Income tax bill introduced: some things fixed, but still problems

Last week I wrote a long post detailing several problems with a draft of the proposed income tax ordinance. This afternoon, Council members Lisa Herbold and Kshama Sawant officially introduced an updated draft into the Council’s legislative process. They addressed some of the issues I raised, but others remain untouched and are still problematic.

Along with the new draft of the bill came a Summary and Fiscal Note memo which gives some context to the bill and explains the financial implications: how much income it is expected to bring in, and how much it will cost to implement it. It’s still far from a detailed plan, and the memo states that the executive branch will come back later with such a plan — “once the legal status of this legislation is further resolved.” That is to say: they know it will be immediately challenged in court and most likely spend months, if not years, working its way all the way up to the state Supreme Court. And only if it wins — a long shot — will the city actually figure out how to implement it.

They do provide some guesses as to what it will take, though. First, it is assumed that the city will contract with the federal Internal Revenue Service to gain access to federal tax returns, which they expect will drive their process of identifying who needs to pay the local income tax. In addition to that agreement, the city will need to build out its own IT system to track tax returns and payments at a one-time cost of $10-13 million. That system will need to be built, tested and deployed before tax collection can begin — so assume a delay of at least two years. They will also need to hire an operations staff of 20 to 25 people, to “maintain this IT system, draft necessary rules, develop and disseminate taxpayer education materials, serve as account representatives to answer questions and assist taxpayers in complying with the income tax.” They estimate this will cost the city $2.5 to $3 million annually.  The city also needs to hire an “enforcement staff” of another 20-25 people for “reviewing tax submittals, investigating cases of potential under/over-payment, conducting audits, etc.” This will also cost $2.5 to $3 million annually. So altogether it’s $10-13 million upfront costs, and $5 to $6 million ongoing annual expenses.  However, this doesn’t address the fact that the City Attorney’s office will be responsible for prosecuting tax violations, and the Hearing Examiner will be adjudicating the cases; there is no estimate for additional staff or costs for either department.

They reiterate their prediction of $125 million in annual revenues, projected from IRS data on 2014 tax payments. They give no further explanation or insight into how the number was derived, nor any thought as to whether it is likely to go up or down in future years. Instituting a new tax often leads to changes in behavior that decrease revenues over time, such as a soda tax driving down consumption, or an income tax on Seattle residents encouraging people to move outside the city limits. The city needs to look at what would happen to the projected revenues if the richest 5% of those who are subject to the tax moved away. On average, the 8,700 Seattle residents who make more than $250,000 will pay $14,367 in local income tax. But it isn’t a “normal curve” distribution around that average; it’s a “power law” distribution with most people on the low end near the $250,000 income threshold who are paying almost nothing, and a long “tail” down to a handful of very wealthy people who are paying a lot. Unfortunately, that means that losing a small number of wealthy Seattle residents could cost the city a large chunk of its income tax revenue.

(ok, it’s actually more complicated than this. Local income tax is deductible from federal income tax, so a wealthy person’s total tax burden doesn’t necessarily go up the full amount of the local tax. On the other hand, the local income tax is based on “total income” before deductions and exemptions, so it’s entirely possible that Seattle’s wealthy residents would end up paying more in local income tax than they do in federal income tax! Still the point stands: it’s not enough to just declare an estimate of $125 million in local income tax revenues; they need to show their work, because there are likely all sorts of assumptions built into that estimate that may not be valid)

If we look at the bill itself, we see that several of the minor, technical issues I raised were addressed, including:

  • it now lists all five IRS filing status categories, instead of just three;
  • it corrects the calculation for future inflationary changes to the $250,000 income threshold;
  • it grants an automatic six-month extension of the April 15th filing deadline for anyone who submits a copy of their federal extension request to the city. Still, this doesn’t seem well thought through: surely they can get this information from the IRS since they are relying on a relationship with the feds anyway. That’s what other jurisdictions do. Also, the IRS requires paying an estimate of one’s tax liability when filing for an extension; the city’s ordinance just defers all payment until the extended deadline. That will distort the city’s cash flow.

