Tax Policy – Seattle Officials Return with New Proposal for Taxing Employment

Seattle’s city council—or at least a few of its members—are again gearing up for an effort to increase taxes on the city’s largest employers. The targets of the proposed taxes have been constant; the nature of the tax and what it is intended to fund has been a moving target.

The latest proposal would place a 1.3 percent tax on the payroll expenses of large businesses, intended to generate $500 million in annual revenue, with an initial $200 million intended to provide cash assistance to low-income households impacted by the COVID-19 crisis, and collections split thereafter between affordable housing (75 percent) and the city’s Green New Deal efforts (25 percent).

The latest Council bill represents a third wave of efforts to tax employment in the city. The first attempt, placing a $275 tax on each employee (initially proposed at $500 per person), was enacted but repealed in the face of popular opposition before it could go into effect. The second attempt would have placed a 1.7 percent tax on payroll expenses of large businesses operating in Seattle, designed as emergency legislation tied to the COVID-19 crisis in an attempt to shield it from a citizen-initiated repeal resolution.  Seattle Mayor Jenny Durkan (D) made clear that this approach was a non-starter and that she would not support it, and the measure quite clearly lacked the supermajority support on the Council necessary to be enacted as an emergency bill.

The most recent proposal would impose a 1.3 percent tax on payroll expenses, similar to the second attempt but with a reduced rate. The bill currently is in the Select Budget Committee after a June 10th presentation on the bill.

The tax would apply to businesses with Seattle payroll of $7 million or more and which are not in a specifically exempted category. Businesses that are exempted include grocery businesses, nonprofits, independent contractors who are counted in the payroll of another business, and businesses that are exempt from city taxation by federal or state statutes (such as insurance companies, liquor distributors or sellers, gas stations, and motor fuel distributors). The tax would fall on about 800 Seattle businesses.

Notably, subcontractors would be considered to be on a company’s payroll for purposes of the tax, and employees who don’t work primarily within Seattle city limits could still count if they do not have another work location that constitutes their primary place of business. The bill could create a strong incentive if not to relocate existing employees at least to focus expansion outside of Seattle city limits.

Grocery stores are exempt in recognition that they tend to have very low profit margins (frequently 1-2 percent) and a payroll tax of 1.3 percent could cut deeply into those margins. However, the definition of grocery business included in the legislation excludes many retailers for which groceries are combined with home goods and other merchandise, as it requires that at least 75 percent of gross income be attributable to the sale of food and food ingredients that are exempt from the retail sales tax. It’s a definition even some pure grocery stores (not, say, a Walmart or Target) may struggle to achieve, since prepared foods, cleaning supplies, plates and cutlery, pet food, and other common grocery store items are outside the definition.

Grocery stores, moreover, are far from the only low-margin businesses in Seattle, and any such business—mostly retailers, but also newly established companies that have yet to turn a profit, or businesses that are currently struggling—could face very steep effective tax rates under the proposal.

This tax is based on payroll expense, which has little to do with the profitability of a business and does not take into account a business’s ability to pay. As with taxes that are levied on gross receipts, like Washington’s Business & Occupation (B&O) tax, businesses with small profit margins such as restaurants and retailers will see their already small margins be shrunk. In some cases, this bill may push employers to reduce payroll, which may take the form of hiring freezes or canceled raises.

In a post-COVID economy, any tax that may cause hiring freezes and stagnant wages is particularly undesirable and tends to target the most vulnerable (low-income consumers and those with tenuous employment) even if the tax is legally imposed on relatively large businesses. A tax on payroll changes companies’ employment decisions. First, if an employer is getting close to the $7 million mark for payroll expense, they might think twice about hiring another employee. Second, employers at or above the $7 million kick-in may be less inclined to give raises or hire fewer new employees.

Other than unemployment insurance taxes, which are designed as a social insurance program, governments tend to avoid direct taxes on employment—and with good reason. Seattle officials have struck out on their attempts to implement such a tax twice. Will they strike out once more?

Source: Tax Policy – Seattle Officials Return with New Proposal for Taxing Employment