Council continues to work on income tax ordinance, up to a point


Last Wednesday the City Council held its first committee hearing on the proposed income tax bill as introduced. This coming Friday they will hold another meeting to start considering amendments. They hope to have the whole thing wrapped up and passed into law by the middle of July – even though the city’s understanding of how to implement it is far from complete. The Council members know that, and they’re fine with it.

Their thinking is straightforward: the ordinance they are writing is intended to challenge state law and past state Supreme Court rulings that make an income tax illegal in Washington state. As soon as it’s passed, third parties will sue to stop it, and the issue will be tied up in courts for several months, if not years. And there’s a very good chance the ordinance will be found illegal and nullified by the courts. So they are spending the minimum amount of time required on the details: the implementation plan, revenue forecasts, costs, timeline to implementation, enforcement, and other issues, leaving them for a future Mayor and City Council if the ordinance runs the legal gauntlet and survives. City staff even admitted that they were punting on making a real budget until some unspecified time in the future when the legal certainty of the ordinance is better understood.

At last week’s meeting the Council members threw softball questions at city staff about the ordinance in a friendly exchange that avoided any pressure to sort out all the unknown details about how this is actually going to work. Since the Council seems willing to punt on the hard questions, here are ten questions they should be asking:

  1. Why is the B&O Tax the right model to use for implementing the income tax? To the extent that implementation details are presented, they have largely been lifted from the city’s implementation of its Business and Occupation Tax. That includes which department implements and enforces it (FAS), enforcement powers and duties of FAS staff, penalties (both civil and criminal) for violations, and the rulemaking process. The rationale for using it is simple: the city already implements it fairly successfully, and there are more businesses paying the B&O tax than individuals making over $250,000 who will be subject to the income tax. In other words, “this is just another tax, and we’ll do it the way we’ve done other taxes.” Council members quickly bought into this thinking: it’s easy, it’s plausible, and it avoids them having to do a bunch of work on something that may not see the light of day – at least while they are in office. None of them bothered to ask “is this really an appropriate model?” or “are there more appropriate models?” So here’s the counterargument: businesses and individuals are different. Businesses are required to keep a set of books that list all their revenues and expenses, and make those books available to city officials upon demand – that’s why most businesses have accountants. Individuals aren’t. Businesses have to pay both income taxes and the B&O tax, which are calculated in completely different ways; individuals don’t. In last week’s meeting Council member Sawant suggested that people making $250,000 a year surely have accountants and tax attorneys to help them navigate the rules; while certainly the more you make the more likely you are to need and use those services, there are many people making $250,000 a year who don’t (thank you TurboTax). That includes people who might have a really good year that pushes them over the threshold, or might sell their house or some other investment that will push their income over $250,000 just once. Taking a system designed for businesses that are expected to maintain a complete set of records of all their financial transactions and applying it to individuals is not an obvious solution. It may, in fact, be an okay solution, but first you need to thoroughly explore whether the expectations you have for what businesses can and are willing to do – and both the carrots and sticks – are appropriate for individuals.
    The first, most obvious point of comparison is the IRS, particularly since city officials have already acknowledged that successfully implementing a local income tax requires a data-sharing agreement with the IRS. Establishing that agreement is “a very elaborate process,” requiring “an enormous infrastructure of data storage and security.” They’re already getting in bed with the IRS; why wouldn’t you start by looking at their model? They could also look to the income tax models used by other states and by the District of Columbia.
  2. How would you change the implementation plan in anticipation of broadening the income tax to a wider set of Seattle residents? This question cuts to the heart of the appropriateness of using the B&O tax implementation as the model for the income tax. As initially envisioned, the income tax will only be paid by Seattle residents with incomes greater than $250,000, and the city estimates that there are roughly 8,500 such individuals. But if Seattle’s income tax survives legal challenges, it will likely become the local tool of choice for reforming the highly regressive tax system currently in place by replacing sales and/or property taxes, at least in part, with a broader, progressive income tax. That means eventually hundreds of thousands of Seattle residents might be subject to it. If the Council and city staff design a system with the assumption that income taxes will only need to be collected from 10,000 people or less, they will find themselves redesigning it shortly after it takes effect.
  3. How does the penalty system compare with what the IRS uses? The Council and city staff had a good chuckle last week at my use of the word “draconian” to describe the financial penalties they were proposing for failure to file an income tax return or failure to pay the taxes due, saying that they are no more severe that what the city imposes elsewhere (once again using the B&O tax as the point of comparison). The B&O tax penalties are a statewide standard, and are in fact quite severe as well: on top of interest due on late payment, the law calls for a 9% penalty if paid by the due date on a notice of payment due. At the end of the first month after the due date, it’s 19%, and at the end of the second month it’s 29%. If it’s a substantial underpayment (i.e. less then 80%), then another 5% is added, increasing up to 25%. If it’s “willful disregard of written instructions” then there is another 10%; tax avoidance costs another 35% and tax evasion is 50%. By comparison, the proposed local income tax charges 1% per month, up to a maximum of 25%; intentional disregard is another 10%, and fraud is 100%. Their proposal is actually structured closer to the IRS model, except that it’s much more severe than the IRS’s; the feds only assess .5% per month up to 25%, with a 20% penalty for “accuracy related” issues including willful disregard and tax evasion, and fraud is 15% per month up to 75%. So for the most common penalty, late payment, the city’s proposal is double what the IRS charges.  Last week city staff claimed that they had looked at other cities and states and their proposal is comparable, but they provided the Council no data to back that claim up – and the Council didn’t ask for it.
