One dispute (among many) in this legislative session centers on the capital gains tax. The disagreements extend beyond whether the tax is appropriate or necessary to meet the state’s current funding obligations, obligations that include substantial new funding for education to comply with the state Supreme Court’s McCleary order.
Rather, the parties debating the budget disagree on whether the capital gains tax is an excise tax or an income tax. State voters have repeatedly rejected the income tax at the polls. House Democrats, who have included a capital gains tax in the revenue package, contend the tax is an excise tax, not subject to the constitutional prohibition on progressive income taxes. Others disagree.
Here’s how it plays out. In The Daily News, Madelyn Reese reports,
House Democrats are touting their proposed operating budget as one that not only fully funds basic education, but is also one that’s progressive and fixes Washington’s “regressive” taxing system.
“We looked at making sure we did not hit working families and the middle class disproportionately, and did not have a strong impact on people in poverty, low-income people,” said a state Rep. Kris Lytton, Chairwoman of the House Finance committee…
Some have criticized the House’s proposed funding, including a 7 percent capital gains tax on the sale of corporate stocks, bonds and investment property. Republican opponents have called it an “income tax,” though Lytton challenges that claim.
“Capital gains is not an income tax, it’s an excise tax,” Lytton said.
An op-ed by Rep. Matt Manweller, R-Ellensburg, challenges that position.
In Olympia, Democrats will tell you there is no interest in a state income tax, yet just Tuesday, they proposed a capital gains tax as part of their proposal to raise $8 billion in taxes over the next four years. Democrats will also tell you a capital gains tax is not an income tax – despite past precedence in court rulings stating otherwise.
Manweller supported a constitutional amendment that would have prohibited an income tax. It failed in the Senate and got nowhere in the House. He, along with others, believes the capital gains tax is proposed as a vehicle to get the income tax question before a sympathetic state Supreme Court.
There is a strong likelihood the question of whether or not a “capital gains or excise tax” is an “income tax” is headed to the courts. The proposed capital gains tax could be that first step income tax proponents are looking for.
In its recent report on capital gains tax proposals, the Washington Research Council wrote of the capital gains legislation favored by the governor and House Democrats,
Both bills describe the capital gains taxes to be excise taxes “on the privilege of selling or exchanging long-term capital assets.” For all intents and purposes, these taxes would appear to be income taxes. However, if the capital gains taxes are income taxes, the rates, 7.9 percent for Gov. Inslee and 7 percent for the House Democratic Caucus, would run afoul of the state constitution, which sets a 1 percent cap on the tax rate that can be applied to income.
By describing the taxes as excise taxes, the two proposals are trying to dance a narrow line drawn in two 1933 cases by the Washington Supreme Court. In the first of these cases, Chase v. Cullen, the court ruled that income is property and therefore that an income tax is subject to all the restrictions which the state consti- tution imposes on property taxes. In the second case, Stiner v. Yelle, the Court ruled the precursor to business and occu- pation tax to be a constitutionally permitted excise tax on the privilege of doing business rather than an unconstitutional property tax on the business’s income…
Every state that currently taxes capital gains does so through its state income tax rather than through an excise tax.
The WRC concludes,
Because their constitu- tionality is questionable, the capital gains taxes proposed by Gov. Inslee and the House Democratic Caucus are not good sources for such revenue, as they would be tied up in court for several years.
The Washington Policy Center has also looked at the capital gains tax. Analyst Jason Mercier concludes,
f enacted, this would be the first stand-alone capital gains income tax in the country. No other state without an income tax taxes capital gains, and those states that do tax this type of income collect it through their state income tax code.
Supporters of these bills say the proposed tax is not on income; instead they call it an “excise tax for the privilege of selling or exchanging long-term capital assets.” It is arguably, however, an unconstitutional form of income tax that will be challenged in court. This legal challenge could be used by proponents in attempt to overturn the state’s 84-year-old income tax ban that is based on past court decisions.
It’s far from clear that the capital gains tax legislation can pass the Legislature this session. If it should, it is very clear that the next stop is the court.