Business split over income tax on rich

Bill Gates Sr., the retired lawyer and wealthy father of the Microsoft co-founder, thinks Washington's tax system is out of whack and needs repair.

The poor pay too much tax; the rich pay too little, Gates says. And the school system, which is such a springboard for future economic growth in high-tech Washington, suffers with too little funding because the wealthy aren’t paying their fair share of the investment, he says.

Gates’ solution – an income tax on earnings that exceed $400,000 a year per couple or $200,000 for an individual – is drawing protest from Washington business leaders and owners, as well as anti-tax allies such as Tim Eyman, who says the phrase “income tax” is politically toxic in Washington.

Initiative 1098 would give tax credits to an estimated 80 percent of Washington-based businesses and would cut the state share of property taxes by 20 percent for businesses and homeowners. Critics say I-1098 would harm the economy by taxing earnings of people who own the businesses – money that most likely would put people back to work.

The Defeat 1098 campaign also says an income tax on 38,400 of the state’s highest earners would erase one of the state’s competitive advantages (Washington is one of seven states without an income tax) and could drive away entrepreneurs. Even Gov. Chris Gregoire’s Commerce Department has touted the lack of an income tax in its national magazine pitches about Washington’s business climate.

Gates sponsored I-1098 and donated $600,000 to Washingtonians for Tax Relief to show he means it. He has been featured in television ads in which children toss balls and knock the kindly faced older man into a dunk tank – in effect soaking a rich guy who doesn’t mind.

Gates rejects his opponents’ complaints. He calls Washington’s tax system “dramatically regressive,” something he and others say they proved in 2002 when he led a commission created by the Legislature to study the state tax system. The commission recommended replacing a large portion of the sales tax or property tax with an income tax that would rebalance the tax load.

More recently, Gates cites data from the national Institute on Taxation and Economic Policy that show Washington’s poorest 20 percent of earners pay the equivalent of 17 percent of their income in sales, property and other taxes. By contrast, the wealthiest 1 percent pay less than 4 percent of their earnings in taxes, which makes Washington the most “regressive” – or easiest on the rich, hardest on the poor.

And the gap between rich and poor tax burdens is more dramatic here than in California, Oregon or Idaho, three nearby states with income taxes that take a larger bite out of earnings than anything in I-1098, Gates says.

“It’s not a matter of picking on someone,” Gates told The Olympian’s editorial board last month. “It’s a matter of correcting to some extent a bad historic situation and arguing – I think absolutely persuasively – that this is a proper source for a serious financial shortfall in our operations, namely the public education system.”

The two sides in the debate have raised more than $11 million, making this one of the most expensive initiative fights in history – but not the most expensive this year (a repeal of taxes on soft drinks is most expensive). A recent Washington Poll showed I-1098 was failing by a 42 percent to 51 percent margin, wider than the survey’s margin of error.


The campaign is swimming against a tide of history and popular beliefs.

Washington voters overwhelmingly approved an income tax in 1932, only to see if tossed out on a 5-4 decision by the state Supreme Court. Justices ruled that a graduated income tax was unconstitutional because it taxed income at different rates. Gates and some constitutional scholars say the legal precedents for that court ruling and later iterations since have been rendered moot.

Since 1932, Washington voters have rejected four income-tax proposals, the three most recent in the 1970s, when Republican Gov. Dan Evans backed an income tax.

This time around, Evans is on the other side, saying I-1098 is the wrong approach. He is joined by many in the high-tech field and the Association of Washington Business in arguing that an income tax won’t be good for business.

In fact, while Gates Sr. has support from his son, Bill Gates Jr., the Microsoft co-founder, and investor Nick Hanauer, other high-tech names such as Microsoft co-founder Paul Allen and Microsoft’s current chief executive, Steve Ballmer, have donated heavily to the Defeat 1098 side. Ballmer has donated $425,000, making him the largest single donor to Defeat 1098, which had raised $5.5 million and spent about $2.24 million as of mid-October.

A range of business groups has lined up against the measure, including the Association of Washington Business, Washington Technology Industry Association, Building Industry Association of Washington and Washington Farm Bureau.

People in the tech industry say that taxing the high wages of high-earners could make it harder for high-tech firms to attract or retain high-caliber talent.

“While we respect the opinions of both sides, a significant majority of our members are not in favor of this particular initiative, which is why we have chosen to take this position (against it) as an organization,” WTIA President Susan Sigl said in a statement.


Joe Barer, president of Seattle business-consulting firm Lake Partners, disputes the claim that Washington’s tax system is regressive. The state collects most of its taxes from sales taxes, a tax on gross receipts of businesses, property taxes and real-estate excise taxes, and many of those taxes get passed on to consumers.

But Barer says analysts who say those taxes hit the poor more severely than the rich do not take into account that retirees get tax breaks and low-income people often qualify for aid programs.

He also says that, based on his own analysis of Internal Revenue Service data, I-1098 would hit the owners of small businesses that have high earnings. That is because many family-owned businesses are formed as S-corporations under the tax code. This tax status lets company profits flow to the individuals and lets them avoid paying both federal corporate taxes and individual income taxes.

Under I-1098, the income would be taxed and so would capital gains, Barer says.

Gates and campaign spokesman Sandeep Kaushik shrug off the complaint, saying it is up to company owners how they file taxes. Gates said the S-corporation designation is in effect a windfall for some wealthy business owners who can easily afford the additional tax.


Both sides are advertising heavily, and Defeat 1098 mailed fliers to voters this week in Olympia. In one flier, I-1098 is described as a “backdoor” attempt to extend taxes to all residents and says a simple, 50 percent majority of lawmakers can carry that out in two years.

“It’s a risk Washington taxpayers can’t afford to take,” the flier says in big letters, echoing a theme the Defeat 1098 television ads have used.

But that is misleading. Gates said there are political realities to bear in mind if lawmakers were to consider something as “Draconian” as lowering the levels at which income can be taxed.

“It’s very probable the Legislature would decide it had to go to a vote of the people” for that, he said.


The two sides also argue whether I-1098 is constitutional. The Yes on 1098 campaign cites the opinion of constitutional scholar Hugh Spitzer, an affiliate professor at the University of Washington Law School, who says it is.

Spitzer says major cases relied on for state Supreme Court decisions on the graduated income tax were based on legal precedents that equated income to property but since have been overturned or rendered moot.

But while Spitzer believes a new court would look at the tax issue through fresh eyes, the Association of Washington Business and others have cited an opinion by former Justice Phil Talmadge, who wrote recently that courts are likely to toss out the tax again if voters approve it. Talmadge cites the precedents Spitzer disputes.

The result: a court challenge is likely and could delay the state’s ability to collect the income tax. But Gregoire said recently that she thinks the courts could let the initiative take effect, allowing tax collections, while they review the legal arguments.

The Yes on 1098 campaign also has made misleading claims, saying in one ad that the measure can’t be changed without a vote of the people. In practical terms, that might be true – because lawmakers might fear the wrath of voters – but lawmakers can amend any initiative two years after its passage without a vote of the public and by a simple majority vote.

Gregoire has spoken against an income tax in the past, saying in her 2008 re-election campaign that the recession was the wrong time to enact a general tax increase on struggling businesses.

More recently, she has said she has come to support I-1098 reluctantly and believes it could offer funds that let the state avoid some of the deep cuts to school programs and the human-services safety net that she is considering.

Brad Shannon: 360-753-1688 bshannon@theolympian.com www.theolympian.com/politicsblog