"Defeat 1098": Questions and Answers

[DP]

A few weeks ago I posted some questions and answers on I-1098 that I had put together with some help from the folks at the “Yes on 1098” campaign. (I provided the Q’s, they provided the A’s.)

At that time, WS Blogger maplesyrup asked if I could do the same process with the “Defeat 1098” campaign. So I did, and you will find that information below.

Please note that the questions I have asked the “Defeat 1098” campaign are different from the ones I asked the “Yes on 1098” folks. And many thanks to Mark Funk, Communications Director for “Defeat 1098”, for supplying us with this great information. Please honor the hard work Mark put into answering these questons by keeping your comments polite and thoughtful.

More information from “Defeat 1098” is available at this link: http://www.defeat1098.com/

If you’d like a PDF document containing the Q & A information from this blog post, please go here:

http://roominate.com/blogg/Defeat_1098_Q_and_A.pdf

(Disclosure note: I am in favor of 1098 but am not affiliated with the campaign in any way. I simply want to encourage a vigorous debate on this important issue.)

—David

          * * * * * * * * * *  

Q: What do you think I-1098’s chance of passing in November is?

A: People simply don’t believe arguments made by pro income tax activists. Respected independent pollster Stu Elway got to the matter’s heart in a recent survey: 70 percent of the voters he polled stated if I-1098 passes “it will only be a matter of time before the income level is lowered and everyone will end up paying a state income tax.” Seventy percent. People don’t trust Olympia with an income tax. And when it comes to the growth of taxes, history suggests they are right.

That said, some of Olympia’s most powerful interest groups – public employee unions like the Service Employees International Union – are prepared to spend millions of dollars to impose an income tax on Washingtonians. From their perspective, it’s a modest investment for a potentially massive payoff. The first year alone the income tax is expected to take nearly $2 billion out of the private sector. And the pay out continues year after year. Hitting the Lottery pales by comparison.

 

Q: According to the “Yes on 1098” organization, only 3% of Washingtonians—those with incomes of more than $200,000 per year ($400,000 for couples)—will have to pay the tax. Most voters in this state make far less than $200,000. To many of them, this proposal must seem very attractive. Is it hard selling the idea of “Defeat 1098” to these voters? How do you do it?

A: The people’s deep-seeded suspicion of an income tax existed well before pro-income tax activists qualified I-1098 for the ballot, as the independent Elway survey reminds us. That suspicion is also a Yes on 1098 concern: The campaign’s first TV advertisement never mentions the words “income tax,” failing to inform voters what the initiative really is about. The Defeat 1098 effort doesn’t have to sell anything. Fear of the camel’s nose under the tent is very real among voters. They know legislators can change I-1098 after just two years. They know legislators can raid the dedicated funds into which I-1098 puts tax dollars. Pro income tax activists have, perhaps, the more difficult “selling” job: Convincing people that Olympia – which, according to the state budget office’s most recent six-year projection, faces a huge deficit by 2013 – can be trusted with an income tax. It is a high hurdle.

 

Q: The specter of a lawsuit is raised quite frequently in the debate over I-1098. Is there language in the Washington State Constitution that specifically forbids a tax like the one proposed by I-1098?

A: Former Washington state Supreme Court Justice Phil Talmadge, a Democrat who served West Seattle in the state Senate, had some thoughts on that question recently. Here’s his letter: http://blog.thenewstribune.com/politics/files/2010/08/Talmadge-.pdf

Article VII, Sec 1 of our State Constitution says, “The power of taxation shall never be suspended, surrendered or contracted away. All taxes shall be uniform upon the same class of property within the territorial limits of the authority levying the tax and shall be levied and collected for public purposes only. The word “property” as used herein shall mean and include everything, whether tangible or intangible, subject to ownership.”

If money is property, you can’t tax some money at one rate and some at another (or not at all). You also can’t promise to suspend the power of taxation in an initiative. Our Supreme Court has consistently ruled that taxing “income” is taxing “property.” Every other state with a graduated income tax has a part of their constitution that allows it. Washington and Nevada are the only two states in the country with this kind of broad definition of property. Neither has an income tax.

