The Washington state Supreme Court ruled that a statewide tax on capital gains is lawful, allowing the legislation to move forward nearly two years after it was approved by lawmakers.
The central issue for the court was to determine whether the capital gains tax is an income tax or a sales tax.
In its opinion issued Friday, the court concluded that the capital gains tax “is a valid excise tax under Washington law.” Justices voted 7-2.
The capital gains tax made waves in the tech industry since it targets stocks, which can be a key part of compensation for workers.
The law imposes a 7% tax on capital gains of more than $250,000 from the sale of stocks and bonds, excluding revenue from real estate and retirement accounts, among other exceptions. It’s the first tax of its type in state history. The tax went into effect in January of last year and the first payments are due in April.
The tax is “appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves,” wrote Justice Debra Stephens in the court’s opinion.
“This understanding of the tax is consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself,” Stephens wrote.
In a dissent, Justice Sheryl Gordon McCloud argued that a tax is “determined by its incidents, not by its legislative label.”
“The structure of the capital gains tax shows that it is a tax on income resulting from certain transactions—not a tax on a transaction per se,” McCloud wrote. “Therefore, the tax is an income tax, not an excise tax. Under our constitution and case law, an income tax is a property tax.”
The estimated $500 million in yearly revenue the tax is expected to generate is earmarked to be funneled into early-childhood education programs and school construction.
“We applaud the Court for seeing through this delay tactic by ultra-millionaires to avoid paying what they owe for Washington’s child care, pre-schools, and other education programs,” said Treasure Mackley, executive director of Invest in WA Now.
Jason Mercier, director at the Center for Government Reform at the Washington Policy Center, called the decision “unreal.” Mercier has been a vocal opponent of the new tax on the grounds that it constitutes a tax on income.
“Every other tax jurisdiction in the world says a capital gains tax is an income tax,” he tweeted Friday.
Douglas County Superior Court judge Brian Huber last year struck the law down on the grounds that it violated Washington’s constitutional mandate for taxes to be applied uniformly.
“Those who’ve done extremely well in Washington have a responsibility to act together to invest in our state and our communities.”
Huber sided with opponents of the new tax who argued it was an illegal income tax under the state constitution, which sharply limits income taxes. Huber said in a written decision that the tax “shows the hallmarks of an income tax rather than an excise tax” as argued by state lawmakers.
The state Supreme Court agreed to take up the issue following an appeal from Attorney General Bob Ferguson.
In a statement, Ferguson called the ruling a “significant win for education.”
Proponents of the tax said it is not an income tax but instead an excise or sales tax that only is collected when a sufficient amount of stock is sold.
Advocates said it’s one way that Washington’s regressive tax laws can be altered to help low-wage earners and even the playing field for people of color and rural communities who are overrepresented in low income brackets. The state has no personal or corporate income tax and generates most of its revenue through sales, property, and business and occupation (B&O) taxes.
“Washington’s capital gains tax helps right an upside-down tax structure where low-income Washingtonians ultimately expend a much larger share of their income in taxes than our wealthiest residents,” Gov. Inslee said in a statement.
The challenge on the capital gains tax could tug a legal string that could unwind case law stretching back decades.
Legal experts said there was potential for the court to reconsider a 1933 ruling that classified income taxes as property taxes and must therefore be applied uniformly to all citizens. But the opinion issued Friday did not go that far.
“The court could have unwound the 1933 income tax ruling, but it did not need to because Washington’s capital gains tax was carefully structured as a straightforward excise tax under Washington precedent,” said Professor Hugh Spitzer, interim associate dean for academic administration at the University of Washington School of Law. “The court simply did not need to go so far as to annul its early income tax decisions.
An estimated 7,000 households — the wealthiest in the state — are estimated to be affected by the capital gains tax law, according to Invest in WA Now. Roughly two-thirds of those households are in King County.
Some opponents of the tax say it poses a significant threat to Washington’s ability to attract business, and keep the state’s wealthiest residents.
“This ruling undermines Washington state’s competitive status making it harder for our state to attract, retain, and grow jobs and economic opportunity,” Washington Policy Center CEO Mike Gallagher said in a statement.
Sharon Chen, a former Microsoft manager currently on the board of Progress Alliance, said “that’s not how it works.”
“Wealthy people move to, and stay in, places that have great schools and universities, clean air and water, healthy food, and a vibrant culture,” she said in a statement. “Those who’ve done extremely well in Washington have a responsibility to act together to invest in our state and our communities.”
Most states have a capital gains tax, in addition to federal capital gains taxes.
Washington fell 13 places to No. 28 in a recent ranking from the think tank Tax Foundation on state business tax climates, “primarily due to giving up its status as a state without an income tax,” after the capital gains tax approval.
“Washington … has always been buoyed on the Index by forgoing an income tax,” the foundation wrote. “With the loss of this distinctive, the state plummeted in our rankings.”
Capital gains tax ruled constitutional by Washington state Supreme Court by GeekWire on Scribd
