Tax Foundation op-ed: Whatever the spin, legislators’ proposed capital gains tax is an income tax.

In a Seattle Times commentary, Jared Walczak, vice president of state projects at the Tax Foundation, effectively dismantles the claim that the Legislature’s proposed capital gains tax is anything but an income tax. It’s a clever piece. He writes that the legislative pursuit of an income tax has become a ritual.

Like so many disputed rituals, it is ultimately a fight over words and what they mean.

The rite has an established form. Lawmakers introduce a tax on capital-gains income, creatively designed to avoid troublesome words like “income,” as if the state constitution’s constraints on income taxation are a taboo that can be sidestepped by tiptoeing around certain words and phrases.

We recommend reading the op-ed. He notes the wordplay proponents are using to get around the state constitution’s restrictions on taxing income. 

[They] argue that a tax on capital gains income does not run afoul of the constitution because it isn’t an income tax at all: it is an excise tax on the privilege of earning capital gains.

But,

Excise taxes, according to the Internal Revenue Service (IRS), “are taxes that are imposed on various goods, services and activities,” sometimes on volume and sometimes on sale price. They are usually designed to establish a user-pays system or to internalize some social cost, though they can become pure revenue-raisers. Common examples include the gas tax (a user-pays system for roads), the cigarette tax (internalizing the public-health costs of smoking) and the real estate excise tax (taxing the total sale price of a home). Proponents say they have designed something new in the world of tax: a capital gains excise tax, on the privilege of buying or selling an asset.

Their tax, though, is not imposed on the asset transfer itself, or even on the transaction price. It is based instead on net capital gains income as reported for federal income tax purposes. It even includes an exemption of $250,000 of capital gains income so that the tax only falls on high-net-worth individuals, hardly a characteristic of an excise tax. 

Were a capital-gains tax an excise tax, it would fall on the entire sales price (or a specific price per transaction), not just the net gain. It would be imposed on each transaction, not the aggregate of gains and losses. There is no question that the net proceeds from the sale of an asset are income, or that this money in an investor’s possession is — per Washington courts’ definitions — intangible property subject to ownership. By the logic proponents employ, they might just as easily get around the income tax prohibition for wage earners by imposing a tax on the privilege of employment, measured by wage income.

He concludes:

make no mistake: The sleight of hand that disguises a tax on capital gains income as an excise tax is employed just as easily to tax all income, including wage income.

It’s an income tax. And it’s highly unpopular, as our recent poll found.