That said, our Supreme Court is elected by popular vote. There’s no way to predict what they will do. They could allow wages to be taxed but not capital gains or business income, which would cause all sorts of economic distortions. Also, I-1098 is structured as an “excise” tax on the transaction of receiving income. The IRS would have to rule if this is federally deductible, which causes even more uncertainty. Uncertainty is bad for the economy. This is yet another reason we believe voters should vote to defeat 1098.

 

Q: One West Seattle Blog reader said that, as an owner of an “S-corporation,” he will be taxed on proceeds from his business that is not really disposable income but is actually more like operating capital. Do you have any comments about S-corporations and 1098? (Bonus point for answering this: Does an S-corporation confer some tax advantage to the owner?)

A: Let’s go for the bonus point first: An S corporation does not pay income taxes. The company’s profits show up on Line 17 of the owner’s federal Form 1040, where the owner adds this to salary, capital gains, dividends, rental income, etc and pays taxes personally on his or her total income. A C corporation pays a federal income tax (approximately 35 percent) and then the profits, when they are paid out as dividends, show up on Line 9 of the owner’s 1040, where they are taxed as dividends. So if you own a business and pay out 100 percent of the profits, an S-Corp is taxed at your personal rate (35 percent top rate) while a C-Corp is double taxed (35 percent corporate rate plus 15 personal dividend rate). This is why most businesses with fewer than the limit of 100 private shareholders choose S corporations or similar structures.

This leads us to the crux of your reader’s issue. What happens if you pay out less than 100 percent and leave money in the business to reinvest?

IRS rules force you to pay tax on the entire amount of profit, even if you leave it in the business. So, take a company that leaves $1 million profit in the business at the end of the year to open a new location, hire more people, or buy new equipment. The IRS takes 35 percent of that off the owner’s personal tax return, leaving $650,000 to reinvest. If the owner is above I-1098’s nine percent threshold, the state would then take another $90,000. This reduces the amount available for reinvestment by fourteen percent. That’s a lot.

IRS statistics show that 67 percent of those earning over $200,000 are business owners, just like your reader. They are growing our economy, creating our jobs, giving to our charities and paying our B&O tax.

 

Q: State revenues have fallen far short of expectations recently, and the budget shortfall for the remainder of FY 2009-2011 is predicted to be $2.6 billion. (Source: http://www.governor.wa.gov/priorities/budget/faq.asp )Your assumption seems to be that all of that can be made up by cutting waste. What makes you so sure? Have you pinpointed where all of that “waste” is?

A: The Defeat 1098 effort is focused on beating one very bad idea – an income tax that falls heavily on the most innovative parts of our state’s economy, pulls almost $2 billion out of the private sector in the first year alone and is so volatile that it should never be used to fund the state’s paramount duty: education. The campaign assumes nothing beyond that. In fact, many people associated with Defeat 1098 are working right now with Governor Christine Gregoire and her Committee on Transforming Washington’s Budget. As Governor Gregoire said when introducing the committee: “We are going to challenge every program in state government with a series of tough questions to ensure we are getting the best value for the most essential functions of state government.” It’s important work that’s being shared all across the state’s political spectrum, with ample opportunity for people to speak.

 

Q: If it’s true that the state budget can be balanced without raising taxes in the long term, won’t there still be a significant short-term funding crisis while the Legislature figures out how and where to cut?

A: See above answer.

 

Q: One of the concerns raised by people opposed to I-1098 is that the income threshold of $200,000 could be lowered at will by the state legislature after a two-year waiting period. The “Yes on 1098” campaign responds that any attempt by the legislature to lower the tax threshold unilaterally, without first submitting such a proposal to Washington voters, would amount to “political suicide.”* This seems to follow the reasoning from your own “Defeat 1098” Web site, which points out that, “Recent gubernatorial candidates who have endorsed an income tax have been soundly defeated.” Do you disagree with the claim that it would political suicide for legislators to unilaterally lower the income threshold later on? If so, why?

