A Douglas County Judge ruled on Tuesday that the statewide capital gains tax, which progressive legislators passed last year, is unconstitutional. The ruling concerned two lawsuits that were consolidated into one—one by the conservative Freedom Foundation, the other by Republican former state attorney general Rob McKenna.
The decision marks a win for Washington’s ultra-wealthy, like Steve Gordon of Gordon Trucking and hedge fund manager Brian Heywood, who each contributed $20,000 to an initiative campaign to repeal the tax; former Starbucks CEO Howard Beher, contributed $5,000. Unsurprisingly, the Attorney General Bob Ferguson, a Democrat, said he would appeal the decision to the state Supreme Court.
Douglas County Superior Court Judge Brian Huber wrote in his ruling that the 7 percent tax on the sale of intangible financial assets, such as stocks and bonds, violates Washington’s constitution’s “uniformity clause” because it imposes “zero tax on capital gains below that $250,000 threshold.” The uniformity clause prohibits the state from taxing different property at different rates.
Democrats have argued that the tax is constitutional because it doesn’t assess property, but rather, the sale of property, making it an excise tax, not an income tax. Huber rejected that argument, saying the plaintiffs “properly characterized [the capital gains tax] as an income tax” in their lawsuit. And since Washington considers income to be a form of property, any income tax would need to meet the state constitution’s uniformity clause.
Washington is one of the few state’s in the country without an income tax. The state instead relies heavily on business and sales taxes to generate revenue. Democratic lawmakers have frequently criticized this model as regressive, because it means that people who earn less pay a larger percentage of their income in taxes than wealthy people pay. Democrats saw the capital gains tax as a way to reverse this regressive .
Following the judge’s decision, State Attorney General Bob Ferguson said if the tax were ultimately struck down, the state could lose hundreds of millions in funding for childcare programs, early learning, and school construction projects. “Consequently, we will continue defending this law enacted by the peoples’ representatives in the legislature. All the parties recognize this case will ultimately be decided by the State Supreme Court. We respectfully disagree with this ruling, and we will appeal.”
After a year of dire revenue predictions and a pandemic that exposed class fault lines, 2021 looked like the year for tax reform. Firmly in control of both houses, Democratic lawmakers proposed multiple tax bills to reverse Washington’s regressive tax structure. However, at the end of the 105-day session, lawmakers only passed two new progressive taxes: the capital gains tax (SB 5096) and the working families tax exemption (HB 1297).
The capital gains bill imposes a 7 percent tax on profits, or capital gains, of more than $250,000 on the sale of intangible financial assets, like stocks and bonds; about 7,000 taxpayers are expected to pay the tax. The revenue will fund childcare and public schools. The Working Families Tax Exemption will give low-income residents and families in Washington a tax rebate of up to $1,200 a year.
Both of the bills had been in the works for more than a decade, and tax reform advocates say they’re a good start, but that the state needs to do much more done. According to a 2018 study from the Institute of Taxation and Economic Policy, sales and property taxes siphon away roughly 18 percent of low-income residents’ annual incomes, and this year’s tax reform bills did little to improve that statistic.
The state’s sales tax, which is regressive because it costs lower-income people far more as a percentage of their income than higher-income residents, supplies more than half of the state’s general fund—roughly $22.5 billion during the 2017-2019 biennium. Because it’s such a major contributor to state revenues, cutting it would lead to a major deficit and the state would need to pass additional taxes to neutralize the revenue loss. “It would be logistically difficult to pull off in Washington state,” Andy Nicholas, policy director for the progressive Washington State Budget and Policy Center, said. Nicholas has suggested imposing higher sales taxes on luxury goods than on basic necessities.
Nicholas says broader reforms are likely to come “in a couple years.” In the meantime, he hopes legislators pass more rebates to ease the impact the current tax system has on the state’s lowest-earning residents. He says a tax rebate for renters could offset the cost renters pay for property taxes, which landlords generally pass along to tenants as part of their rent. Nicholas said Rep. Kristen Harris-Talley (D-37, Seattle) could attach the rebate to her anti-displacement property tax exemption (HB, 1494) which she proposed earlier this year. The House Finance Committee passed her bill, but it died in the Appropriations Committee.
Because of some of these policies, she says, “BIPOC communities and low-income communities haven’t been able to have the same benefits.” —Treasure Mackley, Executive Director Invest in Washington Now
Discriminatory private- and public-sector policies have prevented BIPOC communities from gaining social mobility, Treasure Mackey, Executive Director of Invest in Washington Now, told PubliCola. For example, Washington state allows judges to issue fines against criminal defendants, and they charge higher fines, on average, to people of color. In the private sector, discriminatory hiring practices kept workers of color out of high paying jobs and redlining confined people of color, particularly Black home buyers, to certain parts of cities like Seattle. Without the ability to generate lasting wealth, communities are stuck in a position where they have to spend a fifth of their income on regressive taxes.
“We need to not only modernize our tax systems to catch up with the economy that we have, but we also need to rebalance our tax code in a way that is fairer and more just and creates a level playing field for everybody,” Mackley said.
Democrats discussed a number of potential new taxes this year, including the wealth tax (HB 1406), which would have imposed a 1 percent tax on the worldwide wealth of the wealthiest Washingtonians. They also discussed a payroll tax similar to one Seattle implemented in 2020. The city imposes a tax of 0.7 to 2.4 percent on the payroll expenses of its largest employers; the larger the employer and the higher an employee’s pay, the higher the tax.