  4. How did the city arrive at the estimate of $125 million in revenues for the first year of the income tax?  City staff said that they based it on U.S. Census Bureau 2014 data on Seattle taxpayers, but provide no details. The distribution of incomes is very important, because it may turn out that a small fraction of the estimated 8,500 who will be paying the tax are in fact paying a substantial share of the total amount. Which brings us to the next question:
  5. How much would the revenue projection decline if the top 1% of taxpayers moved their residence out of Seattle? Or the top 5%?  1% would be 85 people; that could easily happen, especially if it saved them 2% of their earnings over $250,000. For someone making $5 million, moving outside city limits would save them $95,000 per year. I’m not claiming they all would definitely move, but they certainly would think about it.
  6. What are the revenue projections for the first five years? Looking at one year isn’t enough. As with the recently-passed soda tax, imposing a new tax causes a response in taxpayers that usually causes revenues to decline in the early years before stabilizing at some lower point. The city needs to understand what the real expectations are for income tax revenues five years after implementation.
  7. What are the priorities for the revenues raised?  So far, the city has given five intended uses: lowering the burden of regressive taxes; replacing federal funding cuts; providing public services such as housing, education and transit; creating green jobs and meeting carbon reduction goals; and implementing and administering the new income tax. These are so broad (especially “providing public services”) that you might be able to write a shorter list of things that the revenues can’t be spent on. The message behind this is “we just want more money to spend,” with no real sense of priority. That’s a pretty weak argument. They could say “the priority is to offset reductions in property and general sales taxes to reduce the tax burden on poor people.” Or they could say “housing” or “services for the homeless.” As it is, we really have no idea what they – or a future Mayor and Council – will do with the money.
  8. How much will it cost the City Attorney’s Office and the Hearing Examiner’s Office to handle the increased workloads they will see under this proposal? The Summary and Fiscal Note is incomplete; it has an estimate of 40-50 new hires, $10-13 million of upfront costs, and $5-6 million of ongoing annual costs, but no consideration of costs for the City Attorney and Hearing Examiner. The Council noted that this was missing, but didn’t press city staff to fill it in.
  9. What is the actual timeline for implementation, and what is the trigger for beginning it? As mentioned earlier, city staff won’t even begin to start working on implementation (building the IT system; negotiating an agreement with the IRS; hiring staff; the rulemaking process; setting up processes) until some unspecified future point in time when the Mayor decides that the legal uncertainty surrounding the ordinance has sufficiently cleared. So the starting point is unknown, but how long it will take after that is also completely unknown. The Mayor’s vague criteria for when to start working on it is understandable, but also frustrating: there will be a long lead time to do all of this work. The ordinance says that income is taxable starting on January 1, 2018, with the first tax payment due on April 15, 2019, but even if it passed into law today and work started immediately it’s not clear they would be ready to go 21 months from now (the IT system alone could easily take that long to design, build and test). Even if the income tax stands up in court, it’s anyone’s guess as to when it will really take effect.
  10. What is the minimal amount of enforcement power that must be granted to city staff to allow for a successful implementation? The ordinance, as currently drafted, adopts the B&O tax enforcement structure, which in most cases declares that the city’s income tax enforcement staff are presumed to be correct in all of their decisions about how much taxpayers owe, whether violations have occurred, and whether those violations are willful, evasive, or fraudulent – with the full burden of proof on taxpayers to disprove the city staff’s assertions. Further, it grants those same enforcement personnel powers as “non-uniformed special police officers” with powers not only to issue citations but also to make criminal arrests. It’s not enough to simply ask whether that’s “standard” in the city’s other tax codes, because this will apply to a different set of taxpayers than the other taxes do – and potentially a much larger number of taxpayers in the future. This is an extension of the police accountability discussion: what are the limits of local government power, and how do we give it enough to accomplish the goal without creating opportunities for abuse, overreach, and unnecessary intrusion into people’s lives? Again, businesses are not the same as individuals, and before the City Council grants police powers to tax enforcement officials it should look deeply at exactly what powers are required, how frequently and under what circumstances they will be used, and whether there are alternative methods to accomplish the same thing (like issuing arrest warrants and letting SPD make the actual arrests).

The fact that these questions haven’t been answered, and that the Council isn’t interested in getting answers to them, shows just how unusual this ordinance – and this situation – is. Everyone involved knows that for at least the next year the answers are irrelevant, and if the ordinance is rejected by the courts they will never matter. Nevertheless, it’s eyebrow-raising to see the Council push this bill forward into law with so much left unknown — or left to be worked out by future elected officials. They are passing a bill without any idea of whether it will actually take effect, and likewise sparse information about what happens if it actually does.