June 2010
Now citizens need to step up and do it right.
We can generate income from a low rate tax and fix what is most broken and burdensome about our tax system and fill the budget hole completely.
Three points I want you to get, if nothing else
#1
This is the only revenue alternative that is to the scale of the problem. We have a big and chronic or structural hole. this is up to filling it.
#2
The B&O is broken and burdensome to small business as well as being regressive. This fixes it and makes it simple, sturdy and based on ability to pay. It does not increase the tax burden because it shifts it toward the ability to pay. It is riding on the strongest shoulders, not the weakest.
#3
This reformed B&O has attractiveness to the Right. It is a flat tax. It favors small business. It extends the load to hated government.
Before getting to how it works
Magnuson understood -- and we should understand today -- that the economy and its citizens cannot stand the breakdown of the government, its spending, or its services.
That is maybe the biggest difference between this Depression and the last one. The size of government, the balancing effect of automatic payments going out, and the automatic and discretionary stabilizers from the federal budget.
Schools at all grades and levels, roads, highways, ferries, courts, police, utilities, public health and welfare, emergency services, mass transit, parks and recreation facilities, resource management -- all are much larger and more important than they were in 1930. Consequently our standard of living is higher and the economy has greater balance. These activities of government involve middle class jobs and the services provide for the flow of people and commerce, their education and development, and they organize and protect the markets in which they operate.
The economy cannot stand the failure of state government. The cuts envisioned in the Governor's budget constitute that failure. Short-term effects are severe, but the effect of not stemming the tide (and in effect amplifying the downturn) is more severe. If tax cuts were the key to prosperity, Tim Eyman and George W. Bush would have led us into the Promised Land by now.
This proposal to reform and restructure the B&O tax can meet the challenges as no other option can. It is political fantasy to expect an explicit income tax in Washington. The chances of increasing the property tax are nil. The sales tax is maxed out. Sin taxes and special fees are nickels and dimes when we need tens and twenties.
So how does it work? How do you produce big revenue without increasing the effective burden significantly and in a way that will garner bipartisan support?
First some very rudimentary accounting
Sales price“Value added” comprises the firm's contribution to the value of a product. It is composed of wages & salaries, benefits to labor, profits to owners, retained earnings to business. In the case of a loaf of bread, the value added of the farmer is the grain, of the miller the turning the grain into flour, of the baker the creation of the loaf of bread, of the trucker the getting product from one point to another, of the grocer the marketing of the bread. The total price is composed of the value added of each of these.
minus purchased inputs
equals value added
or in reverse
Purchased inputs
plus value added
equals the sales price
(Dispensing with one point of confusion: a value added tax or VAT is often confused with a sales tax. This is because of historical accident and the way it is reported to the customer in some countries. A value added tax is a tax on value added.)
Notice value added is identical to income, to workers, shareholders, or the business. A tax on value added is a tax on income, which is a tax on ability to pay.
In cases where there is no profit or retained earnings, such as in governments and nonprofits, compensation to employees is a proxy for value added. It is not a substitute, because of the fact that the "sales price" is nonexistent. Private business recognizes the value of its product by market price. Government recognizes only the sum of the costs.
What is changed?
Reformed B&O taxes the bottom line
Returning to our simple accounting
Sales price
minus purchased inputs
equals value added
The current B&O taxes the top line. The adjusted or restructured B&O taxes the bottom line plus extends the tax to government.
• Reformed B&O has one rate for everybody, not many rates for different business types
The current B&O has many rates because different businesses have different cost profiles and it was necessary to make some sort of crude adjustment for equity sake. For example, services are taxed at 1.5%, while retail is taxed at .471%. The revised B&O can tax at a single rate because it is applied to a standard measure of ability to pay.
• Reformed B&O avoids the "pyramiding" that makes the current tax unfair to small business
Because a tax on the full sale price is charged at every link in the supply chain, the "bread" accumulates more tax the less the firm is vertically integrated. Companies like Wal-Mart which provide warehousing, distributing and retailing in-house, are taxed only at final sale. Betty's Espresso, which relies on distributors and suppliers, has the value of its final sale taxed several times before it reaches her cash register.
• A key feature of this proposal is a $100,000 standard deduction that replaces all the current small business and R&D credits, simplifying and making more fair the tax.
What gives this proposal a fair chance?
• As a "flat" tax the reform not only appeals to a certain political bias, but avoids legal obstacles.Obstacles
There is a certain segment of the political spectrum which prefers a "flat tax." The proposal has a single low rate. It is made progressive, however, by the standard deduction, which creates a much lower rate for the very small businesses.
The 1930s scramble by Warren Magnuson and others was made necessary by a ruling of the state's supreme court. A graduated income tax had been passed in the 1930s by the voters and was then struck down by the court on the grounds that income was property and property under the state’s constitution could not be taxed at a variable rate. This is a questionable line of reasoning. But here, there is no variable rate and the tax would not be subject to this precedent, even if ruled an income tax.
• Progressive constituencies will support it.
Good government folks will support it because it is the only option that is up to the task. It fills the hole and prevents the state from failing.
Government employees themselves may be divided. But state employees would likely not get their scheduled raises without new revenue, and many would lose their jobs.
• Small business owners and those with extended supply chains will materially benefit from the elimination of pyramiding.
• Retailers may benefit, for even though the rate might be four or five times the current rate, it will be based on margin, not total sales, and the margins for many are not very big.
• Large, big-box retailers who benefit from vertical integration, avoid the pyramid penalty, and ride the current tax system to an advantaged position will object.
• Depending on details of the design, out-of-state manufacturers may not like it, as it could distinguish purchases from taxpaying firms vs. non-taxpaying firms in allowing for the deductibility of costs.
• Large manufacturing firms and software developers may have questions. Being politically powerful, they may have an effective veto at the capitol. It would be well within the bounds of reason to allow very large companies to calculate their liability in the same way as government -- based on labor and profit payouts.
What is a good tax?
- Fair to all taxpayers.
- Broad-based and sturdy, producing revenue in ups and downs without being burdensome.
- Levied on a measure of ability to pay.
- Low rate, so that attempts to avoid the tax are not financially rewarding.
The B&O is not a good tax
• It is not fair, treating different business categories, sizes and profiles with different effective tax rates.
• Burdensome in down times, since it is not levied on a measure of ability pay.
• Needlessly complex
The restructured B&O is a good tax
Conclusion
If there is anything I would like you to take away, it would be these three points:
1. This is the only option that is up to the task of preventing the failure of state government. It fills the hole. It is robust.
2. This fixes a broken and burdensome part of Washington's tax code, it shifts the load so all share it fairly and evenly.
3. Our citizens and our economy need a state government that works at a high level and we need government leaders that step up to challenges.
It is a figment of Tim Eyman's imagination that taxes are collected in some dark hole. Those state revenues produce the education, infrastructure, services and protections we all need. Commerce and business depend on the transportation services and huge workforce development of state educational spending, as well as on public security and courts. Workers, retired people and children depend on these and other services. And we all depend on the circulation of goods and services and the effective demand of people with good jobs.
Magnuson would say, and probably did, that we cannot afford NOT to fund our government.