A: Winston Churchill once observed that in war you die once, in politics many times. As the independent Elway survey notes, 70 percent of the people polled believe an income tax will be extended to everyone if I-1098 passes. So, pro-income tax activists must ask people to trust the politicians in Olympia. The Legislature is able to modify I-1098 after two years. And while lowering the income tax rate might be a tough vote, the reality is that the state budget office predicts more deficits by 2013. Is dropping an income tax on to the middle class a tougher vote than raising our state’s sales tax above 10 percent?

 

Q: Another issue raised by I-1098 opponents is that tax receipts allotted to an education and health-care trust funds could be raided by the legislature to pay for other things. To back this claim up, the “Defeat 1098” Web site lists examples of cases where it claims the Legislature has “raided ‘dedicated accounts’” in the past. Let’s suppose that legislators could somehow raid the trust fund money created by 1098. Given that, historically, education and health care are two of the Legislature’s top priorities, and given that these two programs are also at the heart of the current budget crisis, why do you think the Legislature would divert funds away from them?

A: There’s no need to “suppose” legislators could raid the 1098 trust fund money. They can and they will. In just the last decade, as the Washington Research Council reports, the Legislature transferred $2.3 billion to the general fund from 74 separate dedicated accounts, including accounts created to secure health and education funding. While most state spending goes for health and education, the categories are broad. The initiative specifically states the money will go into the Education Legacy Trust account and supplement funds for the basic health plan. Both are restricted accounts set aside to fund a very narrow slice of the state’s education and health care obligations.

The programs are also discretionary – the Legislature is not obligated by the constitution or federal matching fund requirements to maintain spending in the two accounts. So, when money gets tight, these funds are among the first to be raided. Both have been tapped previously and they will be again. Money will get tight: Lawmakers already face a budget shortfall next year and the recession is projected to linger for at least another year. The six-year forecast provided by the state budget office is equally bleak.

The money may still go to “education” and “health care.” It’s true, that’s where most of the state budget goes. But experience shows that the education and health care that it funds is much more likely to go to generous health insurance programs for teachers and state employees than for lower class sizes and the basic health plan. Don’t be misled by the restrictive language. The state’s budget history tells a compelling story of repeated manipulation of dedicated funds to prop up the status quo.

 

Q: Much has been made of Washington’s business climate and how a state income tax would negatively affect it, yet much of the “evidence” in this area is anecdotal. Can you cite any academic research or other scientific evidence that directly links an incremental increase of x in income tax with a loss of y jobs or z businesses?

A: The anecdotal testimony of business owners that have chosen to leave states with an adverse business climate can be extremely persuasive. And, as the question acknowledges, there’s plenty of such anecdotal evidence – including many recent from Oregon, where a recent steeply progressive income tax increase has caused entrepreneurs to depart to more business-friendly states. But we’re not limited to anecdotes.

Let’s look at a survey the Association of Washington Business recently completed with nearly 900 of its members. Employers expect I-1098 would result in significant cuts in hiring and reinvestment in their businesses. Overall, 33 percent plan to decrease hiring and salaries and 47 percent expect to decrease reinvestment.

The greatest impact was on businesses with fewer than 500 employees, which provide 56 percent of Washington jobs. A third of these employers reported that they would slow hiring or cut salaries. These small- and medium-sized businesses also planned to make the largest cuts — reducing hiring by an average of 30 percent and salaries and benefits by about 15 percent. In addition to hiring, these employers were most likely to reduce reinvestment in their business, with 47 percent expecting to make cuts.

The smallest businesses – those with 20 or fewer employees — expect to make significant cutbacks. Twenty-seven percent said they would decrease hiring, 29 percent would decrease salaries and benefits, and 39 percent would decrease reinvestments in their businesses in Washington state if I-1098 passes. For a complete look at the survey, go to: http://tinyurl.com/2wzvrwx

*See my earler Blog post for the “Yes on 1098” campaign’s responses. —D.P.

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[Ken]

wadda maroon.

Fear is all he has so he spreads it on thick.

These are the same people who normally tell you a mfg company with 1500 employees is a “small business”.

Note the AWB is according to their own web site, “one of two chambers in the country accredited with distinction by the U.S. Chamber of Commerce.”

