WA Supreme Court upholds capital gains tax

The Washington state Supreme Court has upheld the constitutionality of the state’s capital gains tax, cementing a long-sought victory for state Democrats and nudging the state’s tax system in a more progressive direction.

The court ruled 7-2 Friday morning to uphold the tax. The court declined to revisit its nearly century-old precedent, which bars a progressive income tax, but instead ruled the capital gains tax is constitutional because it is an excise tax, which is a tax on a good or service, and not a property tax.

Democrats passed the measure in 2021, with plans to spend the revenue on early childhood education programs. It applies a 7% tax on the sale of financial assets such as stocks and bonds. The tax applies only to profits over $250,000 and does not apply to real estate or retirement accounts.

It is expected to initially bring in about $500 million a year in revenue.

Gov. Jay Inslee spoke in historic terms in hailing the court’s ruling.

“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,” Inslee said. “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.”

A bevy of challengers had risen up, filing lawsuits to try to block the new law, arguing, among other things, that the law is a tax on income and violates the state constitution’s requirement that taxes be applied uniformly across the same class of property.

Supporters argued the tax is better understood as an excise tax, and that it is not a tax on income or property because it applies to sales or transfers of assets.

A Douglas County judge last year ruled for the challengers, finding the tax unconstitutional because it taxed capital gains above $250,000 at 7% and gains below that level not at all.

But the Supreme Court reversed that ruling, finding that the capital gains tax is not a tax on property and is not subject to the requirement that taxes on property be uniform.

“The capital gains tax is an excise tax because taxpayers do not owe the capital gains tax merely by virtue of owning capital assets or capital gains, like a property tax,” Justice Debra Stephens wrote for the court. The tax relates to “the power to sell or transfer capital assets — like an excise.”

Justices Sheryl Gordon McCloud and Charles Johnson dissented, and would have ruled the tax unconstitutional for violating the uniformity requirement.

“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,” Gordon McCloud wrote. “ ‘Capital gains’ are income. In Washington, income is property. A Washington ‘capital gains tax’ is therefore a property tax.”

Because the court ruled the tax is an excise tax, it stopped short of revisiting the 1933 state Supreme Court decision that disallowed a progressive income tax.

But the court did seem to go out of its way to both cast doubt on and bemoan the results of that opinion.

Stephens recounts the history of the opinion, noting that the court had only eight justices at the time and was deadlocked 4-4 on the constitutionality of the state’s income tax.

“The governor appointed a new justice who appeared to favor the tax, but, as the story is told, one justice changed his position while the case was pending, resulting in a five to four vote to void the tax,” Stephens wrote.

Washington is living with the results of that decision today, Stephens wrote.

“Ours has been recognized as a uniquely regressive tax system that ‘asks those making the least to pay the most as a percentage of their income,’ ” she wrote. “The wealthiest households in Washington are disproportionately white, while the poorest households are disproportionately BIPOC,” she wrote, using the abbreviation for Black, Indigenous and people of color. “As a result, Washington’s upside-down tax system perpetuates systemic racism by placing a disproportionate tax burden on BIPOC residents.”

Sen. Jamie Pedersen, D-Seattle, one of the architects of the tax, said the majority opinion didn’t “immediately open the door” to an income tax, but did include “a lot more recognition than I have seen in any previous court ruling about how uniquely bad and regressive our tax system is.”

The Supreme Court, late last year, allowed the state to begin collecting the tax while it considered the case. The court heard oral arguments in the case in January and the state began collecting the tax last month.

Progressives have long lamented the state’s regressive tax structure, which depends heavily on sales and business taxes. Washington is one of a handful of states without an income tax. Due to that combination, people who make less money pay a higher share of their income in taxes.

Jason Mercier, director of the Center for Government Reform at the Washington Policy Center, a conservative think tank and longtime opponent of the tax, said he was “a little bit shocked” by the court’s opinion.

“As far as what that means down the road for future income taxes, I guess we’ll just have to wait to see how many other income taxes the Legislature redefines as excise taxes, and if the court goes along with it,” Mercier said.

Sen. Lynda Wilson, R-Vancouver, budget leader for Senate Republicans, said it was a “a relief” that the court ruling doesn’t authorize “a full-blown income tax in our state.”

“But taxpayers clearly need to be on their guard,” Wilson said. “We should expect the Democrats to start adjusting the parameters of this tax so it applies to more and more people over time, which means more and more of their money going to government.”

Inslee said Friday he was unaware of any talk to expand the capital gains tax, and people should be cautious about drawing too many conclusions based on this decision.

“This decision is a decision on one particular revenue source and I think the court got it just right,” he said.

State Attorney General Bob Ferguson, in his brief to the Supreme Court defending the tax, called it “the most progressive change in Washington tax policy in generations.”

In a Friday morning tweet, Ferguson called the ruling “a significant win for education.”

The court’s opinion landed just as lawmakers in Olympia have started to reveal their plans for state spending for the next two years.

Senate budget writers built the new tax into their capital and operating budget proposals, released this week.

The tax is projected to bring in about $1 billion in the upcoming two-year budget.

“Today’s decision provides much needed certainty for budget writers as the Legislature continues to craft our state’s next two-year operating budget,” said Sen. Christine Rolfes, D-Bainbridge Island, chair of the Senate Ways and Means Committee. “We are eager to expand support for working families, and today’s ruling locks in dedicated funding to increase access to affordable early learning and child care.”

Rep. April Berg, D-Mill Creek, chair of the House Finance Committee, said the ruling “provides the clarity needed to move forward with this significant reform to our tax structure.”

“It’s time for the wealthiest among us to share in the responsibility of funding the needs of our communities,” Berg said.

Seattle Times staff writer Jim Brunner contributed to this report.