Wash. high court upholds effort to balance tax code

SEATTLE — The Washington Supreme Court last week 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 Friday, the justices found the tax to be an excise tax — not a property tax, which the state Constitution limits to 1 percent 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 a 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 percent 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.

The challengers argued the state’s labeling of the capital gains tax as an excise tax was merely designed to conceal its true nature as an income tax. An excise tax is broadly defined as a tax on certain goods, services or activities — in this case, not a tax on property or income, but on what someone does with that property by selling it, the state insisted.

The 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.

“Today’s ruling by the State Supreme Court is at odds with the legal opinion of every other state in the country and the federal government,” Jackson Maynard, general counsel of the Building Industry Association of Washington, which sued over the tax, said in an emailed statement. “This makes Washington state the only place in the country where a capital gains tax is not considered an income tax. This is a radical departure, creating an undesirable inconsistency that will cripple our state’s competitiveness and drive more businesses out of our state.”

Washington 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 percent 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 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.