Seattle is currently having a contentious debate over a proposed "head tax" to fund more affordable housing and services for its large and growing homeless population. Under the proposal, large and mid-sized Seattle businesses (those with more than $20 million in gross revenue) would pay 26 cents per hour worked for each employee, which is about $500 per full-time employee per year (for each "head"). In 2021, the head tax switches to a 0.7 percent payroll tax—collected from the same employers. Seattle expects to collect about $70 million a year from the new tax, with about 30 percent of the total from Amazon and the rest from more than 500 other employers in the city.
Predictably, businesses, including Seattle’s most-prized business, Amazon, are complaining loudly about a "job-killing" tax. Our colleague Howard Gleckman is also not a fan of the proposal and makes the case against the tax in a related post.
And we agree that Seattle could design its head tax a little better. But the root question, and one that other cities might watch closely, is: How are fiscally constrained cities supposed to find revenue as their populations and services grow? Given limited taxing alternatives, a head tax may be a good option to raise needed revenue.
Other cities use these types of taxes. For example, Pittsburgh and Denver each have small head taxes, which they collect from employers (including the self-employed). Pittsburgh’s tax is $52 a year on employees engaging in an occupation within the city. Denver’s tax is $117 a year on employees who perform services in the city. These taxes generally are used to fund local services, including police, fire, and emergency medical services. The cities believe the costs of these types of services are related to employment levels.
Businesses often complain that head taxes and payroll taxes discourage employment, which, to some degree, is true. But these local taxes are typically small compared with federal payroll taxes, like Social Security taxes (12.4 percent including the employer and employee share, with a $128,400 cap), Medicare taxes (2.9 percent including the employer and employee share on all earnings and an additional 0.9 percent paid by individuals on earnings over $200,000), and unemployment taxes (with federal tax rates about 6 percent with a $7,000 cap, and states imposing their own taxes, which mostly can be credited against the federal tax). For an employee in Seattle making $100,000, existing payroll taxes are roughly $15,000 a year. So, an additional $500 or $700 (for a payroll tax assessed at 0.7 percent) is relatively minor. A new per employee tax or payroll tax also is relatively easy to administer and enforce, as employers report the number of their employees, and their payrolls, quarterly for unemployment tax purposes.
Seattle’s $500 tax would fall disproportionately on lower-paid employees, until the 0.7 percent payroll tax takes effect in 2021. To avoid this effect, Seattle might consider starting with the 0.7 percent payroll tax. And, if Seattle wanted to make the tax more progressive, it could exempt the first $15,000 of earnings, or possibly have it begin where unemployment taxes end ($47,300 in Washington). Seattle also could expand the tax to more employers (such as smaller firms and tax-exempt entities) and thus lower the tax rate while raising the same amount of revenue, which would reduce distortions and lesson the burden for all taxpayers.
But, with or without the improvements, there are no good alternatives for Seattle. The city cannot increase property taxes without further increasing the cost of housing—and exacerbating its housing problems. Further, because of the state’s uniformity rule, it cannot tax business property at a higher rate than residential property. Seattle already taxes the gross receipts of most businesses, and gross receipt taxes are notoriously inefficient. An increase to the local sales taxes would be both regressive and problematic given the combined state and city rate is already over 10 percent.
Seattle’s biggest constraint is that it cannot impose an income tax, which is prohibited by state law. In fact, Seattle passed an income tax on its wealthiest residents in 2017 (which would have raised $140 million per year), but it was quickly struck down by the courts. This fiscal limitation is why the city believes it has maxed out its reliance on other taxes and is now searching for new ones.
We feel its pain. In 2014, we staffed the District of Columbia’s Tax Revision Commission that recommended a $25 quarterly fee per employee (or $100 a year) collected from employers with five or more workers (which we called a "service fee"). While the District has an income tax on residents, it is barred by Congress from taxing the income of anyone who is not a resident of the city. The District’s property tax also has its scope limited because there are so many tax-exempt government and nonprofit buildings in the city. Like in Seattle, the "service fee" was a proposed solution to fiscal constraints.
The D.C. Council initially rejected the recommendation but, two years later, adopted a 0.62 percent payroll tax on employers starting in 2019 to fund its family leave program.
Every tax distorts behavior. There are two key questions to address: (i) are the distortions fatal; and (ii) are there good funding alternatives (assuming the taxing authority really needs the money). For Seattle's new head tax, we feel the answers are (i) no, and (ii) no, at least until the state of Washington allows it to tax income. As is often is true in cases like this, cities should not let the perfect be the enemy of the good in pursuing necessary goals like increasing affordable housing.
