Washington's $450 Million Tax Giveaway For Cars

Car dealerships versus public education: the legislature decides.

** UPDATE 11/16 — Crosscut published an updated and refined version of this piece.

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Washington’s legislature will soon be convening for a special session that the governor has already called “brutal” for its potential impact on education and other services. Today, she outlined $1.65 billion in cuts to cover the projected two-year budget shortfall.

It’s going to be a tough session, but I can knock out one-fifth of the state’s budget problem right now—$344 million in new state revenue—just by closing a single tax loophole designed to boost car sales. Plus, closing that loophole would provide an additional $106 million to cash-strapped local governments over the next biennium.

Too good to be true? Hardly. Check out the Washington Department of Revenue’s most recent “Tax Exemption” report. (It’s circa 2008 with a new one due out next year.) If you can make it through to page 288 of the full report, you’ll find the goldmine I’m talking about: ol’ RCW 82.08.010, better known as the “trade-ins exemption.” As the name implies, the law exempts trade-ins from sales tax by defining the purchase price of an item, the price eligible for taxation, as the price of the item minus the price of a trade-in item. So if I trade in a $5,000 used car in order to buy a $20,000 new car, I only pay taxes on the $15,000 balance.

By contrast, if I sell my used car to a private buyer, he would legally be required to pay sales tax on my $5,000 car, and then I would pay sales tax on the $20,000 new car I buy. So the trade-ins loophole is a very sweet deal for car dealerships. And it is mostly about car dealerships. Vehicles constitute by far the dominant share of trade-ins, though there are other items like farm equipment and boats that are also commonly traded in. (Things like bicycles and musical instruments are too sometimes, but the purchase prices are so low that they don’t represent an important share of the tax exemption.)

Oddly enough, the trade-ins loophole is the product of a quarter-century old ballot measure, Initiative 464. (A 1982 version of the measure, Initiative 426, failed to gather enough signatures to qualify for the ballot.) Like many bad ideas, I-464 was a smash hit at the polls: it passed with 69 percent of the vote.

Reading the 1984 voter’s pamphlet is illuminating. The “statement against” arguments
have been proved basically right. Here’s my updated version of them:

  • It’s a fundamentally regressive tax loophole, mainly benefiting the well-off who have high-priced vehicles to trade in frequently. It doesn’t do much to help lower income folks who are far less likely to own cars, and when they do own cars tend to own lower-priced cars that they maintain for a long time.
  • It stimulates auto sales, which probably help in-state dealerships, but the automotive industry is not a big factor in Washington. If anything, encouraging car purchases is a bad economic strategy because fuel costs are so high, and because Washington supplies essentially none of its own fuel.
  • Higher education funding tends to bear the brunt of state revenue losses. I’d wager that Washington’s public universities could make good use of $344 million right now.

The bottom line is that the state budget is in a bad place. There are no easy spending cuts left and there are not likely many easy revenue-raising options either. Yet closing tax loopholes—especially those that are regressive and yield small economic returns—is the smartest path toward stabilizing public budgets.

Among the many obstacles is Tim Eyman’s undemocratic (and probably unconstitutional) minority-rule provision put in place by last year’s Initiative 1053. It’s time to challenge 1053 in court, ignore it legislatively, or else just close the worst darn tax loopholes by super-majority vote.

One closing note. If I hear one person—just one person—tell me that closing this tax loophole isn’t “politically possible” or “is too heavy a lift” for this session, I’m officially going to blow my stack. You know what’s too heavy a lift? Cutting low income people off from health care, dismantling the public education system that the middle class relies on, slashing environmental protections, and all the other stuff that the legislature has been hacking away at over the last couple of years. It’s about time we share the pain with car dealerships.

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Comments

  1. Matthew Amster-Burton says:

    Eric, this kind of post is exactly why I’m a Sightline donor. I didn’t know anything about this loophole, and your analysis is dead-on. Thank you.

  2. Alan Durning says:

    The legislature should ignore I-1053. That’s the way to set up a constitutional test. The problem, as I’ve explained here, is the state’s lieutenant governor. He interprets the rules in the state senate, and he has insisted on following supermajority voting requirements, even if they’re unconstitutional.

