As expected, the state Court of Appeals today unanimously upheld Seattle’s employer compensation tax. Though the tax is a questionable economic policy, Seattle successfully threaded the legal needle to avoid the prior constitutional violations of its invalidated local income tax. From today’s Court of Appeals ruling:

“We conclude that the City’s payroll expense tax is an excise tax on businesses imposed under powers vested in the City by the state legislature and the state constitution. Engaging in business is a substantial privilege on which the City may properly levy taxes, and the use of a business’s payroll expense is an appropriate measure of that taxable incident. Unlike Cary, the City’s payroll expense tax is not a tax on employee income or the right to work for wages. Summary judgment in favor of the City was appropriate.”

Now that Seattle has received a green light for the employer compensation tax, expect conversations to quickly turn to how to increase it to respond to the city’s overspending-induced budget problem. As reported by the Seattle Times:

“’Structural problems require structural solutions, like Jumpstart, and as budget chair, that’s what I’ll be exploring as we head into the budget season this fall,’ Mosqueda said, committing to finding a ‘progressive’ revenue source, or one that is graduated based on income."

Though some cities may take inspiration from Seattle’s tax victory and look to impose their own employer compensation taxes, pursuing this type of tax on a statewide basis was recently rejected by the Washington Tax Structure Working Group. The work group voted back in March to remove the following taxes from its possible list of recommendations to the legislature:

• Value Added Tax (VAT);
   
• Employer compensation tax;
   
• Flat or progressive corporate income tax; and
   
• Flat or progressive personal income tax.  

The Tax Structure Work Group consultant’s report noted that Washingtonians were opposed to the tax because of “concerns that the employer compensation tax might hinder economic growth.”

A valid concern other cities should keep in mind before following Seattle’s lead.