This reform affects the B&O tax in two basic ways:
First, it revises the tax base for business by allowing the deduction of inputs purchased from other tax-paying entities and setting a single rate accross the board for all classes of business.
Second, it extends the B&O to government and nonprofits which are not now included in the B&O by applying the new rate to employee compensation, which is a fair measure of the value added of these entities.
Is this a brand new idea?
No. It combines two old ideas. One is reform the B&O. This tax is the only gross sales tax in the nation for good reason. It was proposed as a stop-gap in the 1930s and lingers to this day. The second idea is a subtraction method value added tax. This was studied closely during the process of the Washington State Tax Structure Study (the Gates Commission), and received very strong support, second only to a new personal income tax.
Why is this better?
The current base for the B&O, gross receipts, does not work for many, many reasons; among them: (1) the tax "pyramids" as products go through the cycle of production and sale, creating an effective rate that is different for virtually each business, (2) the tax falls most heavily on in-state businesses (Wal-Mart pays a lower effective tax than home-grown businesses); (3) the tax hits smaller businesses much harder than larger businesses; (4) it is not based on ability to pay (a tax is due whether or not your business makes money); and (5) unlike the sales and property taxes, the B&O excludes a large part of the state's economy -- public and nonprofit entities.
Can it address the enormous state budget shortfall?
Yes. This reform can fill the budget gap. Because of the flaws above, the B&O rate is constrained by its potential to do significant damage to some of its payers. By adjusting to a rational base, a single low rate can be spread across a very wide base. Extending the base by applying it to government and non-profit occupations alone can generate very significant revenue.
For illustration, with respect to business, a rate applied to the reformed base that is revenue neutral (does not produce any more net revenue) would -- even without the proposed $100,000 standard deduction -- produce a lower B&O obligation for a large majority of Washington's businesses. The larger the business, as a rule, the greater the value added (which is the effective base of the new tax). A few large businesses would pay more. The great majority would pay less. So even if the rate were increased from a revenue neutral position, many if not most businesses would have a lower effective tax and the higher tax would fall on those most able to pay.
At the same time, because deductions are allowed only from "other tax-paying entities," the product of an enormous number of out-of-state producers who sell into Washington would for the first time be taxed at the same rate as in-state producers.
Is it pragmatic? Is it do-able?
There are complexities to every tax. The principle idea as outlined above, of course, has to adapt to the details of many kinds of businesses and to a sometimes Byzantine web of tax regulations.
Again, because of the stipulation that deductions are allowed only for "other tax-paying entities," there is no need to fight the battles of closing the (relatively few) exemptions. For example, Agriculture is excluded from paying the B&O. It would also be excluded under the reform. But because the sale of its product is not deductible to the buyer, the tax is captured at the next stage.
The extension to government and non-profits is sticky politically, but since it is the occupations employed by these entities, and not the governments themselves that are taxed, it does not run afoul of prohibitions on one governmental stratum taxing another. For example, the federal government applies income and payroll taxes to state and local workers.
But there are complications. The B&O has sister taxes, most notably the Public Utilities Tax. Treatment would continue as now, with the PUT being deductible under the reform. Real estate rents, some banking operations, and corporations with interstate and international operations may need special treatment. In the latter case, when international operations may disguise or complicate receipts, large corporations could be allowed to calculate their exposure by the compensation to their employees.
Can the reform find political support?
The question has two parts: (1) Is the reform good for most people and businesses? and (2) Are there entrenched and powerful forces which will be in opposition? And really, there is a third critical part to the political calculation. Is there any group or individual who will lead? The last question is perhaps the most problematic.
A state government which is slashing its services, laying off its workforce and failing to provide direction into the future is a state government that is failing. It cannot be an option for the state to fail.
This reform has the single most important attribute of any now on the table: It is adequate to the revenue challenge. Thus it should have political support from government and non-profits, because without new revenue, these sectors are facing a bleak future. At the same time, as a flat tax and one which puts new obligations on public sector employees, the reform could garner support from parts of the political spectrum which are traditionally anti-tax. Since the reform benefits small business and home-grown Washington businesses, it seems a natural political winner if those benefits are understood.
What is the Alternative?
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