fiscal year.  Washington has never exceeded this revenue limit.

Local Government

Cities, towns, and counties are provided monies from the motor vehicle excise tax for sales tax equalization.  For counties, there are two equalization payments: 1) a "minimum" floor payment to any county receiving less than $150,000 (adjusted by the Governmental Price Index - $199,000 for FY 89) in local sales tax revenues; and 2) a payment to any county that receives less than 70 percent of the statewide per capita sales tax average of all counties.

Cities and towns may qualify for sales tax equalization payments. Those cities and towns receiving less than 70 percent of the statewide average per capita sale tax revenues of all cities and towns receive payments under the program.  Cities and towns do not receive the "minimum" floor payment. 

For the 1987-89 biennium, outlays for counties approximate $10.1 million.  For cities and towns, payments are approximately $24 million.  Payments are made each calendar quarter by the State Treasurer after being calculated by the Department of Revenue. Approximately 115 cities and towns received equalization payments during 1987-89.  Nine counties receive "minimum" payments.  An additional 12 counties received payments under the 70 percent payment program.

Taxing District Reimbursement

Initiative 62 requires that the state not pass on new program responsibilities or increases in services to local taxing districts unless reimbursement is provided. 

Transportation

Transportation funding is provided through revenues from the motor fuel tax, license fees, and motor vehicle excise tax.  Of the 2.454 percent motor vehicle excise tax rate, 0.1 percent of the rate is dedicated to ferry construction (this rate and dedication to expire with license renewals in January, 1990); and 0.2 percent of the rate is provided to ferry capital (pledged to bonds until August, 2008). Of the remaining rate or 2.154 percent, distributions are made to the general fund, Department of Licensing, cities, and counties.  A significant portion of motor vehicle excise tax revenues support local transit operations.  Revenues are provided to local transit operations based on a formula of local taxes that are matched by the state through this revenue source.

SUMMARY:

SUBSTITUTE BILL:

Personal Income Tax

A personal income tax is imposed, with a regular rate of 4.1 percent on all incomes, and an additional rate of 2.4 percent, for a total of 6.5 percent for incomes over $100,000.

For the regular tax, taxable income equals adjusted gross income, as defined for federal tax purposes, minus personal exemptions and deductions.  The personal exemption level is $3,750, and the deductions are $9,000 for single filers, $15,000 for joint filers, $7,500 for married persons filing separately, and $13,200 for individuals filing as heads of households.

The additional tax is applied to federal adjusted gross income over $100,000, without allowing personal exemptions or deductions.

Corporate Income Tax

A corporate net income tax of 4.1 percent is imposed on federal taxable income.  For corporations with income attributable to multistate activities, federal taxable income is apportioned and allocated to this state according to a standard three-factor formula of sales, property, and payroll.  The formula is set forth in the Multistate Tax Compact.

A corporate minimum tax is imposed at the rate of 2.4 percent of "alternative minimum taxable income" as determined for the federal alternative minimum tax.

The personal and corporate income tax revenues are constitutionally dedicated to K-12 and higher education.

Business Excise Taxes (B&O and Public Utility)

Business and Occupation and Public Utility tax rates are reduced by 20 percent.  Small businesses are provided with additional tax relief.  Businesses below a specified threshold are exempt from taxation, and businesses above the threshold receive a phased out deduction.  The threshold is $168,000 a year for retailing businesses, $60,000 a year for sole proprietors in services, and $96,000 a year for all other businesses.  The deduction is completely phased out at $1,008,000 for retailers, $360,000 for sole proprietors in services, and $576,000 for all other businesses.

Sales and Use Tax

The state sales and use tax rates are reduced from 6.5 percent to 4.1 percent.

Labor costs on construction of new manufacturing and research and development facilities are exempted from state and local sales and use taxes.

State Property Tax Levy

The state levy for support of common schools is reduced from $3.60 per $1,000 of assessed value to $3.05.  Additionally, a new levy of $.15 per $1,000 is levied for common school construction. The total proposed new state levy is $3.20 (including the additional $.15 dedicated to common school construction).

