Washington State Supreme Court Upholds New Capital Gains Tax

SEATTLE (AP) — The Washington Supreme Court on Friday upheld the state’s new capital gains tax, which was adopted by lawmakers in an effort to balance what is considered the nation’s most regressive tax code.

In a 7-2 decision, the justices found the tax to be an excise tax — not a property tax, which the state Constitution limits to 1% annually, or an income tax, which Supreme Court decisions dating to the 1930s have found unconstitutional.

“For 134 years, Washington state has been waiting for the day when a fairer tax system came about, one where working people were not carrying an inequitable share of the burden,” Gov. Jay Inslee, a Democrat, said in an emailed statement. “Today is that day. 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.”

Washington is one of nine states without an income tax, and its heavy reliance on sales and fuel taxes to pay for schools, roads and other public expenses falls disproportionately on low-income residents. They pay at least six times more in taxes as a percentage of household income than the wealthiest residents do, according to lawmakers. Middle-income residents pay two to four times as much.

Inslee and other majority Democrats in Olympia sought to begin addressing that in 2021, when they enacted a 7% capital gains tax on the sale of stocks, bonds and other high-end assets, with exemptions for the first $250,000 each year and gains from sales of retirement accounts, real estate and certain small businesses.

It was expected to be paid by 7,000 people — fewer than 1 in every 1,000 residents — and to bring in close to a half-billion dollars a year to help pay for public education in Washington. But it faced a legal challenge from wealthy residents and business and agricultural organizations that said it violates the state and federal constitutions and would discourage the investment in the state.

“This tax will generate substantial new revenue for public education without exacerbating existing inequities … by requiring Washington’s wealthiest to pay a greater share of their overall income in state taxes,” Justice Debra Stephens wrote for the majority. “Plaintiffs may disagree with the legislative policy behind the capital gains tax, but they fall short of demonstrating that policy is unreasonable.”

Among the key issues in the case was whether the new tax is, as the state insists, an excise tax — broadly defined as a tax on certain goods, services or activities — or an income tax, which the court long ago held unconstitutional in Washington state.

Voters overwhelmingly passed a graduated income tax in 1932. But in a 5-4 decision the following year, the state Supreme Court struck it down, ruling that a tax on income was a tax on property — and the state Constitution says property taxes must be uniform and limited to 1% per year.

Last year, Douglas County Superior Court Judge Brian Huber in central Washington sided with those challenging the capital gains tax as a forbidden income tax. Democratic Attorney General Bob Ferguson appealed, saying Huber got it wrong because the tax is not on property — it’s on what an owner does with that property by selling it.

The arguments came as progressives are making a push in several states to have the rich pay more in taxes. Bills introduced early this year in California, New York, Illinois, Hawaii, Maryland, Minnesota, Washington and Connecticut all revolved around the idea that the richest Americans need to pay more. But the proposals all faced questionable prospects.

Those challenging Washington’s capital gains tax argue the state’s labeling of the capital gains tax as an excise tax is merely designed to conceal its true nature as an income tax.

Some 41 states that tax capital gains tax it as income. Seven other states have no income taxes at all: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming. New Hampshire taxes only dividends and interest income earned by individual taxpayers.

The challengers noted that since the 1930s, Washington’s voters have 10 times rejected constitutional amendments or initiatives in favor of income taxes.

If Washington wants such a tax, “the way forward is to amend the Constitution,” former Republican Attorney General Rob McKenna argued on behalf of the challengers during oral arguments in January.

The justices hustled out their decision because the first payments on the tax are due next month, and lawmakers needed to know whether they’d be able to spend the money.