Understanding How I-1098 Will Hurt the Economy and the State Budget

Let's be clear. I-1098, the proposed income tax on high earners, will land heavily on business in this state. Over at the Economic Opportunity Institute, the group that helped put the misbegotten initiative together (EOI president John Burbank is listed on this PDC filing as 1098's campaign chair), they claim that "very few business owners will pay state income tax" under 1098. Even by their own erroneous analysis, they calculate that 25 percent of all tax returns over $200,000 - the lowest 1098 threshold - included business income. That's one-in-four returns - hardly very few.

But EOI fails to pick up partnerships, S Corps and LLCs. The 25 percent is based on data drawn from an abbreviated IRS statistical report (Historic Table 2 in the quarterly Sources of Income publication). Those of you so inclined can follow the link, see Line 20 for "business or professional net income" and find the 27,760 filers cited in the EOI post. Then, go to Line 9 to get the 111,258 total filers with more than $200,000 AGI and do the math. You get the 25 percent claimed by EOI.

So easy and so wrong. All EOI considers is Schedule C income - completely missing partnerships, S Corps, LLCs and, for that matter, farms and rental income. The mistake significantly understates the damaging effect of I-1098 on thousands of businesses in our state, including many of the firms at the heart of the "innovation economy" consistently celebrated by our state's political leaders.

The data can be found in Individual Income Tax Returns Pub. 1304. It takes some digging around. I'll save you the trouble. Because the state level tables do not report the S Corps, etc., we extrapolate from US data. Of the 4.5 million returns with AGI of more than $200,000, 42 percent show partnership, S Corp and LLC income and 26 percent Schedule C (compared with the 25 percent we get from the state returns). Put them together and you have a whopping 68 percent of filers affected by 1098 with business income.

Let's concede that there's likely some double-counting. You can show partnership, LLC, and Sub S income in addition to Schedule C income. Some business owners do have multiple ventures. On the other hand, we didn't count rents, royalties and farms.

Shave it a bit. But there's no way you can claim "very few" businesses will be hit by 1098.  With well over half and maybe as many as two-thirds of taxpayers affected by the initiative reporting business income, the damage will be clear and immediate. For them, owners of many of the state's most dynamic ventures, it's a business tax.

Sloppy initiative drafting? Or just an economy-killing disregard for the job creation and investment potential of our state's most dynamic entrepreneurs?

Either way, it's another reason - a decisive reason - to oppose I-1098.

Updated to clarify.

Comments

[Washingtonpolicywatch]

You're right that we didn't include S-Corp/Partnership income in our initial analysis, and I've updated our fact sheet accordingly. (See first link below.)

But your own analysis above is incomplete, in that you address only business income for taxpayers with an AGI above $200,000. A more comprehensive approach would include all tax filers claiming net business income.

Our updated fact sheet reflects that broader perspective, noting that of all WA tax returns claiming net business income (from a sole proprietorship, S-corporation and/or partnership), only 10.6% show an AGI of more than $200,000. And since 85% of high-income returns are filed jointly, under I-1098 a substantial proportion of those tax filers would be exempt from paying state income tax on AGI up to $400,000 per year.

Most business owners will also see a tax cut under I-1098. According to analysis by the Department of Revenue, I-1098 would exempt 81% of Washington businesses from B&O tax payments, and reduce B&O tax payments for another 12%. Every business that owns property would also see a 20% cut in the state portion of their property taxes. (See second link below.)

Links:

http://washingtonpolicywatch.org/2010/06/22/initiative-1098-will-business-owners-pay-state-income-tax-updated/

http://www.eoionline.org/tax_reform/fact_sheets/PropertyTaxReductions-Jun2010.pdf

~Aaron Keating
Communications Director
Economic Opportunity Institute

[Richard S. Davis]

Thanks for acknowledging that Sub S, LLCs, and partnerships will be affected. While your data show four-fifths of B&O filers may benefit from the B&O credit, the credit amounts to less than 10 percent of all B&O collections.

It's just not a lot of money, reflecting the fact that most of the businesses will benefit are very small, employing few people and generating only modest economic impact. The relief will be good for them, but it's unlikely to stimulate much economic activity. The innovation economy firms most affected by the new income tax create jobs and stimulate new investment. I-1098 makes a bad long-term economic trade-off for our state.

The property tax relief is trivial.

[Steve Roth]

The missing piece of data here is the % of >$200K filers that make more than $400K.

Assuming 30% (a generous assumption, I think) and Aaron's 85% joint-filers number, here's the result:

What Percent of Filers are Affected?
% of >$200K filers with bus income 41%
% of filers with bus income 4.2%
% of filers .65%

Details and spreadsheet here:

http://www.asymptosis.com/washington-state-income-tax-initiative-1098-whos-affected.html