JLARC Preliminary Report: 2015 Tax Preference Performance Reviews

Wholesale sales of the following unprocessed agricultural products are exempt from wholesaling business and occupation (B&O) tax:

• Unprocessed Milk
• Wheat
• Oats
• Dry Peas
• Dry Beans
• Lentils
• Triticale (a wheat/rye hybrid)
• Canola
• Corn
• Rye
• Barley

The tax preference applies to sales by bulk grain and unprocessed milk distributors, such as cooperatives and grain elevators, that purchase from farmers or other distributors.  These entities then distribute these commodities to food processors, industrial manufacturers, animal feed processors, exporters, and other buyers.

Absent this preference, these distributors would pay B&O tax on their wholesale sales at a rate of 0.484 percent.

The tax preference does not apply to:

• Wholesale sales of processed products made from these unprocessed products;
• Wholesale sales made by farmers, which are exempt from B&O tax under a separate statute.

In addition to this B&O tax exemption, wholesalers and distributors of these agricultural products that own or operate large warehouses or grain elevators also may qualify for sales and use tax preferences for constructing, expanding, and equipping these facilities.  JLARC staff are reviewing this preference in 2015.

Non-farmers making wholesale sales of grains started receiving preferential B&O tax treatment in 1935.  The Legislature enacted the current exemption for these grain sales in 1998.

Non-farmer wholesale sales of unprocessed milk received the same preferential treatment as grain in 1935.  The preferential treatment ended in 1939.

The Legislature returned to providing the same preferential treatment for milk as grain in 2007 by adding wholesale sales of unprocessed milk to this exemption.

1935

When the Legislature first enacted the B&O tax in 1935, it chose to treat wholesale sales of agricultural products differently from other products:

• The Legislature exempted farmers’ wholesale sales of agricultural products from B&O tax.
• The Legislature taxed non-farmers’ wholesale sales of agricultural products on a net basis rather than on a gross sales basis.  Non-farmers’ wholesale sales of agricultural products, including grains and unprocessed milk, were taxed on the basis of the sales price minus the purchase price.  This was different from other wholesale sales of goods, which were taxed on the “gross income” or “gross proceeds of sales.”

The Legislature stated that, in the case of wholesale sales of agricultural products, it intended the B&O tax on gross proceeds of sales to be imposed only on the last in a succession of wholesale sales of agricultural products.

1939

The Legislature repealed the unique tax treatment provided in 1935 for non-farmer wholesale agricultural product sales.  The Legislature instead created a new preferential B&O tax rate of 0.01 percent for non-farmer wholesale sales of a subset of agricultural products (wheat, oats, and barley).  The rate was applied to the gross proceeds of sales of these products, in the same manner as other wholesaling activities.  The general wholesaling tax rate remained at 0.25 percent.

1941

The Legislature added corn to the list of wholesale sales receiving the preferential rate.

1951

The Legislature added a surtax to most B&O tax classifications that raised the general wholesaling rate to 0.30 percent.  For wholesale grain sales, however, the Legislature instead applied a B&O tax rate of 0.25 percent (compared to the prior rate of 0.01 percent).  Both the surtax and higher tax rate for wholesale grains sales were scheduled to last from November 1, 1951, through April 30, 1953.

1953

The Legislature extended the time period for the surtax through April 30, 1955, but allowed the temporary higher rate applied to wholesale sales of certain grains to expire as scheduled.  The applicable B&O tax rate for wholesale grain sales fell back to the prior 0.01 percent rate.

1965

The Legislature added dry peas to the list of wholesale sales receiving the preferential rate.

1969

The Legislature added rye to the wholesale sales receiving the preferential rate.

1981

The Legislature added dry beans, lentils, and triticale to the wholesale sales receiving the preferential rate.

1995

The Legislature added canola to the wholesale sales receiving the preferential rate.

