Washington state kicks off major tax fight with new capital gains levy
The home of the two richest men in America is on the brink of implementing a new tax on capital gains that would raise billions of dollars for early childhood education and child care programs — while setting off a years-long legal fight that could end a nearly century-long resistance to an income tax.
Washington state legislators are finalizing language on a bill that would tax capital gains over $250,000 at a 7 percent rate, in what may prove to be one of the most substantial tax increases approved by any state legislature in 2021.
Supporters of the measure say it would fall on just a few thousand of the wealthiest families in a state full of major technology companies and budding startups, from Amazon and Microsoft — companies founded by Washington residents Jeff Bezos and Bill Gates, numbers one and two on the list of the world’s richest people — to IMDb and Redfin.
In a state where the tax code remains one of the most regressive in America, the new tax would help even out the growing disparities between the wealthy and a shrinking middle class that has been pushed to the brink.
“We’re seeing extreme inequality that leads to rampant homelessness, lack of access to education and opportunities,” said state Sen. Joe Nguyen (D), one of the bill’s lead sponsors. “This is a way to invest in people, a way to invest in infrastructure and the needs we have in order to make people successful.”
The capital gains tax has passed both the state House and Senate, though the two chambers have appointed members of a conference committee to hammer out several disagreements between the two versions. The legislators on the committee have until Sunday, the end of this year’s legislative session, to reach a deal.
Tara Lee, a spokeswoman for Gov. Jay Inslee (D), said Inslee would sign the bill if it makes it to his desk in time.
Legislative analysts estimate the new tax would pull in $550 million a year beginning in 2023, when it would take effect. Some estimates suggest it would impact about 8,000 tax filers, while others say it could hit up to 60,000 people — in either case, just a fraction of the 2.9 million households in the state.
Much of the money would be earmarked for childhood education and child care programs, with the rest set aside for the state general fund. The bill exempts real estate, assets held in retirement accounts, livestock and timberlands, a critical industry for Pacific Coast counties.
Opponents of the measure attack the proposed tax as a job-killer that could hurt small and multi-generational businesses, regular arguments against raising taxes on businesses or investments.
But the proposed bill, Washington Republicans say, comes with a twist: Opponents see a longer-term legal play aimed at overturning an 85-year-old policy that has made Washington one of the few remaining states without an income tax.
Washington’s Supreme Court ruled in a landmark 1936 case that the state constitution required all property to be taxed at the same rate. The court ruled that income counted as property, striking down a graduated income tax rate that voters had approved a few years earlier.
Since then, Washington has been one of just a handful of states without an income tax. Voters have defeated six subsequent attempts to implement an income tax at the ballot box.
If the new tax on capital gains passes, Republicans see it as a path to open a new legal challenge to the validity of a graduated tax, one that might find a more receptive audience before a more liberal state Supreme Court.
“The goal is to get it to the Supreme Court so they hope that the Supreme Court will overturn their ruling,” said state Sen. Lynda Wilson, the top Republican on the Senate Ways and Means Committee. “They know it’ll be challenged in court. They’ve been promised that over and over again.”
Washington is one of just nine states that does not levy a tax on capital gains. A 7 percent rate would put Washington on par with states like South Carolina, Connecticut and Maine, which tax capital gains at about the same rate.
Jason Mercier, director of the Center for Government Reform at the conservative Washington Policy Center, said the tax on capital gains would be unique among all 50 states. Other states levy a capital gains tax through their income tax systems, a system Washington does not have.
“This effort is not about taxing capital gains. If this were to be enacted, this would be the only stand-alone tax on cap gains in the country,” Mercier said. “We’re not reducing anybody’s taxes, we’re just increasing taxes on somebody else.”
Capital gains taxes are among the most volatile revenue streams any state can tap. California, which levies the highest capital gains tax rate in the country at 13.3 percent and which is the most dependent on capital gains tax revenue for its budget, found that out the hard way during the last recession, when the stock market collapse sent the budget into a tailspin.
“If you’re only hitting a handful of people, what happens when that individual decides to relocate their domicile?” Mercier said. “Why would you pick probably the most volatile tax source outside of severance tax?”
Wilson, the lead Republican on the Ways and Means Committee, said the new tax would endanger Washington’s standing as an attractive area for the booming tech sector.
“If you look at our tech industry, I believe a lot of the reason that they’re here is because of our tax structure,” Wilson said. “Companies will just not come to do business here. We have a competitive advantage right now.”
One major difference between the House- and Senate-passed versions of the bill could end up giving voters the opportunity to override the legislature. A provision in the House-passed measure would have made the capital gains tax exempt from a voter referendum, under which opponents could gather signatures to force a popular vote on the measure. The Senate stripped that provision out at the behest of four Democrats who opposed a so-called emergency clause.
The debate in Washington comes as President Biden plans to propose a new higher capital gains tax rate on the wealthiest Americans. Biden plans to roll out a proposal to nearly double the rate that those earning more than $1 million a year would pay on capital gains from 20 percent to 39.6 percent, with an additional 3.8 percent surtax to help pay for the Affordable Care Act.
An analysis from the nonpartisan Tax Foundation found that the highest earners in Washington state would pay an effective rate of 43.4 percent under Biden’s plan, an amount equal to the other seven states that do not have an income tax.
In spite of its progressive reputation, Washington has a tax code that falls most heavily on those who earn the least. Sales taxes, which take up a greater percentage of a salary earned by a low-income family than a high-income family, account for more than 46 percent of Washington’s tax receipts, according to the state Department of Revenue and the Tax Foundation, a higher share than any other state.
“We’ve enabled the rich to get richer, yet we’ve basically punished the people who are poor for the sake of being poor,” Nguyen said in an interview. “Housing costs are too high. Things are too expenses. So the people who were at the margins, who were basically just existing now, go into homelessness.”
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