A Close Look at the Proposed Head Tax

As part of officially introducing the employee hours tax (aka the “head tax”) into the budget process last week, Council members O’Brien, Harris-Talley and Sawant submitted draft legislation for it. Now that it’s something concrete and not just a set of talking points, let’s look at what it says, and what it means.

The tax is officially described as an “employee hours tax for the privilege of engaging in business activities within the City.” It is measured by “the number of employee hours of work conducted within the City during the calendar year.” The amount of tax due is that number of hours multiplied by $0.052083. Alternatively, an employer can calculate the number of full-time employees (FTEs) working in the city, including salaried employees whose hours aren’t tracked, and pay $100 per FTE.  The tax is due annually, at the same time a business pays its annual business tax or its final quarterly business tax installment.

There are several classes of businesses that are exempt from paying the head tax:

• Any business with annual taxable gross income of $5,000,000 or less;
• Businesses that are preempted from taxation by cities under federal or state law. That includes insurance businesses and their agents; businesses that only sell, manufacture or distribute motor vehicle fuel; businesses that only distribute or sell liquor; and federal and state government agencies and subdivisions.
• Volunteers and persons providing services in return for “only aid or sustenance from religious or charitable organizations.”

Restated: any organization that has a business license in Seattle might be subject to the head tax, unless it falls into one of the above exempted categories. Right off the bat, we know Safeco, ARCO, Shell, Washington State Ferries, and the big wine shops won’t be paying it. But the real rabbit hole is in that first bullet: the definition of “taxable gross income.”

“Taxable gross income” is a term officially defined in the Seattle Municipal Code and is already used for setting the thresholds for business license fees and B&O taxes. It is “gross income” — i.e. revenues — minus a set of allowed deductions. Those deductions turn out to be a fairly eclectic set of items, including:

• membership and certain service fees for nonprofit youth organizations;
• initiation fees, dues, contributions, donations, tuition fees;
• charges by a nonprofit trade or professional organization for space at a trade show, conference or educational event not open to the public;
• charges for privately operated kindergartens;
• endowment fund income;
• funds received by “Artistic and Cultural Organizations” for business activities (except retail sales), from federal, state or municipal governments in support of programs, or from tuition charges;
•  day care activities;
• funds received as compensation from a government entity to a health or social welfare organization for health or social welfare programs (but not through an employee benefit plan);
• interest on investments or loans secured by mortgages or deeds of trust;
• interest on state or municipal bonds;
• interest on loans to farmers or ranchers, producers or harvesters of aquatic products, or their cooperatives;
• proceeds from sales destined out of state or to other parts of Washington State outside of Seattle;
• funds used for “repair, maintenance, replacement, management, or improvement of the residential structures and commonly held property” for residential cooperatives, homeowners and condo associations;
• sale proceeds of precious metal bullion;
• certain advertising agency fees for radio and television broadcasting;
• interstate trucking;
• sales of electricity or water for resale by other municipalities or utilities.

With all of these deductions, some random set of local businesses will probably get under the $5 million threshold and avoid paying the tax, and others such as KinderCare, Safeco, liquor distributors, companies that primarily sell out of state, and possibly some financial services companies will see most or all of their revenues exempted. Meanwhile, both Seattle City Light and Seattle Public Utilities are subject to the head tax — which they will pay right back to the city, albeit into a different bucket of money. But what’s more interesting is how this affects nonprofits, all of which need to have business licenses and are potentially subject to the head tax. Some the like the YMCA and Mary’s Place will avoid it because of the deductions for donations and government grants; others like the Seattle Aquarium, Pacific Science Center, and Woodland Park Zoo will almost definitely pay it because of their admissions fees (disclosure: I’m on the Board of Directors of the Woodland Park Zoo, an unpaid volunteer position). Others are stuck in the middle: El Centro de la Raza probably won’t have high enough non-exempted revenues this year to meet the $5 million threshold, but they’re close so they might in future years, and they don’t meet the qualifications for an Arts and Cultural Organization exemption (nor do the aquarium, zoo or science center). Seattle University’s and University of Washington’s donations and tuition are exempted, but some of their other revenue-generating programs aren’t and they could easily make the $5 million threshold.  The bottom line: if you think you know which organizations are going to be paying the head tax, think again, because the rules are very complicated.