Transportation Revenues

The general fund share of motor vehicle excise tax revenues is reduced by 10 percent and dedicated to multi-modal transportation purposes (state highways, roads, streets, bridges, ferries, transit, rail, and air transportation). 

Revenues for Cities, Towns, and Counties

A targeted fiscal assistance account is created.  One-half of the interest retained by the state from bi-monthly local sales tax distributions attributable to cities, towns, and counties are credited to the account.  From the account, city and town payments are based on the following criteria:  1)  Cities and towns who receive less than 70 percent of the average per capita city and town sales tax revenues, and; 2) cities and towns who have a per capita assessed valuation of property that is at or below 70 percent of the statewide average per capita assessed value of property for all cities and towns. 

Monies in the targeted fiscal assistance account, based on the above criteria are distributed beginning July, 1990 and each July thereafter to each city and town equaling 75 percent of the statewide average per capita local sales tax revenues for all cities and towns.

From the targeted fiscal account beginning January 1990, payments to counties are made to any county that receives less than $350,000 in annual county sales tax revenues. 

City, town, and county payments are doubled if the city, town, or county has imposed the maximum 1 percent local option sales tax rate.

Taxing Districts - Reimbursements

The existing requirement that the state provide reimbursement to taxing districts for mandated new programs or increases in services is changed to allow the Legislature to authorize revenue sources for taxing districts as a means of reimbursement.

State Revenue Limit

The existing state revenue limit is changed in several ways.  The revenue limit is changed from a statutory to a constitutional limit.  The revenue limit is also changed from an annual to a biennial revenue limit. The revenue limit is based on a six calendar year average of state personal income rather than a three year average.  The revenue limit can only be exceeded by a 60 percent vote of the legislature or by initiative or referendum approved by the people.  The limit is re-indexed every three biennia to the previous biennial actual revenues (rather than the previous biennial revenue limit).  Revenues dedicated to a specific purpose can be excluded from the limit only by a 60 percent vote of the legislature or by initiative or referendum approved by the people.

Reserve Account

If revenues exceed the revenue limit, the excess will go to a constitutionally established reserve account.  Unobligated balances in the general fund-state at the close of any biennium will also go to the reserve account.  When the balance in the reserve account exceeds 3 percent of the previous biennial budget, the excess will go to the common school construction fund.  Monies may only be withdrawn from the reserve account by a 60 percent vote of the Legislature.

Proportionality of State Tax Rates

The relative proportionality between rates of state sales and use, business and occupation, public utility, personal and corporate income taxes cannot be altered except by a 60 percent vote of the legislature or through the initiative or referendum process.

Tax Preferences

New tax exemptions, credits, deferrals, deductions or preferential tax rates may not be enacted except by a 60 percent vote of the Legislature or through the initiative or referendum process.

Fiscal Management

Salary increases approved by the Legislature for any state employee or official shall become effective on July 1st of each year.  Salary increases for common school employees shall be September 1st of the year in which such increase is approved by the Legislature.

The Governor's budget document is to disclose an itemized estimate of the expected fiscal impact of each new proposed bill, resolution, program or item which will increase or decrease or tend to increase or decrease state government revenues and expenditures.  A detailed fiscal forecast, including summaries by fund for each agency for the prior and ensuing biennia, must be contained in the document.

Constitutional Amendment

This bill is contingent on the enactment of SHJR 4205 at the general election in November 1989.

SUBSTITUTE BILL COMPARED TO ORIGINAL: 

Personal Income Tax

The substitute bill increases the personal income tax from 3.9 percent to 4.1 percent, and imposes an additional tax of 2.4 percent on incomes above $100,000.  The personal exemption levels and standard deductions are increased from the original bill's personal exemption of $2,900 and standard deductions of $10,000 for joint filers, $6,000 for single filers, $8,800 for head of household filers, and $5,000 for married couples filing separately. 

Business taxes

The original bill had no corporate net income tax and no reduction in business and occupation tax rates.  The small business relief provision is changed from the original bill's deduction, which was phased out between $96,000 and $576,000 for all businesses, to a phased out deduction that varies among retailers, sole proprietors in services, and all other businesses. 