The U.S. Chamber of Commerce is a wingnut infested political front for right wing tax regressives. It is repudiated by nearly all the local chambers.

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[WAPolitico]

Ken,

Four local Chambers of Commerce have come out against 1098 so far:

1.) Seattle

2.) Tacoma-Pierce

3.) Spokane

4.) Tri-Cities

I would expect many more to come out against this initiative as well. So while you try to pit “nearly all the local chambers” against the AWB, just realize they’re on board w/ each other on this.

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[Carson]

The surprise isn’t that 4 Chambers have come out in opposition, the real surprise would be that any come out in support. This is the same wacko organization that considers health care a luxury that the poor need not be part of.

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[JanS]

AWB has supported Tim Eyman’s initiatives…and I believe that our dear Mr. Dino Rossi is also involved with AWB (don’t quote me on that). Just associating themselves with Tim Eyman makes them suspect in my book. Just a HO on my part.

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[dobro]

Seems to be devoid of any actual facts. Just anecdotal fearmongering and scare stories about “you know if they pass one tax then it will be another, and another…blah-blah-blah.”

People that make more money should pay more taxes. It’s called progressive taxation and it’s much more fair than our REgressive system.

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[JoB]

what strikes me is the disparity between the questions asked by the OP…

for the pro side of this measure…

the questions concerned the content and actual impact of the measure if passed…

for the con side of this measure

the questions and subsequent answers to all questions concerned the likelihood of it’s passage… not content.

Bad government results when the question of whether or not you can win a political point by defeating a measure is more important than whether or not it is a good idea.

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[Seattle Friendly]

In his answer to his question about S-Corporations, Mr. Funk made a HUGE mistake. He stated that, “If the owner is above I-1098’s nine percent threshold, the state would then take another $90,000.”

That is factually incorrect. In fact, the tax would be ONE THIRD of what he quoted. I-1098 exempts all income below 400K (joint filers). And it taxes the amount between 400K and 1M at 5%. It only taxes the amount ABOVE 1M at 9%. So if a S-Corp owner takes home over 1 million dollars in one year, he would only pay 30K in income taxes (600K x 5% = 30K). That’s an effective tax rate of 3% for a person who makes a million dollars a year in income.

Cry me a river.

But don’t take my word for it. He’s a direct quote from the text of the initiative: “If taxable income is over 1,000,000, then the tax is $30,000 plus 9.0% of the excess over $1,000,000.”

Is it surprising that the PR director for the 1098 opposition doesn’t even know how to do basic math? Perhaps he’s starting to believe his own BS about 1098.

Also, FYI, WA Politico works for the opposition.

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[maplesyrup]

DP, thanks very much for pursuing this.

I was initially against 1098 but have to admit that the pro-1098 spokesman did a better job explaining their position.

I’m still on the fence though. I run a small business HQ’d in WA, and while 1098 won’t make much difference to me now, it could in 3 years. Most of our operations are already in another state for logistical reasons but if the income taxes here get too high I could easily relocate the HQ. We already pay very little B&O tax due to the nature of the business.

I don’t foresee a mass exodus as a result of 1098 passing- WA is a very nice state and to some degree we pay a premium to live here. But you also can’t dismiss the results of the AWB survey just because you don’t like their politics. I am pretty sure that at least some of the survey respondents weren’t blowing smoke. (BTW I am a member even though I don’t like a lot of their politics, and I did take the survey.)

Anyway I’m glad there’s still time to think and read more about the issue.

Thanks again DP.

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[DP]

With both of these questionnaires, I tried to frame the questions from an adversarial point of view.

The pro-1098 camp claims that a state income tax will help education and health care without hurting small businesses or middle income taxpayers. Since they are making postive assertions, I asked them to refute some specific arguments against those assertions.

The anti-1098 camp claims that the tax is unconstitutional, that small businesses will leave the state, and that there are other ways to balance the budget. Since they are making a negative assertion, I asked them to provide evidence supporting their claims.

The actual content of I-1098 is not in dispute, so I didn’t spend any time on that. What’s in dispute are the constitutionality and potential impact of the initiative, so I tried to focus on that.