Which leads us back to one of the bigger questions: which organizations should be paying such a tax? If you buy into the intent of the sponsoring Council members, the tax is intended to force the companies that have benefitted the most from Seattle’s economic boom to pay for the issues that the boom has created, in particular the lack of affordable housing and the homelessness crisis. But the problem with that argument is that it’s poorly aimed. At one level that’s because of the issue we just discussed: the arcane and scattershot rules and exemptions for taxable gross income. But in larger part it’s because it relies on gross income, rather than net income (aka “profit”), as a proxy for who has benefitted the most.  There are companies that make more than $5 million in local revenues that are losing money, or whose profits have steadily declined over the past several years. It’s difficult to argue that they have benefitted from the boom.

A case in point: local favorite Nordstrom. In 2013, the company’s gross income was $4.72 billion and its net income was $735 million. This year, its gross income climbed to $5.32 billion, but its net income was $354 million — a 50% drop in five years. Its stock is in the tank too.

Another one: Tableau Software. It had a good run in the early 2010’s, but it lost $84 million in 2015 and $144 million last year.

But let’s look more broadly at industry sectors in Seattle. Fortunately, our city government collects data on that. Here are employment growth numbers for the top industry sectors:

Clearly retail (aka Amazon) and services (also in part Amazon, as well as Zillow, Accenture, and lots of smaller shops) have grown substantially.

However, other sectors haven’t fared nearly as well. Trade, transportation, utilities and construction have seen some ups and downs but the last few years have been relatively robust — despite some significant layoffs at Boeing in the greater Seattle metro area but outside the city limits.

However, manufacturing  is lagging the rest of the regional economy.

And everyone’s favorite punching bags, Finance, Insurance and Real Estate, have actually been downsizing.

Clearly saying “the biggest companies are the ones benefitting the most from Seattle’s boom,” which is what Council members O’Brien and Sawant are saying in support of the head tax, is both wrong and also a dramatic oversimplification of what’s actually happening in Seattle’s economy.

The Council members have also been claiming that Seattle businesses haven’t been paying their “fair share” towards solving local issues. “Fair share” is a completely amorphous standard that allows each one of us — and especially politicians — to insert their own moral judgment into the equation, much as Council candidate Jon Grant insists that residential developers should set aside 25% of their units for affordable housing. But we can look at how much businesses in Seattle do actually pay into the city coffers.

Here’s a chart of the projected 2018 “general subfund” revenues of $1.27 billion  (figures in $millions):

Right off the top, companies are paying $268 million in B&O taxes, and B&O tax revenues are growing faster than the local CPI rate.

There are also $260 million in sales taxes and $213 million in utility taxes that are assessed on companies and passed through directly to customers (both businesses and consumers). Though for that matter, B&O taxes are also passed through indirectly to customers as markup on prices. There are also additional property taxes collected that don’t go into the General Subfund — for parks, education, and several other programs. The “fees and charges” also include a variety of permits required to conduct business.

A big chunk of property taxes are also paid by businesses. Here are the top property tax payers in Seattle for 2016 — all businesses:

Collectively these ten alone paid $36.5 million in property taxes. It should be no surprise that the top property taxpayer last year was Amazon, at $19.3 million.

And then there’s the Real Estate Excise Tax, levied on every real estate sale in the city. A large (though currently shrinking) fraction of those are commercial buildings, expected to be about $25 million in REET revenues this year:

And a portion of the residential and condo transactions are actually business transactions by developers selling new construction or renovated buildings. To sum up: B&O taxes are paid by businesses, utility and sales taxes are driven by businesses, and businesses pay utility taxes, sales taxes, license fees, permit fees, property taxes, and Real Estate Excise Taxes. It’s several hundred million dollars every year.

In the brief discussion of the proposed head tax last week, it was clear that there wasn’t broad support for it. Some Council members voiced their concern that the business community hadn’t been consulted before the tax was proposed. Council member Harris-Talley responded “it hurt my heart” to hear that, because in her experience the city only held that view when asking the business community for money, but not when asking people.