1998

The Legislature eliminated the 0.01 percent preferential tax rate previously applied to wholesale sales of various agricultural products and replaced it with a B&O tax exemption.  The Legislature took this action in a bill that consolidated the number of B&O tax rates from ten to six.

2007

The Legislature expanded the exemption to include wholesale sales of unprocessed milk. Previously, sales of unprocessed milk were taxed at the general wholesaling rate (0.484 percent).

For ease of discussion, the non-milk products including peas, beans, lentils, and canola covered by this exemption are grouped under the heading “grains” in the rest of the review.  Exhibit 2, below, shows the B&O tax treatment for wholesale sales of unprocessed grains and unprocessed milk in comparison to the general wholesaling B&O tax rate through the years.

What are the public policy objectives that provide a justification for the tax preference? Is there any documentation on the purpose or intent of the tax preference?

The Legislature did not state the public policy objectives for:

1. The preferential B&O tax rate provided to wholesale sales of certain grains in 1939;
2. The B&O tax exemption for wholesale sales of certain grains enacted in 1998; or
3. The B&O tax exemption for wholesale sales of unprocessed milk in 2007.

Wholesale Grain Sales – 1939

It is unclear why the Legislature provided a preferential rate to wholesale sales of wheat, barley, and oats and not to wholesalers of other agricultural products.

When the Legislature enacted the B&O tax in 1935, it provided the same preferential tax treatment to wholesale sales of all agricultural products.  The Legislature discontinued this strategy in 1939.  Instead, the Legislature taxed most wholesale sales of agricultural products in the same manner as all other wholesale sales, with the exception of wheat, barley, and oats, which received a lower rate.

It is also unclear why the Legislature chose to later add certain other agricultural products to the preference.

Wholesale Grain Sales – 1998

JLARC staff infer from testimony in 1998 by the prime sponsor that the public policy objective for the B&O tax exemption for wholesale sales of certain unprocessed grains was to simplify tax reporting for both taxpayers and the Department of Revenue (DOR) by consolidating B&O tax classifications and rates.  This preference was part of a bill that reduced the number of B&O rates from ten to six, in part by eliminating the 0.01 percent rate that had applied to wholesale sales of grains since 1939.

Wholesale Unprocessed Milk Sales – 2007

JLARC staff infer from testimony at committee hearings by proponents, including the lobbyist for Northwest Dairy Association (Darigold), the public policy objective was to tax wholesale sales of unprocessed milk the same way as wholesale sales of unprocessed grains.

What evidence exists to show that the tax preference has contributed to the achievement of any of these public policy objectives?

Wholesale Grain Sales – 1939

Because the public policy objective for why the Legislature imposed a preferential B&O tax rate for sales of wheat, barley, and oats and not for other agricultural products is unclear, it is not possible to determine if the public policy objective has been achieved.

Wholesale Grain Sales – 1998

The inferred public policy objective to consolidate and simplify tax reporting for taxpayers and DOR was achieved after this preference was enacted in 1998.  Completely exempting wholesale grain sales from reporting or paying B&O tax relieved these taxpayers from any reporting on their wholesale sales activities.

Repealing the 0.01 percent tax rate may have also saved DOR administrative efforts to ensure correct tax reporting and payments.  JLARC staff analyzed tax return data from businesses that reported under the preferential B&O tax rate from 1995 through 1998 and found that more than half of the businesses that reported income under the preferential rate appear to have misreported.

Wholesale Unprocessed Milk Sales – 2007

The inferred public policy objective to tax wholesale sales of unprocessed milk consistently with wholesale unprocessed grain sales has been achieved.

Who are the entities whose state tax liabilities are directly affected by the tax preference?

Because there is no accountability reporting requirement, it is not possible to specifically identify the beneficiaries.

Wholesale Grain Sales

The potential beneficiaries of this preference include entities making wholesale grain sales or that own or operate grain elevators or warehouses.  These can be private businesses or cooperatives.  A 2014 Washington State Department of Agriculture (WSDA) report noted there were 38 grain or seed elevators or grain/seed warehouses and 32 grain or seed dealers licensed in Washington with WSDA for the period July 1, 2014, through June 30, 2015.

