Washington state Democrats renew efforts to pass a capital gains tax despite likely uphill legal battle

(The Center Square) — Washington is one of nine states to lack a capital gains tax that courts have ruled against over the years, but proponents see new life for one amid concerns about the pandemic’s economic toll on the state.

In December, Gov. Jay Inslee unveiled his latest capital gains tax proposal as part of his 2021-2023 proposed budget.

Inslee’s proposal taxes the sale of stocks, bonds, and other assets at a rate of 9% on capital gains above $25,000 for individuals and $50,000 for joint filers. Retirement accounts, homes, farms and forestry would be exempt under his proposal.

The new tax would affect an estimated 42,000 taxpayers or under 2% of state households in the first year, according to estimates from the governor’s office.

It is estimated to raise $975 million in 2021 and has been introduced in a bill sponsored by Washington Rep. June Robinson, D-Everett. It exempts the sale of fewer than four residential dwellings, farm animals, and farm land.

Inslee is selling a capital gains tax as a way to pay for his $57.6 billion proposed operating budget for 2021-2023, which includes a $5.5 billion increase in state spending for renewable energy, affordable housing, and more school counselors.

Currently, 41 states have capital gains taxes including Oregon, Idaho, and Iowa.

Opponents of a capital gains tax argue that it stands little chance of holding up in court.

For more than 80 years, the Washington Supreme Court has ruled income is property under the state Constitution, which effectively bans a progressive income tax through a property tax uniformity clause.

The clause provides that “taxes shall be uniform upon the same class of property within the territorial limits of the authority levying the tax… All real estate shall constitute one class.”

Thus, taxes must be the same on real property of the same market value.

In a unanimous one-page 1960 decision, the court ruled that “the constitution may be amended by vote of the people.”

Washington voters have rejected six attempts to amend the state constitution to allow for a graduated income tax over the past 80 years. A ballot measure establishing a state income tax on “adjusted gross income” above $200,000 for individuals and $400,000 for joint-filers funding education and health failed in 2010 by a margin of 28 points.

Hugh Spitzer, a professor of constitutional law at the University of Washington, wrote in a 2014 research paper that state courts’ interpretation of taxation is largely inconsistent with legal thinking nationwide.

“When income is converted into an asset, it is then appropriately treated, and taxed, as property,” Spitzer wrote. “But as a number of court opinions in other states have observed, property is the tree and income is the fruit. Both income and property may be taxed under the appropriate rules, but it is illogical, and today quite rare, to treat them as one and the same.”

Capital gains tax opponents also argue new taxes are unnecessary when state revenue is forecast to be relatively strong for the near-future.

State revenue is forecast by state analysts to be as high as $54.6 billion by 2023 or up by about $2 billion while the state’s cash reserves are still at $1.6 billion.

Plus, capital gains tax opponents point to the past volatility of the stock and real estate markets as a hindrance to a capital gains tax raising sufficient cash.

“You can’t rely on that kind of revenue,” Jason Mercier of the free market Washington Policy Center testified to state lawmakers on Thursday. “It’s extremely volatile.”

The Washington Department of Commerce names “no taxes on capital gains or personal or corporate income” as among the state’s chief “competitive advantages.”

Those advantages were not enough to keep Boeing from moving its lucrative 787 jetliner production from Washington to South Carolina in 2020.

On Friday, Chester Baldwin with the Building Owners & Management Association and other commercial housing groups, testified against the bill on the grounds it would multiply the tax burden on local real estate.

“We have a housing crisis in this state and putting a 9% tax on housing of four or more units will be detrimental,” Baldwin said.

In 2020, Washington’s real estate excise tax of 3% on property worth $3 million or more was among the highest in the country.

Capital gains tax supporters have long argued the state’s widening wealth gap is reason enough to tax untapped income from top earners.

According to a 2018 report by the Economic Policy Institute, the average income for the top 1% in Washington made 24.2 times more than the other 99%.

Washington was also home to 12 billionaires in 2020 whose combined net worth of $321 billion was the third highest in the nation behind only New York and California, according to Forbes.

Those billionaires include Amazon founder and CEO Jeff Bezos, whose net worth totaled $182 billion in 2020 based on data by the Bloomberg Billionaires Index.

Last summer, Seattle City Council member Andrew Lewis introduced a 1% capital gains tax on stock and bond sales which would bring in an estimated $37 million per year for the city. Retirement accounts and real estate would be exempt.

Lewis and supporters say the tax would pay for more affordable housing projects to fix Seattle’s estimated 6,500 housing unit deficit. City staff estimated the tax would apply to 30% of Seattle residents.

In the past decade, Washington’s statewide housing deficit has climbed to about 225,000 homes in 2019.

Should the state or federal eviction moratoriums be allowed to expire, homeless advocates worry the COVID-19 pandemic could generate even greater demand for state-funded shelter.

The Washington Housing Trust Fund paid for 37 affordable housing projects in 2020 statewide, including 168 units for the mentally ill.

A capital gains tax, supporters argue, would also help offset the state’s reliance on sales and use taxes, which some reports show burden low-income residents.

In 2020, the state retail sales and use tax rate was 6.5% and as high as 10.4% in some municipalities. Those taxes brought in 45% of Washington’s total yearly revenue or about $22 billion, according to the state Department of Revenue.

A 2018 study by the Institute on Taxation and Economic Policy found Washington households earning less than $24,000 per year paid 13.3% in sales and excise taxes compared to the 1.7% paid by households earning more than $545,900 per year.

Washington’s tax structure may present more challenges for the state’s 229,500 jobless residents still buying necessities during the pandemic.

“We have an upside down tax system,” said Sen. Keiser, D-Des Moines, chair of the Senate Labor and Commerce Committee. “It’s really not equitable. And we are looking at ways to make it more fair.”

In June, more than a dozen economic policy experts wrote a joint letter to state lawmakers calling for progressive taxation.

By law, passing a progressive income tax would require a two-thirds majority of the legislature, likely requiring votes from a Republican minority that’s largely opposed to new taxes.

“I do not believe we will pass a budget that is an all cuts budget,” Keiser said. “We did that once before in the Great Recession. Those like myself, who went through that, are not willing to do it again.”

Sen. Joe Nguyen, D-White Center, also petitioned state lawmakers to vote against any austerity measures ahead of the 2021 legislative session.

During the onset of the Great Recession in 2008, then-Gov. Christine Gregoire signed into law more than $4.4 billion in spending cuts, which included slashing enrollment in Washington’s Basic Health Program by 40,000 people.

The 2021 Washington legislative session, which began on Monday, is slated to adjourn on April 25.

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