Politics & Government

House Democrats want a capital gains tax to raise money for their budget plan. Is it even legal?

Pedestrians walk in the rain near the Legislative Building on March 28 at the Capitol in Olympia as cherry trees display spring blossoms.
Pedestrians walk in the rain near the Legislative Building on March 28 at the Capitol in Olympia as cherry trees display spring blossoms. The Associated Press

It’s a long-running argument in the state Legislature: Is a new tax on capital gains a good idea? Or even allowed under Washington’s Constitution?

Depends on whom you ask.

Democrats who control the House are convinced it’s a permissible excise tax. They proposed it as part of their $44.9 billion two-year budget that aims to bankroll a court-ordered fix to how the state pays for education, along with new raises for state workers and upgrades to other social services.

Gov. Jay Inslee, a Democrat, wanted a capital gains tax for the 2015-17 budget, as well as the one that lawmakers are now writing.

Republicans contend such a tax is not only unreliable, but unconstitutional. The GOP, which has a slim majority in the Senate with the help of a conservative Democrat, proposed a new flat property tax to raise money for its budget plan.

Here’s a look at the basics of the House capital gains proposal, and if it has a chance of becoming law in Washington:

Whom would the tax affect?

The House’s capital gains measure would tax money made on the sale of stocks, bonds, certain property and other high-end financial assets at a 7 percent rate.

That comes with limitations. Only people who report more than $25,000 in capital gains — $50,000 for couples — on their federal taxes would be subject to the tax. The proposal would exempt retirement accounts, and the sale of single-family homes, farm land, timber and much livestock.

The tax would raise about $715 million in the next two years, according to a House Democrat analysis. But only about 1.5 percent of people who file taxes in the state would pay the tax in a given year, according to a Democrat analysis.

That’s a key reason Democrats want the tax: It charges high-earners at higher rates in the aim of not burdening the poor and middle class, said Rep. Kris Lytton, a Democrat from Anacortes.

Rep. Drew Stokesbary, R-Auburn, told reporters Monday that middle-class families might still have to pay the tax “at least once or twice in their lifetimes,” when they cash in on capital assets to, say, pay for a child’s college tuition.

Republicans argue the tax could discourage investment and would hit employees of valuable startup companies that get income through stock or stock options.

Washington is one of nine states without a capital gains tax.

Is it legal?

The debate over the tax’s legality centers on whether a capital gains tax is an income tax, or an excise tax. An excise tax is “taxes paid when purchases are made on a specific good,” according to the Internal Revenue Service website.

One of the most common excise taxes is the gas tax. Washingtonians pay a 49.4 cent state tax on every gallon they buy.

House counsel says it’s possible the capital gains tax qualifies as an excise tax under state law, according to a legal analysis.

That memo says one could argue the Democratic proposal taxes people for the “privilege” of voluntarily selling capital assets such as stocks, which is different than broadly taxing a person’s entire income.

State Rep. Laurie Jinkins, a Democrat from Tacoma, compared it to the state’s excise tax on the sale of real estate.

But Republicans say the House capital gains proposal is an income tax because the measure collects money from the income people make on sales of capital assets.

If it is an income tax, the proposal could be struck down by the courts. A nonpartisan fiscal analysis of a 2015 capital gains proposal predicted “up to five” Superior Court challenges could surface if lawmakers passed the tax.

The state Supreme Court has ruled in the past that income taxes are a form of property taxes — which must be applied at a flat rate under the constitution. The capital gains tax measure isn’t uniform because higher earners pay more, Republicans say.

Conservative groups are ready to put that to the test: the Freedom Foundation think tank delivered a note to Inslee Thursday saying the organization will “promptly” file a suit to overturn a capital gains tax should one pass the Legislature.

Not everyone believes today’s court would rule in the Freedom Foundation’s favor. Hugh Spitzer, a constitutional law professor at the University of Washington, has said the state’s current Supreme Court would likely uphold a state income tax because today’s justices might not view income the same as property.

Is it too volatile?

Another Republican objection to the capital gains tax is that it’s unreliable, especially during a recession. Conservative groups point to a nonpartisan fiscal analysis on a 2012 capital gains tax proposal that concluded the tax is “extremely volatile from year to year.”

“I think it’s far too irregular to really depend on for fully funding public education,” Stokesbary said.

Some Democrats acknowledge the tax tends to swing.

To address concerns about volatility, Inslee’s budget proposal created a reserve fund to store extra money from his capital gains tax in good years to account for lower revenue in down years.

But the House plan doesn’t contain such a measure. Lytton said she didn’t think it was necessary, claiming volatility concerns are overblown by opponents. She said she is open to changes, though.

Jinkins said while the tax can be volatile, it helps diversify the state’s “portfolio” of other taxes, which can fluctuate along with the economy. She said one upside to the capital gains tax is that it recovers faster after a recession than other taxes the state uses.

“Almost every individual tax has volatility to it,” she said.

Can it pass?

Even if such a tax is legal, it would have an Everest-size political mountain to climb. Republicans appear united in opposition to a capital gains tax, and there’s little evidence it could pass the state Senate.

Democrats might have better luck finding common ground on a new carbon tax. Some in the GOP have signaled support for past carbon tax measures. Two current state senators endorsed the carbon tax in Initiative 732 on last year’s ballot.

That measure wouldn’t have done much to help this year’s budget. It aimed to raise taxes while lowering other ones, resulting in no new revenue for the state. Voters did not approve it.

Neither the House nor Senate had a carbon tax in their budget proposals, though, and Senate Majority Leader Mark Schoesler, R-Ritzville, has been staunchly opposed to one.

For their part, Democrats aren’t excited about the GOP property tax, saying it doesn’t go far enough to tax the rich more than others.

Negotiations toward a budget compromise are ongoing.

Walker Orenstein: 360-786-1826, @walkerorenstein