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“Good Politics Make Bad Tax Policy, Alas”

Thomson Reuters David Brunori

David Brunori is a regular contributor to Checkpoint State & Local Tax News. David is a partner at Quarles & Brady and a professor at The George Washington University. The views expressed in his articles are his own and should not be construed otherwise or as legal advice. He can be reached at [email protected].

Recently a city council member asked me which local governments got it right and wrong when it comes to tax and economic policy. There are many cities and counties that get it right. But Seattle has become the poster child for getting its tax and economic policies all wrong. I note from the outset that I love Seattle. The people, the food, the sites are terrific. But Seattle gets it all wrong on economics, particularly when it comes to taxes.

I have spent some time talking to folks in Seattle. It occurred to me that the politics of redistribution, and income equality, and other liberal panaceas are so strong that virtually no one cares about good policy. Consider the city's decision to raise the minimum wage to $13 an hour. Who doesn't want the lower income workers to earn more? But economists will tell you that higher minimum wage leads to less employment. And that is exactly what happened in Seattle. I am sure the guy who lost his job appreciates that the city council really cares about his welfare.

Consider Seattle's decision to tax guns and ammunition. The idea was to curtail the sale of firearms in the city – in the belief that less legally purchased firearms will lead to less gun violence. After all, who doesn't want less gun violence? Seattle politicians were right about one thing. If you tax something you will get less of it. The few gun stores in the city closed up and moved to the suburbs. Legal gun purchases fell to almost nothing. But, as I, and people far smarter than me predicted, gun violence did not decrease. In fact, gun violence has risen in the city since the gun tax. The reason of course is that people who buy firearms legally tend not to commit crimes.

This leads us to the decision by Seattle to impose an income tax on its wealthy citizens. Like the minimum wage, the income tax was driven by concerns over income inequality and making the rich pay their fair share. The city enacted a 2.25 percent tax on individual income over $240,000 and couples earning over $500,000. There was a lot of excitement at city hall as supporters sporting Tax the Rich signs were partying it up.

No matter how much you want to hurt the rich, eat the rich, or kill the rich, taxing rich folks in a city is a bad policy idea. When cities try to tax their rich folks they inevitably end up with less rich folks. People and companies will eventually move to the suburbs where the politics of envy are not so obvious.

More troubling however is that the stridency of the politics caused the enactment of a clearly illegal tax. It is one thing to ignore economics; it is quite another thing to ignore the law. Washington law (RCW 36.65.030) expressly says that a city shall not levy a tax on net income. Proponents say their tax is on total income - not “net” - so the prohibition doesn't apply. But the courts will not be fooled by such clever arguments. But more telling is the Washington Constitution which mandates that all taxes be uniform. A progressive income tax is by definition not uniform.

I was going to opine on the weirdness of adopting a local income tax when your state does not tax income. But if politics trump economics and law, it will certainly be undeterred by tax administration.

Massachusetts thinks like Seattle

Two incredibly bad ideas from a tax policy perspective were introduced in Massachusetts recently. One measure (s 1548) would require worldwide combined reporting for all Massachusetts companies that are part of a unitary group. The goal is to prevent corporations from nefariously shifting their income overseas. But worldwide combined reporting is a poor tool for doing that for reasons that I will share in my next column. But it's a bad idea.

Actually the other corporate tax proposal (s 1555) is worse. That bill would impose a two percent excise tax on net income of corporations who pay their executives too much. The proposed law offers a complicated formula for doing that. But basically if your CEO earns more than 100 times the median compensation for all employees you pay the tax. This is inane on so many levels. But the state should not be using the tax laws to influence the compensation of private parties. It seems to me that if a corporation wants to pay its CEO a trillion dollars and everyone else minimum wage, that is an issue for the board of directors – not the department of revenue.

Invest in Michigan – get money

By the time you read this Michigan will have enacted a very generous tax incentive. The new law will allow businesses to keep the withheld income taxes from employees for ten years. Michigan is not the first state to do this of course. Illinois and many others have been letting companies keep their employees' taxes for some time.

To get the money, a Michigan business must create 250 or more jobs at an average wage equal to 125 percent of the regional average wage. The more high paying jobs you create, the more money you keep. And you get to keep 100 percent of the withholding for ten years. If you create 500 or more jobs at the average regional wage, you get to keep 50 percent of the withholding for five years.

Yes, the employee may be thinking her taxes are being used to pay for police officers or kindergarten teachers or University of Michigan football coaches. Instead they are bolstering the bottom line of her employer. But regardless, this is a good deal for companies looking to invest in Michigan.

Crony conspiracies

Back in 2009, Virginia Gov. Terry McAuliffe founded an electric car company called GreenTech in Mississippi. Mississippi gave GreenTech $6.4 million in incentives. McAuliffe left the company to pursue the governorship. But GreenTech never invested as much as it promised. And it never created as many jobs as it promised. Mississippi wants its money back. Why does this matter? McAuliffe founded the company with money from Chinese investors many of whom were mainly interested in obtaining visas. Those investors were recruited by Hillary Clinton's brother. Okay, maybe I'm watching too much cable news.

Let's Be Honest about the SALT deduction

With Federal tax reform being discussed on Capital Hill, the question of whether state and local taxes should be deductible inevitably comes up. First, there is no tax policy reason for the deduction. It does not make the tax system better or fairer or more efficient. It benefits states with a heavy reliance on income and property taxes. It benefits the wealthy (90 percent of the deductions go to people earning over $100,000). And the richer you are the more you benefit. If you are middle class in North Dakota or West Virginia, you are subsidizing New York and California. It is fun watching those on the left try to defend the deduction.

All things being equal, eliminating the state and local tax deduction will mean that taxes will go up – mainly for the affluent. But, presumably, federal income tax rates would come down as part of reform. States will have a tougher time increasing tax burdens without the federal subsidy. Is that okay?

Trivially speaking

The answer to the last tax trivia question was urine. Many people answered correctly but only one was first. I am a movie fan. I am particularly excited to see Dunkirk – which I may have seen by the time you read this. The Battle of Dunkirk is an amazing story. This week's question is: what was the first state to offer targeted tax incentives to film producers? First person to answer correctly will receive autographed copy of State Tax Policy. You have not experienced living until you are lounging on a beach with a bottle of rum and a state tax policy book.


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Originally published in Thomson Reuters and is reproduced here with permission, July 24, 2017