On May 4, Gov. Jay Inslee (D) signed a law creating a 7% capital gains tax, which will come into effect next year. On November 2, lawmakers in Washington will hear what voters think.
While the poll metric asking voters to recommend whether to keep or repeal the new tax is purely consultative, this indicator of voter sentiment could be particularly enlightening as Washington moves forward with the implementation of a highly volatile tax. and constitutionally suspect that violates the state’s historic barrier to income tax.
Under the measure, Washington residents would be taxed on capital gains greater than $ 250,000, which would raise an estimated $ 527 million in fiscal 2023, rising to $ 734 million by 2031, for a 10-year projection of $ 5.74 billion in additional tax revenue. Of course, all the state’s Office of Financial Management can do is assume that capital gains will increase each year, when in practice capital gains are extremely volatile.
Realization of capital gains decreased by 71% between 2007 and 2009, 55% in 1987 and 46% in 2001. As part of the unusual dynamics of the COVID-19 pandemic, the stock markets recorded gains substantial, but in a typical economic downturn, other taxes income streams decline, but income from capital gains taxes is not there. This makes a stand-alone capital gains tax a particularly undesirable source of income for recurring expenses.
The Washington State constitution functionally prohibits an income tax by providing that “all taxes shall be uniform on the same classes of property” (called the uniformity clause and present in many states) and that “the word âPropertyâ as used here means and include any, tangible or intangible, subject to retention of title, âwhich state courts have appropriately interpreted to be a definition broad enough to include income. While we don’t generally think of income as property, it’s hard to deny that it meets the definition established by the state constitution. This does not mean that income taxes are prohibited per se, but it does mean that (1) they must be uniform and (2) according to another constitutional provision, all property taxes must not, in total, exceed a rate of 1 percent.
Taken together, these two provisions sounded the death knell for a state income tax, as the only way to meet the constitutional requirements is if it was a lump sum tax, with little or no deductions. or exemptions, with a rate lower than 1%. Policymakers have not been particularly interested in a tax that fits these parameters.
Instead, lawmakers have chosen to stick the camel’s nose in the tent through a stand-alone capital gains income tax, seemingly justified by the claim that it is not about a capital gains tax, but rather an excise tax on the privilege of earning capital. earnings, denominated in net income. It’s an easy argument, but some supporters would agree to see this legal argument falter and use capital gains tax as a way to bring the income tax issue back to court. supreme state, opening the door to a broad base of tax revenue in the near future.
In legal reasoning, the excise tax argument is weak, since the tax adopted by the legislature in no way functions as an excise tax. Not only are capital gains taxed as income in each state with an income tax, and by the federal government, but the proposition here is not to tax the transaction but rather the net, that is to say – say net income.
There’s a reason we often think of sales and excise taxes together: Excise taxes are, at their core, transaction taxes. Often they are ad valorem, on the full cost of a transaction â essentially a special sales tax. Other times, they follow a specified rate schedule; for example, a particular amount per pack of cigarettes, regardless of the sale price. What they never do is come across a net income calculation.
If a capital gains tax were an excise tax, we would expect it to fall on the entire selling price (or a fixed price per sale), not just the net gain. We would also expect it to be taxed on each transaction separately, and not on all capital gains and losses as reported on IRS Form 1040. And although excise taxes are often remitted by the seller, their economic impact is borne by the consumer. That’s not the case here.
The seller of a fixed asset pays capital gains taxes on its income. Tax is not built into the transaction or imposed on that transaction. Instead, it is taxed on the net earnings over the course of a year. It is telling that taxpayers should submit their 1040 federal to report Washington State capital gains. What excise tax works this way?
This tax is not on capital gains transactions, or on the privilege of buying and selling investment instruments. It is net of gains and losses over a defined period. It is definitely an income tax – on a narrow category of income, but an income tax nonetheless. Courts across the country have always been concerned with substance over form when it comes to taxation, and substance over name. The mere fact of characterizing a tax on a category of income as an excise tax does not change its fundamental character.
Legal challenges to the tax are already underway and could ultimately do more to stop it in its tracks than a non-binding advisory vote. Nevertheless, the fate of Advisory Question 37 is important, not only because the capital gains tax itself would be economically damaging, or because it shows disrespect for the constitution of the state. , a concern in itself. This is also important because if voters signal their opposition to taxing that specific category of income, it sends a strong message that they are decidedly not interested in efforts to remove the state ban. impose a broader income tax.
Was this page useful for you?
The Tax Foundation works hard to provide insightful analysis of tax policy. Our work depends on the support of members of the public like you. Would you consider contributing to our work?
Contribute to the Tax Foundation
Let us know how we can better serve you!
We are working hard to make our analysis as useful as possible. Would you consider telling us more about how we can do better?
Give us your feedback