A couple of the more serious issues were also addressed:

  • when a taxpayer fails to provide sufficient information to determine their tax liability, the Director of FAS is now required to determine the tax due “by obtaining facts and information upon which to base the estimate of the tax due.” Previously, the Director was not required to follow any particular process for determining the tax liability (and in theory could just make it up), even though the Director’s determination was presumed to be correct for the purposes of any legal proceedings.
  • The Director is no longer explicitly authorized to distribute tax return information to the Mayor or City Council members. It can only be done “for official purposes only if the Director determines that it is necessary for the implementation, administration or enforcement of this Chapter 5.65, and then only to the extent necessary for such purposes, to the City Attorney or a City agency dealing with matters of taxation or revenue or their authorized designees.”
  • Previously any violation of the ordinance was a criminal offense, a gross misdemeanor subject to a fine of up to $5,000 and/or up to 364 days in prison. Now only willful violations are gross misdemeanors. However, this part still need work: it still states that all violations are criminal offenses, but it doesn’t give any details on the class or penalties for non-willful violations.

Many of the more serious issues were left unchanged, though:

  • The list of potential uses for the funds is still vague. The reference to President Trump’s potential budget cuts was changed to “federal funding potentially lost through federal budget cuts,” which at least recognizes that Trump doesn’t write the federal budget but is still completely speculative. The Summary and Fiscal Note acknowledges that the bill doesn’t appropriate any of the revenues, noting instead that “use of net proceeds (net of implementation and enforcement costs) will be determined at a future date, after anticipated judicial review.” Punting again.
  • The monetary penalties for failure to pay the local income tax, or for underpayment, are unchanged and still fairly draconian. The base penalty is 1% per month up to a total of 25% of the unpaid tax. If it’s intentional, it’s an additional 10%. If it’s fraudulent, it’s an additional 100% of the unpaid tax. This is all in addition to interest charged on unpaid amounts. And the Director’s assessment of penalties is still presumed to be correct with the full burden on the taxpayer to prove it wrong in a court of law.
  • The bill still doesn’t specify what process FAS is required to use for the extensive rulemaking it will need to do in implementing the income tax, or the public’s right to weigh in on those rules.
  • FAS’s 20-25 enforcement personnel will still have authority to make arrests as “non-uniformed police officers” for criminal violations of the tax ordinance. This is crazy; in a city with a police accountability problem, we should not be giving out arrest powers to other city departments. The right way to do this is to have the tax enforcement personnel work with the City Attorney’s office to get a citation and warrant issued, and then let SPD handle the actual arrest. The only reason for doing otherwise is if the city thought there will be so many arrests for violation of the tax code that it would burden SPD to have to deal with them, and I haven’t heard anyone argue that position. We don’t want to train tax enforcement staff on arrest procedures, and we don’t want OPA, the Office of the Inspector General, and the CPC needing to keep an eye on them.

The more serious issues that I raise here can certainly be viewed as policy issues around how much power over taxpayers to give to city government, and the Council may (likely will?) see things differently than I do. That’s fine, so long as they actually raise, debate, and resolve those issues. The danger here is that they kick the can down the road, knowing that the bill will be tied up in court for a long time. That’s dangerous for several reasons. First, if the bill does run the legal gauntlet and survive, it will come back to a different Mayor and Council who may have different priorities and policy goals — and will have lost the legislative context. Second, while this is being introduced as a tax on the wealthiest residents of Seattle, it won’t remain so. As written, it will be a good test case for overturning the state preemption on income taxes without causing any local officials to lose an election. But if it really gets implemented, it will become the central mechanism for rebalancing Seattle’s highly regressive tax structure. Sales and property taxes will be replaced with a broadening of the income tax to residents with lower income levels. It’s easy to look the other way today if you’re not one of the 8,700 residents who make more than $250,000, but the logistical, legal and enforcement structures that get put in place now will be the ones that we all will be dealing with when the income tax inevitably becomes a primary revenue mechanism for the city.

To be clear, I’m not arguing against reformulating the city’s revenue structure around a progressive income tax. On the contrary, I think it makes terrific sense. But that’s why the income tax ordinance in front of the Council now needs to be done right the first time. If it passes legal muster, it will be with us in perpetuity, and we will all be dealing with our local IRS.