Sales Taxes

The substitute bill increases the original bill's sales tax rate of 3.9 percent to 4.1 percent and adds the exemption for construction labor.

State Property Taxes

The substitute bill decreases the state property tax rate from the original bill's $3.60 to $3.05 and imposes an additional levy of $0.15 dedicated to common school construction.

Motor Vehicle Excise Taxes (MVET)

The substitute bill adds a 10 percent shift of general fund MVET revenues to transportation purposes.

Local taxes

All local option taxes for cities and counties were eliminated. The targeted fiscal assistance program implementation dates were changed to reflect timing with the proposed constitutional amendment.  State provided revenues to taxing districts to offset state requirements for new programs or increased levels of services were added.

Revenue:    The bill has a revenue impact.

Fiscal Note:      Requested April 3, 1989.

Effective Date:The bill will take effect January 1, 1990, if SHJR 4205 is approved at the November 1989 general election.

House Committee ‑ Testified For:    Janis Aimee, People for Fair Taxes; Mark Allen, WA Library Association; Harold Anderson, Washington Retired Teachers Association; Basil Badley, AIA, HIAA & ACLI; Walter Ball, Association of Washington School Principals; Terry Bergeson, Washington Education Association; Dennis Bolton, North Thurston Education Association; Eleanor A. Brand, Senior Citizens' Lobby;  Edward Carlson; Frank Chopp, Fremont Public Association; Howard Coble, WASA; C. E. Cole; Bill Daley, Superintendent of Public Instruction; Bill Denney, Covington Appliance; Lon Dickerson, Washington Library Association; Ned Dolejsi, WSCC; Bob Drewel, EVCC; Jerry Fay, Transportation Improvement Board; Stan Finkelstein, AWC; Jean Fioten, EVCC;  Michael Foss, Washington Association of Temporary Services; Jan Gee, Washington Retail Association; Ernie Geissler, CRAB; Bob Gilden, Blaine School District; Mark Haley, Brown & Haley; Lynn Harsh, Washington '92;  Ruth Hertzberg; Charlie Hodde; Jeff Johnson, Washington State Labor Council, AFL-CIO; Ron Knowles, K-Mart; John Knox, BJ's Paints; Tony Lee, Washington Association of Churches; Steve Lindstrom, Washington State Transit Association; Scott B. Lukins, Washington State University; Ian MacGowan, West Coast Grocery; Linda Matson, NFIB; Jim McIntire; Vicki McNeal; Jim Metcalf, Washington Association of Counties; Gary Moore, Washington Federation of State Employees; Joe Mottram, JC Penney; Darwin Nealey, Representative; Mike Ormsby, Eastern Washington University; Ray Otani, Boeing; John Pinette, Washington State Catholic Conference; George W. Schneider, Washington State Medical Association; Art Siegal, SCCD; Dwayne Slate, School Directors;  Karen Taylor-Sherman, WSSDA; Pat Thibaudeau, Washington Women United; Marilyn Tolan, League of Women Voters; David D Webber; Bill Wilkerson, Department of Revenue; and Roy Wiseman, Seattle Holdings Corporation.

House Committee - Testified Against:      Gladys Burns; Meta Heller; Gary Smith, IBA; Paul W. Locke; Norbert Mueller; W. M. Fosbre, WETA; and Thomas H. Ferree, Ferree & Association Inc.

House Committee - Testimony For:    This proposal will result in a tax structure that is more fair, adequate and flexible, and that will grow with the economy. Tax reform is needed to fund better programs in the future, but the plan should also provide more money for programs in the 1989- 1991 Biennium.  The proposal is positive because it provides a more progressive tax structure.  However, a graduated income tax is needed to make the structure even more progressive. 

House Committee - Testimony Against:      The limited ability to raise tax rates is a problem with the plan.  The super majority provisions will severely curtail the democratic process.  The plan does not have enough business tax reform.  A corporate income tax is needed to replace the business and occupation tax.