    • Frequent Poster says:

      Great idea! Ignore an initiative that passed every single county in the state, including King County. Excuse me, but do you have a political suicide wish?

  3. Frequent Poster says:

    Okay, so I trade in my car for 10 grand, and pay $950. Dealer sells it for $13,000 and pays $1,235. Total for the state: $2,185.

    On the other hand, I advertise the car myself, and get $11,000. Buyer pays $1,045.

    Think about this a second. How long do you think it would take until sellers and buyers moved outside of the dealer channel to arrange the sales?

    Gee, I bet ya didn’t even consider it, did ya?

    • Eric de Place says:

      You’re (intentionally?) missing the point: that’s not how closing the loophole would work. Let’s dig in.

      Under current law, if you sell (not trade) your car to a dealership or any other buyer, the buyer pays sales tax. By contrast, if you trade in the car, the dealer does NOT pay tax on that trade, and the buyer still would NOT pay tax on the trade if the loophole were closed. Tax is collected when the dealer sells your old car to a new buyer — that’s the same deal whether the loophole is closed or not.

      A shorter version of this: sales tax is collected when a sale is made. Fair tax policy would assess the sales tax on the full purchase price. (A trade in is just a non-cash way of a buyer coming up with the purchase price.)

      Here’s where the difference is. Under current law, if you’re buying a new car the state’s tax law pushes you into trading in the car rather than selling it to a private buyer. Why? Because if I’ve got a $10k car now but I want to step up to a $20k new car, I can avoid paying taxes on half the value of the new car by trading in my old one to the dealer. If, however, I sell my old car to a private buyer and then buy the new car I’ll have to pay sales taxes on the full purchase price of the new car. When I trade in my old car and buy the new car, the state loses $950 (assuming a tax rate of 9.5%).

      In other words, dealerships get preferential treatment. Current state tax policy is effectively designed to push auto sales away from private transactions and into dealerships. It’s a bum deal for the public coffers and a bum deal for folks who would rather do business without used car salesment intervening.

  4. Elizabeth says:

    Except isn’t the sales tax exemption similar to the sales tax exemption for manufactured products? If I make bakery goods, manufacture furniture, or I am a contractor of some kind I don’t pay tax on the materials that go into my product; that is ultimately sold and then I do pay tax on it. Wouldn’t the same hold true for those industries that have a sales tax exemption? Isn’t that a “loophole” for those also? Why not go after every business segment that doesn’t pay sales tax?

    • Eric de Place says:

      Elizabeth,

      But I’m not proposing to tax the components that go into a manufactured product. I’m simply proposing that we return Washington’s sales tax to the form it had prior to 1984 when it covered the full purchase price of every retail sales transaction.

      Closing the loophole would level the playing field for sales between private individuals, which are now at a tax disadvantage to dealerships that accept trade-ins.

  5. Elizabeth says:

    In addition, aren’t dealers likely to give someone more for their car than maybe someone who is buying direct from a private seller, and consequently the individual may buy a higher priced car? Isn’t it also possible that the trade-in vehicle gets sold at auction and maybe nets the dealership very little to no profit per se? That this is part of the economic mechanics of this particular industry that is reflected in the legislation as opposed to some nefarious, unholy agreement extracted by the auto dealership sector from the legislature?

    The point being is that the bias against cars is coming through this essay.

  6. Eric de Place says:

    Elizabeth,

    Do dealers give someone more for their trade-in car than the private market would? No, not usually. (Spend some time with Kelley Blue Book to see that trade-in values are normally lower than private transactions.) But it doesn’t matter: the state doesn’t have a compelling interest in providing tax incentives for dealer behavior.

    Is it possible that a trade-in gets sold at auction for little to no profit? I have no idea, and I don’t care. If a dealer pays more for a car than he can re-sell it for, he might want to seriously consider taking some remedial business classes. Again, the public has no interest in providing extremely costly tax advantages to this industry’s behavior.

    All I’m asking for is the state to treat all retail sales the alike. Exempting trade-ins is a clear giveway to high income earners. We should close it for cars, trucks, boats, bicycles, trombones, books, everything.

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