Wholesale Unprocessed Milk Sales

When the Legislature expanded the B&O tax exemption to wholesale sales of unprocessed milk in 2007, Darigold representatives testified that Darigold would benefit from the preference.  A DOR fiscal note worksheet for the 2007 legislation noted 12 other wholesale sellers of unprocessed milk, mostly dairies or manufacturers of dairy products, which might qualify for the preference.

What are the past and future tax revenue and economic impacts of the tax preference to the taxpayer and to the government if it is continued?

There is no accountability reporting required for wholesalers of unprocessed grains and unprocessed milk that use this preference.  JLARC staff estimated the beneficiary savings for this preference using 2014 USDA Washington commodity values for unprocessed grains and information used in DOR’s 2007 fiscal note on unprocessed milk sales.

JLARC staff estimate the beneficiary savings for this preference at $8.1 million in Fiscal Year 2014 and $14.8 million in the 2015-17 Biennium.  This estimate is based on the difference between no tax and a B&O tax rate of 0.484 percent, the general wholesaling rate.  See Exhibit 3, below.

If the tax preference were to be terminated, what would be the negative effects on the taxpayers who currently benefit from the tax preference and the extent to which the resulting higher taxes would have an effect on employment and the economy?

If the tax preference were terminated, beneficiaries of the preference (which do not include farmers) would pay B&O tax at the 0.484 percent rate on the gross income from wholesale sales of various grains and unprocessed milk products.

The effect of these terminations on employment and the economy would depend on the extent these businesses could absorb the increased costs or pass them along to their customers.  Their ability to absorb increased costs may depend in part on their profit margins.  According to a 2012 Canadian government study, profit margins for oilseed and grain wholesalers and distributors are lower than for most other wholesale commodities, under 3 percent versus an average of 20 percent for all wholesaling.

Do other states have a similar tax preference and what potential public policy benefits might be gained by incorporating a corresponding provision in Washington?

All but three of the top grain or milk-producing states, including Idaho and Oregon, impose an income tax.

It was not possible to identify preferences for all wholesalers of agricultural products in other states.  To provide a point of comparison, JLARC staff analyzed major grain or milk production states to determine if they provided a state income tax exemption for farmer or agricultural cooperatives, a subset of the potential beneficiaries of Washington’s B&O tax preference.

Farmers’ cooperatives that meet certain criteria have been exempt from federal income tax since 1926.  Fifteen of the 17 major agricultural states (excluding Washington) do not tax farmer or agricultural cooperative income under either an income or franchise tax if the cooperative meets certain federal or state qualifying criteria.  JLARC staff found there were 17 states in addition to Washington that ranked in the top 10 for either wheat/grain or milk production.  See Exhibit 4, below.

RCW 82.04.332

Exemptions — Buying and selling at wholesale unprocessed milk, wheat, oats, dry peas, dry beans, lentils, triticale, canola, corn, rye, and barley.

This chapter does not apply to amounts received from buying unprocessed milk, wheat, oats, dry peas, dry beans, lentils, triticale, canola, corn, rye, and barley, but not including any manufactured products thereof, and selling the same at wholesale.

[2007 c 131 § 1; 1998 c 312 § 2.]

Legislative Auditor Recommendation: Review and Clarify

The Legislature should review and clarify the B&O tax exemption for wholesale sales of certain grains and unprocessed milk because it is unclear why the Legislature chose to provide preferential treatment to wholesale sales of certain crops but not to other agricultural products.

The preference is meeting the inferred public policy objectives of simplifying tax reporting and providing wholesale sales of unprocessed milk the same tax treatment as wholesale sales of grains.

Legislation Required: Yes.

Fiscal Impact: Depends on legislative action.

Available December 2015.

Available December 2015.

If applicable, will be available December 2015.