When I was in my early teens, friends and I would stand on a freeway overpass and pee on Cadillacs, which at the time were symbols of ostentatious wealth, or at least a desire to look ostentatiously wealthy. Piss on the rich. Why not?
No doubt we would all have voted gleefully for the capital gains tax that Governor Jay Inslee signed into law on May 4, and for the “wealth tax” on intangible financial property worth more than $1 billion that died in the House Appropriations Committee.
We would have been happy to tax the rich. Who isn’t? And we wouldn’t have worried much about constitutionality. Evidently, the legislators who voted for the new taxes didn’t worry much about state constitutionality, either. Or, rather, they hoped that faced with the new tax on capital gains, the state supreme court would change its nearly-90-year-old definition of what the state constitution allowed. We’ll see, though the odds are not good for a legal green light.
Inslee hailed the legislation — which lays a 7% tax on all annual sales of financial assets (your real estate is safe) over $250,000, with collection to start in 2023 — as a step toward tax fairness. That laudable goal no doubt motivates many of the law’s supporters. But a push for some kind of income tax — let’s call it what it is — has always been inspired by tangled motives. Advocates used to talk about creating an even flow of tax money, which in practice meant getting more money in bad times, not less money in good. Or about creating a more progressive tax structure. Or about offsetting the new revenue by some cuts to regressive and bad taxes.
Those other rationales aside, securing more funds for more government has been fundamental. In the new law, you don’t see any other taxes being reduced as tradeoffs for taxing capital gains. The new tax contains language that seems to shield it from a referendum. The legislature wasn’t taking any chances on democracy, ruling out a referendum.
All the legal tap-dancing doesn’t mean the new taxes are bad. And it doesn’t mean the taxes are constitutional. To see whether an old story is finally on its way to a new ending, let’s review the basic plot.
In 1932, the depth of the Great Depression, when struggling farmers wanted relief from property taxes and the federal income tax was paid by only a relatively few people, Washington voters enacted a graduated net income tax. (Washington voters have been given ample opportunity, but they’ve never supported an income tax again, and it usually gets trounced at the polls.)
Opponents to the 1932 tax sued. The state constitution said — and still says — that every class of property must be taxed at a uniform rate. In 1933, when the case against the income tax, Culliton v Chase, reached the state supreme court, the court decided – rightly or wrongly, and one can make a good argument for wrongly – that income was a form of property. Therefore, a graduated income tax, which applied different rates to different levels of income, violated the constitution. So they tossed it. People have naturally tried to weasel around Culliton, but so far, at least the court has made it clear that simply calling an income tax something else (such as an excise fee) won’t cut it.
Two years ago, ruling on Seattle’s attempt to tax residents with incomes above a quarter–million dollars (a half million for couples), the Washington Court of Appeals ruled that the tax clearly violated the state constitution. The city claimed it had merely levied an excise tax, but the appeals court didn’t buy that. The court quoted the state supreme court’s 1936 opinion in Jensen v. Henneford that tossed out an “excise” tax passed by the legislature in 1935. (Times were tough during the Depression, and the 1935 legislature also created the state’s sales tax.) The Jensen court said that the “excise tax” was actually a forbidden graduated income tax in thin disguise. The “character of a tax,” that court said, “is determined by its incidents, not by its name.” If it walked like an income tax and quacked like an income tax, what the legislature artfully called it didn’t matter. Seattle took the appeals court’s decision to the state supreme court, which last year declined to review it.
Now, legislators argue that capital gains aren’t income. Tell that to the IRS. You report capital gains on Schedule D of Form 1040 for calculating your federal income tax. Is it any different in the Evergreen State? And, had the wealth tax passed, how could anyone have plausibly argued that wealth wasn’t property? That doesn’t pass any test at all.
The 2010 Initiative 1098, fronted by Bill Gates Sr., would have taxed only high earners, individuals making more than $200,000 a year and couples making more than $400,000. (Individuals making more than $500,000 and couples making more than $1 million would have paid higher rates.) I-1098 would also have reduced the legal cap on property tax rates and would have lowered B&O tax burdens on small businesses. It would not have changed the constitution to explicitly make a graduated income tax kosher. Gates and other advocates knew the measure wouldn’t get the two-thirds majority needed for a constitutional amendment. They figured instead, given this legal opportunity, the state supreme court might be ready to dump Culliton. And the people might finally be ready to pass an income tax. He was wrong about the people. Voters rejected the initiative; nearly two-thirds of the electorate voted “no.” The court was not given the opportunity to toss Culliton.
Why didn’t people support Gates’ initiative? Maybe they figured that sooner or later, legislators would find a way to tax the incomes of people who earned less than $200,000. One big appeal of taxing the rich is that the state (or nation) is taxing them, not you. (The state estimates that only 7,000 people would pay the capital gains tax.) But many people don’t trust legislatures. They’re right, for when the need — or perceived need — for revenue is high, history suggests legislators will reach for whatever is at hand.
Like the doomed 2010 initiative, which would also have directed some money into health care, the capital-gains tax would raise cash for public schools and free up some education money for other things. The first section of the capital gains tax law invokes the state constitution’s statement that education is the “paramount duty” of the state, and cites the state supreme court’s 2012 McCleary decision, which said the state was violating the constitution by under-funding basic education. McCleary dragged on for ten years. In 2007, citing the “paramount duty” language and the 1978 supreme court decision that the language meant exactly what it said — which obligated the state to fund “basic education,” a term that the legislature itself could define — a group of parents, school districts, and non-profits sued the state, saying it was not adequately funding basic education. Before the court finally let the the legislature off the hook in 2017, the justices had held the legislature in contempt, and legislators had come up with substantial — if still in many ways inadequate — extra cash.
By including that hat-tip to McCleary, the legislature seems to be saying, You told us to do it, so let us raise some extra cash to pay for it. Actually, while the first half-billion dollars collected each year would go to a fund established to finance public schools and expand post-secondary opportunity, the legislation also makes pre-K education and child care legal targets of the money. And anything over that first half-billion would go to the common school construction fund. (The likelihood of having any money left over for school construction looks slim, since the tax is projected to bring in only $415 million a year.) As it happens, neither pre-K nor school construction was part of McCleary. That is not to say that pre-K isn’t significant or that school construction hasn’t been under-funded — just that there’s a wee bit of flim-flam going on.
Inevitably, the courts will have a chance to rule on the new tax. Even before Inslee signed the new capital gains tax into law, the Freedom Foundation filed a legal complaint against it in Douglas County superior court. The complaint alleges that the law violates the state constitution not only because it imposes a graduated net income tax, but also because it exceeds the constitutional rate limit for a tax on property; and further that by requiring complete disclosure of federal income tax filings, it violates state privacy protections. The complaint also says that by basing tax liability on where a person lives rather than on where the sale of capital assets takes place, the law violates the U.S. Constitution’s Commerce Clause.
Maybe, maybe, the court is ready to scrap Culliton or at least read it more narrowly. To be sure, when given an invitation to do so by Seattle’s tax on high earners, the court politely declined to even consider it — and that happened just last year. Maybe this time will be different. But don’t bet more than you can afford to lose