If WA capital gains tax is allowed to stand, in time it won’t apply to only the wealthy | Opinion

If you haven’t heard, the legislature recently passed a capital gains income that was ruled unconstitutional by a state superior court and the case is now before the state supreme court. Supporters of this new income tax say it will only impact a handful of wealthy taxpayers, so Washingtonians need not worry about the reach of the taxman coming after them.

The history of taxes, however, is to expand and impose the burden on more taxpayers over time, not less.

In fact, a bill has already been proposed this year (SB 5335) that would not only increase the capital gains income tax rate but repeal the value exemption, applying the tax to all Washingtonians with capital gains income. This bill proposes funding universal health care with a new payroll tax, as well as an increase to the capital gains income tax rate and removing some of the exemptions.

This is why all Washingtonians should be paying close attention to what the state Supreme Court decides on the capital gains income tax. I attended the recent court hearing in person and feel much better about the potential outcome based on the questions asked by justices.

While trying to forecast a court opinion based on oral arguments is about as accurate as shaking a Magic 8 Ball, it’s clear the justices understood the issue at play and the gravity of their future ruling.

It is unclear, however, when the court will issue its opinion. The capital gains income tax is first owed on April 18, 2023.

There are three possible rulings the court could issue.

One possible outcome is for the Court to catch the Hail Mary pass thrown by income tax advocates and by judicial fiat now allow a graduated income tax without a constitutional amendment. This is the preferred course of the Washington Education Association and other interveners who argued to the court that income isn’t property.

This strategy is being pursued by income tax advocates because Washington voters have already rejected six constitutional amendments to allow a graduated income tax (10 straight income tax proposals rejected including initiatives).

As explained by a capital gains income tax supporter, Sen. Jamie Pedersen, in this 2018 email obtained by a public records request: “But the more important benefit of passing a capital gains tax is on the legal side, from my perspective. The other side will challenge it as an unconstitutional property tax. This will give the Supreme Court the opportunity to revisit its bad decisions from 1934 and 1951 that income is property and will make it possible, if we succeed, to enact a progressive income tax with a simple majority vote.”

This effort to have the court change prior rulings and now say Washingtonians don’t own their income has consistently been rejected by the courts. In fact, on September 13, 1960, the state Supreme Court issued a unanimous one-page ruling with this sage advice: Don’t ask the court to reverse its numerous rulings prohibiting a graduated income tax; instead amend the constitution.

Another possible outcome is for the justices to decide that Washington alone has discovered how to tax income as an excise tax and that this a valid excise tax. Should that occur, however, there is the potential for a federal lawsuit for violation of the U.S. Commerce Clause. If the capital gains tax is found to be an “excise tax,” Washington would be attempting to tax activity that occurs in other states.

It is important to remember that no other state has a standalone tax on capital gains. Forty-one states do have personal income taxes, and as income, capital gains are included in those tax bases. This is why those taxes on capital gains income don’t run afoul of the U.S. Commerce Clause. Attempting instead to tax activity that occurs in other states (an “excise tax”) raises federal constitutional concerns.

There is also the possibility that if the capital gains income tax is deemed an “excise tax” by our court, taxpayers will not be able to deduct it from their federal tax burden. According to a Congressional Liaison for the IRS, if the capital gains tax is upheld as an “excise tax,” taxpayers may be prevented from deducting it against their federal income tax returns.

The final possible outcome is that the court could agree with the Inslee-appointed Superior Court judge that the capital gains income tax “is declared unconstitutional and invalid and, therefore, is void and inoperable as a matter of law.”

Some have raised concerns that important programs would be at risk if the state Supreme Court overturns that capital gains income tax. Lawmakers have already made it clear, however, that the targeted spending will occur even if the tax is declared unconstitutional.

Those that monitor the state’s creditworthiness are also not concerned about the capital gains income tax being declared unconstitutional. This is from Standard and Poor’s January 10, 2023, credit rating for the state: “Should the authorizing statute prove unconstitutional, we believe the effects to be marginal, given that it represents less than 1% of projected revenues in the coming fiscal years.”

No matter what the justices decide the fact will remain that literally every tax professional in the world, from the IRS, to every other state, to other countries will tell you the same thing – capital gains are income and taxes on them are income taxes.

For example, here is what the IRS says: “You ask whether tax on capital gains is considered an excise tax or an income tax? It is an income tax. More specifically, capital gains are treated as income under the tax code and taxed as such.”

Forty-nine states agree with the IRS. The California Franchise Tax Board says: “California taxes capital gains as an income tax and they are taxed at the same rate as ordinary income.”

Other countries also agree with the IRS. The Australian Taxation Office says: “You report capital gains and capital losses in your income tax return and pay tax on your capital gains. Although it is referred to as ‘capital gains tax,’ it is part of your income tax. It is not a separate tax.”

This income tax case is of monumental consequence for all taxpayers even if you aren’t currently in the crosshairs.

Jason Mercier is the Government Reform director for Washington Policy Center, a nonprofit research organization with offices in Tri-Cities, Spokane, Seattle and Olympia.