In future sessions, lawmakers will likely craft new tax policy based on the findings of the Tax Structure Work Group, which includes legislators from both parties, officials from the governor’s office and Department of Revenue and members of the Washington Associations of Counties and Cities. The legislature formed the group in 2019 to research replacements for Washington’s most regressive taxes, including like the sales tax and the business and occupation tax; however, legislation is still years away.
The group’s 2020 report recommends a value added tax (VAT) and a corporate income/net receipts tax to replace the B&O tax. VAT taxes a product at every stage of production, but consumers ultimately pay the final cost of the tax, whereas businesses that pay VAT can receive tax rebates. The corporate income tax would be levied on businesses that pay the federal corporate income tax, with exemptions for the smallest businesses. Unlike the B&O tax, the corporate income tax would allow companies to file for deductions on most of their operating expenses.
The work group also suggested instituting a progressive income tax to offset cuts to the sales tax. The obvious problem with this is that, according to a 1933 state supreme court ruling, income is property subject to a constitutional prohibition on graduated taxes. Passing an income tax would mean defending the tax in court and hoping the modern supreme court overturns the nearly 80-year-old decision.
Ostrom said if the court decides they want to protect the most regressive tax structure in the country, “that’s egg on the supreme court’s face.”
In fact, Democrats have set up this very possibility. The benefit (and possibly the purpose) of passing the capital gains tax may have been to force a court showdown; Sen. Jamie Pedersen told PubliCola last week he was excited that conservatives immediately sued. By getting the court to hear a legal challenge to the Democrats’ capital gains tax (which opponents argue is an income tax), the court will have the opportunity to overturn their previous ruling, opening the door to a progressive income tax. Alternately, the court could interpret the bill as an excise tax, which Democrats argue it is, without completely overturning their previous decision. Or the court could simply find that capital gains are also property and strike down the bill.
Aaron Ostrom, the executive director of the progressive statewide organization Fuse Washington, thinks it’s unlikely the court will rule against the tax, but if they did ,Democrats “would probably have to go back to the drawing board.” Ostrom said if the court decides they want to protect the most regressive tax structure in the country, “that’s egg on the supreme court’s face.”
A court ruling will surely influence the next moves for tax reform advocates and lawmakers, Ostrom said. But they will still have the same goal: “We’re all pretty committed to not having Washington have the most regressive tax code in country. It’s not good for the people of Washington, it’s not good for the economy,” he said. “We have to go back and find some strategies that work to shift the tax load off of the folks making the least.”
1. Mayor Ed Murray’s surprise announcement, at a campaign forum last week, that he would put forward “a proposal for a high-end income tax” came at a particularly inopportune time for a group of progressive taxation advocates that has been working for months to craft just such a proposal. Proponents of a local income tax, including council member Lisa Herbold, met last week with city budget director Ben Noble to discuss putting together an income tax proposal that could withstand legal scrutiny. On Monday, Herbold announced she was introducing a resolution—”drafted with the assistance of the mayor’s office” and reviewed by the city attorney—that lays out a timeline and questions that need to be resolved in drafting a local income tax ordinance. The goal, Herbold said, is to begin considering a local income tax proposal by the end of May and to adopt an ordinance in July.
Trump Proof Seattle has proposed a 1.5 percent income tax on incomes over $250,000 a year; Herbold said Monday that one of the goals of the council process will be to decide on an income threshold and what kind of income (earned or unearned) will be taxed. Prior to Murray’s announcement last week, former mayor and current mayoral candidate Mike McGinn said he supported an income tax; Cary Moon, an urban planner and civic activist who announced she was running last week, says she would prefer a capital gains tax.
2. Council member Lorena Gonzalez had a message for legislators who are dithering over whether to require companies in Washington State to provide paid family leave: If they won’t do it, she will. Time is running out for lawmakers to reach a compromise between two dueling proposals, including one (sponsored by Sen. Joe Fain, R-47) that would preempt Seattle from adopting more generous requirements. The details of the two plans vary in the ways you might expect; the Republican proposal is entirely employee-funded and would provide new parents or people who need time off to care for a sick family member just two months of leave at half pay, while the Democratic version is partly employer-funded and provides more generous benefits.
“I feel that a statewide solution is the best solution for all working families, including Seattle working families,” Gonzalez said. “But I have still have a very strong interest, and am incredibly ready to advance, a Seattle-only policy if those conversations are not happening in good faith.”
3. A new job opportunity opened up this week for those with thick skin and a willingness to work for a company that has been widely panned as hostile to unions: Community manager for social responsibility for New Seasons Market in Seattle. New Seasons, you may recall, sparked controversy with its plan to bid on a new location above the Capitol Hill light rail station; labor groups criticized the Portland-based company for being “anti-union,” and the United Food and Commercial Workers organized an “unwelcome ceremony” when the company opened its first Seattle-area location on Mercer Island last year. New Seasons is also rumored to be the anchor tenant at another controversial development at 23rd and Jackson, where the luxury condo behemoth Vulcan plans to build hundreds of new apartments and tear down the unionized Red Apple store that has been a community fixture for more than 25 years. The community manager for social responsibility in Seattle, in other words, is going to have their work cut out for them.
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