That claim is demonstrably false. Last summer, when the Council was debating the sweetened beverage tax, which it knew was provably regressive, it spent a great deal of time consulting the most affected communities and reshaping the legislation based on their feedback, while largely ignoring the feedback from the business community. In contrast, a year ago when it was restructuring the B&O tax to raise more revenues from larger companies, it made little public effort to consult with the business community.

And of course all property tax levies require a public vote.

O’Brien, Harris-Talley and Sawant aren’t entirely wrong to argue for a new tax to create affordable housing and to address the homelessness crisis. O’Brien in particular is right that the city’s current plan — and the Mayor’s proposed budget — are unlikely to make a dent in either issue over the next twelve months. O’Brien has a knack for asking questions that cut to the heart of critical issues. Unfortunately, he also has a penchant for jumping to simple, yet unworkable, solutions. The assumption underlying the head tax is that more money will solve the problem. That may be true, but at this point it’s very difficult to draw the connection between more funding and a better outcome. There is already a $290 million Seattle Housing Levy pumping money into affordable housing, on top of $29 million directly allocated in the 2017 budget and other programs.  And the city is spending over $50 million on homeless programs this year, with an increase proposed in the 2018 budget. One of the biggest frustrations of city officials is that state law prohibits them from spending REET revenues on affordable housing; otherwise they would be pumping far more money into existing and new programs.

That said, there are a couple of problems with the affordable housing investments. One is that they have a long lead time; it’s hard to be patient when people are suffering. Two, they’re not driven by a plan that’s based on an understanding of how much housing is actually needed. Sure, the HALA plan has goals for new housing, but those goals are long-term, and there is no model for how much housing is needed in the short-term both to meet the current need and to provide shelter to the homeless in our city. Already O’Brien, Harris-Talley and Sawant are suggesting that the head tax should be $200 per FTE instead of $100. That’s a debate over what they think they can get passed, not a debate over an actual need.

The problems with the spend on homelessness are worse. The biggest issue is the Human Services Department itself, a massive and opaque bureaucracy that leverages the crisis nature of the problems it is addressing to avoid any true accountability for results — or for the $154 million in taxpayer money it is stewarding this year. Ironically, HSD is pushing forward with a “results-based accountability” program for the providers it funds, yet it unwilling to apply the same principles to its own management of those providers. Given HSD’s failure to make progress on addressing the homelessness crisis, as well as on the mental health and substance abuse crises, there’s no credible reason to believe that throwing more money at HSD today would produce a better result. O’Brien is probably right that the current level of funding for addressing homelessness would be insufficient for a well-run, effective HSD to fully solve the problem, but the first step is to get a well-run, effective, transparent and accountable HSD. The city has gone through several iterations of substantially increasing its spending on affordable housing and addressing homelessness, and every time the problem has worsened. The lesson from that is that the money isn’t the primary problem.

The proposed head tax is a well-intentioned attempt to make a larger commitment to solving two big problems. We can applaud Council members O’Brien, Harris-Talley, and Sawant for proposing something bold. But being bold doesn’t make it the right thing to do. In this case, it’s the intellectually lazy and politically expedient approach. It takes money from an easy political target: large businesses (and especially Amazon), and it does so in a ham-fisted way that will hurt other businesses that can’t afford to pay the tax. For most companies, the head tax will come out of either payroll or consumers’ wallets. And the head tax throws the money in the general direction of two important problems with neither a plan nor an agency that can effectively achieve results.

Rather than chasing a head tax today, the Council should work with the next Mayor to build a real plan for housing and homelessness, one that quantifies the needs and then budgets to meet that need.  How many units of permanent supportive housing do we need? How many beds in mental health and substance abuse treatment programs? How many beds in low-barrier, 24-hour shelters with wrap-around services? How many overnight shelters could be converted to 24-hour, and what would it take to do that? How many sanctioned encampments do we need? People have been asking these questions for two years, and the city has yet to answer any of them — even after doing a “needs assessment” study last winter. Answer the questions, and build a real plan to meet the need.

In the meantime, the Council and the Mayor should focus on reforming HSD into an organization that can spend $150+ million well and that is ready to execute on the plan. If it does that, I think it would find that the business community and the taxpayers of Seattle would eagerly step up to fund it.