As the state slowly but surely emerges from the deep recession that is now four years old, state tax revenues are also slowly recovering. When they ever get back to the 2007 peak is unknown but tax revenues grew by almost $900 million from 2010 to 2011, from $15.123 bil to $16.013 bil. You can see tax collections from 2007 through 2011 here:

http://dor.wa.gov/Docs/Reports/2011/Tax_Statistics_2011/Table02.pdf

The most significant drop was in real estate excise tax. In 2007, REET collected was $1.16 billion. In 2011 the state collected just under $380 million in REET. Other major state taxes, such as retail sales, B&O and property also dropped but have recovered nicely. Retail sales is still below the 2007 peak but B&O and state property taxes were higher in 2011 than in 2007.

From peak to trough, the state lost $1.7 billion in tax revenue. Oviously the real estate bubble was unsustainable but our legislators did not anticipate a drop in revenue and continued to spend. Much of that spending was on K-12 and higher education, along with health care and social services. We can all have 20-20 hindsight but our policymakers should challenge the wisdom of expanding social service programs when unemployment is under 6%. When unemployment goes up is when people need the safety net, not when the economy is booming.

Four concepts underlie a good tax system: broad based, low rates, ease of compliance and ease of administration. Unfortunately Washington fails on most of this. The one area that we do well in is that the tax system is broad based. Everyone pays sales tax on almost everything, except basic necessities. The rate itself is quite high and can be regressive for lower income people. That regressivity is somewhat ameliorated by exempting food and medicine from sales tax.

The B&O tax is also broad based and rates are generally low but it is a tax on gross receipts, not net income. This mean unprofitable companies pay it along with profitable companies.

The purpose of a tax system is to raise as much revenue as possible without damaging the economy or creating disincentives to invest, hire or engage in other tax generating activities.

The purpose of a tax system is not to respond to spending desires. When policymakers raise taxes, they are usually doing so in some kind of “crisis”. Rarely if ever is the underlying policy thought through and usually results in either only short term gains or voter backlash. That is what happened in 2010. The state legislature was desperate to avoid deep cuts in spending. Legislators raised the B&O tax, imposed taxes on candy, gum, soda and bottled water and an income tax initiative appeared on the ballot.

Ballot initiatives overturned the taxes on candy, gum, soda; the income tax initiative was crushed and the voters passed a two thirds majority requirement to raise taxes in the legislature or by a majority vote of the people. The only thing that was kept was the B&O increase. That tax hike was limited to “service” companies, which were already at the highest rate at 1.5%. The rate went to 1.8% and is set to go back to 1.5% on Jan. 1, 2013.

What happened next was the only possible outcome–massive cuts to higher education, health care and social services. Even K-12 saw cuts, which is the state’s “paramount duty” under the Constitution.

As we move through the election season and into a new biennial legislative cycle, you will hear calls for “more revenue”. This is a not so veiled code for raising taxes. The other angle on this is to “close loopholes”. While that makes for a nice sound bite, it has serious implications for companies that take advantage of various tax incentives. The tech industry uses the B&O credit and sales tax deferral for R&D facilities extensively to preserve capital, perform R&D, hire new people and expand facilities.

The tax incentives for R&D are a significant tax policy that helps to lessen the impact of the B&O and the cost of building facilities. Especially for growing but not yet profitable companies. There are legislators and others who think the tech industry should “give up” R&D tax incentives in return for more spending on higher education. This is a false choice and does not stand up under scrutiny.

If the legislature is dissatisfied with the value of the R&D tax credits or have evidence that they are ineffective, then policymakers have every right to make changes to them or eliminate them completely. The evidence, of course, shows otherwise. Washington is in competition with many other states and Canadian provinces for technology companies.

The issue of increasing the number of graduates from Washington’s colleges and universities with high quality degrees in computer science and engineering is a spending decision, not a tax policy issue. In fact, the legislature in the 2012 supplemental budget put in specific budget provisos that required the universities to devote more funds to computer science and engineering. Lo and behold, that has happened. UW, for example, now has just over 600 computer science students–its highest number ever. Which goes to show that if policymakers want a certain outcome, they can get it. It simply takes political will.

Look for more posts on these topics as we go through the election season. WTIA will be promoting the renewal of tax credits for R&D as an important economic development tool for tech companies of all sizes.