JoB, If you have some additional questions you’d like to pose to the “Defeat 1098” camp, I think this would be a good place to do that. Between WAPolitico and a couple of other folks on this forum, I bet you could get an authoritative answer.

Try it . . .

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[jjjpl]

Seattle Friendly:

“That is factually incorrect. In fact, the tax would be ONE THIRD of what he quoted. I-1098 exempts all income below 400K (joint filers).”

It sounds like Mark is talking about the marginal rate. If an owner is already “above the 9% threshold” as stated and leaves $1 million in the business on top of that, the incremental money is, in fact, taxed at 9% under 1098.

If the owner left in $2 million, the extra $1 million would cost $90,000 in tax.

You are correct that the effective rate, combining all personal and business income, will be lower, depending on filing status. The Office of Financial Management estimates suggest that this rate is about 5.5% overall.

But from a business perspective, the marginal rate is important for investment decisions.

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[Seattle Friendly]

So you’re saying that Mark isn’t factually incorrect, he’s just trying to mislead readers.

I get it. Thanks for clarifying.

But, even then, you’re wrong. Mark clearly asked us to assume that “a company leaves $1 million profit in the business at the end of the year to open a new location . . .” In that case the company would be taxed at 3% effective. Even if he meant 2 million, it would only be taxed at a 6% effective rate.

And even that isn’t entirely true. Because the business owner could write off whatever amount he paid in taxes the following year when he turned around and spent it on his business. So again, Mark is either lying or an idiot.

Perhaps he should get a tax accountant to explain it to him: you know, like the tax accountants who helped write the initiative to make sure that wealthy business owners couldn’t evade the income tax.

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[WAPolitico]

Seattle Friendly wrote:

“Also, FYI, WA Politico works for the opposition.”

Some proof would be fantastic. Oh, you don’t have any? K, sweet.

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[jjjpl]

Not trying to nitpick, but the tax rate paid on income left in a business depends on total income, not just the amount left in.

So assuming the business owner makes more than $0 in take home, dividends, capital gains, etc, then your calculations understate the tax. And again, marginal rates matter in business decisions.

I didn’t read any intent to mislead there, in fact Mark was pretty clear to assume the owner was above the 9% threshold.

As to your “write off” point-

Once the government collects the tax, it is gone forever. You cannot get it back.

The $1 million dollars profit left in the business is going to be net of investments you made from money left in the prior year. Just like the profits left in at the end of the next year will be net of investments made that year.

You could, in theory, blow all of your profits every year so you owe no taxes. But you’d have no business, no cash to pay employees on Jan 1, and the state would collect no 1098 tax from business owners.

“Lying” and “idiot” are pretty strong assertions, especially when Mark’s example is accurate.

But if you want to disagree on tax 101 and fundamental business principles, that’s ok. Everyone is entitled to an opinion.

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[Carson]

I just want it to pass as a first step to a revenue neutral state wide income tax! Imagine all those Vancouver residents complaining like crazy that its not fair that they should have to start paying taxes, why do you think Oregon built all those retail stores on the border? For their own residents?

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[Seattle Friendly]

jjjpl:

Wow. You really drank the cool-aid didn’t you.

No. Mark’s example is not right. If “a company leaves $1 million profit in the business at the end of the year to open a new location” then the owner, assuming there is only one owner, would only pay 30K in tax, not 90K in tax.

And you are wrong that “once the government collects the tax, it is gone forever.” You can write off the tax you paid in flow-through profits in year X if you reinvest it in your company in year X+1. So in effect, the government gives it back to you.

You really should not go into business. Even after 1098 you can leave up to 400K in your business without having to pay a penny of income tax on the flow-through. And that assumes that the S-Corp only has 1 shareholder! If the S-Corp had 4 equal shareholders, it could leave 1.6 million in the bank without any of the owners suffering ANY tax liability. That’s a hell of a lot more than in ANY other state in the country except 6 states.

I really hope I didn’t hurt Mark’s feelings. I’m super concerned about hurting the feelings of a guy who distorts the truth every day for elite business interests at the expense of the middle class and small business owners like me.

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[jjjpl]

Seattle Friendly:

What if the businesses owner took a $250,000 salary, sold a $500,000 building, had $100,000 in dividend income and a spouse who earned $150,000?

The money left in the business is taxed at a different rate than you say. It’s taxed on the total amount of income. That’s why marginal rates and total income matter.

And you cannot deduct the 1098 tax paid to the state from your next year’s state income tax. Income taxes paid are not business expenses at the state level.

You don’t even get a full tax shield.

If you have $1M profit at the end of 2010, you pay $90,000 tax.

If you reach into your personal account to refill $90,000 cash back into the business to invest it the following year year (assuming you don’t buy capital assets that are depreciated vs expensed) you get a 9% tax shield on the $90,000 you ponied up. That’s $8,100. You do not get your $90,000 back from the government. At best you save 9%.

I sincerely appreciate the career advice. Your dispassionate and objective feedback helps tremendously.

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[JoB]

have we lost sight of real definition of small business.. who would pay less b&o tax and would not be likely to be affected by this tax?

have we lost sight of homeowners who would definately benefit?

yes.. there are situations in which the tax paid by a small business owner would increase… but pretty much only if that business struck the buy out lottery…

regular lottery winners would pay more too.

should we defeat the tax on the unlikely chance that you or i will win the lottery?

Or.. should we decide that if we win the lottery.. the tax is a small price to pay for such a great place to live?

i believe that if we make this a better place to live by securing income for state services.. everyone wins.

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[Seattle Friendly]

Are you serious? You’re talking about a mythical person lucky enough to have sold a half million dollar building (that he/she apparently owns in full), made 250K, have a spouse who made 150K, AND pulled in 100K in business income. And on top of that this mythical creature happens to have a business where he/she is the SOLE PROPRIETOR AND made $1 million in profit last year. And if this mythical person reinvests that money in wages/business expenses the following year he/she get’s to FULLY write it off. And he/she can either carry it forward or backward for past business investments.

And on top of all that this person pays less in state and local taxes than in almost ANY OTHER STATE IN THE COUNTRY.

And I’m supposed to feel bad that we’re asking this person to pony up 9% in tax on the flow through profit from his/her company that he/she does NOT reinvest in overhead and wages (above the 1 million you already mentioned, of course) in order to support education and healthcare? Wow. You really have a compelling case.

Clearly you are dispassionate and objective as well.

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[maplesyrup]

Why do you assume that the 9% would not be reinvested?

And why are you shouting?

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[Seattle Friendly]

Because you only get taxed on the amount that you don’t reinvest. You’re able to write off any money that you reinvest in your company.

I’m not shouting, I’m emphasizing. :)

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[redblack]

@jjjpl #14: “Once the government collects the tax, it is gone forever. You cannot get it back.”

oh, but you do get it back.

you get it back when you hire an educated, healthy work force whose school was fully funded in a state that isn’t broke. furthermore, if your work force is on the new washington state health plan, you, as an employer, don’t have to pay their health care premiums directly, as you will under the new federal law.

win/win.

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[JoB]

I think the point we are trying to make is that the individuals who have small businesses most likely to be burdened by 1098 will be those who choose to liquidate their business for profit…

in which case there is no guarantee of any kind that the new owners will continue business in Washington.

I understand their concern as individuals. No-one wants to pay more tax than they have to.

However… that argument leaves a lot to be desired as a justification for defeating this measure.

and as has been pointed out..

those who pay the tax still stand to benefit greatly from it’s investment.

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[redblack]

searching for a stat that i lost that says that the majority of small business owners in america have incomes between $80,000 and $140,000.

with smart incorporation and accounting – regardless of their business’ revenue – this tax will not affect most business owners.

nor will obama’s proposed “tax increase.”

furthermore, most people can’t even fathom being in a tax bracket that would be affected. the fact that people who will take 30 years to pay off a $400,000 piece of property are arguing against taxing people with astronomical incomes – perhaps in some vain hope that one day they will be affected – is preposterous.

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[JoB]

Well put.

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[Author]

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