“Blatant illegality” or just another excise tax? The state’s new capital-gains tax has now reached the Washington Supreme Court – as everyone knew it would – and excise tax or not is the basic question the justices have to answer. On that answer hang big political consequences.
And what’s the point? There are plenty of potential points: Soak the rich. Make the state’s regressive tax system more equitable. Skirt or scrap or confirm the 1933 state supreme court decision that ruled a graduated income tax unconstitutional in this state. Bring in more money for big government. Take your pick. Or take all of them. Just don’t take them to the public.
The state legislature certainly didn’t risk popular democracy. Two years ago, the legislature’s Democratic majority passed a law that levies a 7 percent tax on any realized capital gains above $250,000. This tax applies only to sales of securities. It exempts gains from selling real estate, cashing in retirement accounts, selling the farm. The tax is calculated from capital-gains information entered on IRS income tax forms. It would allegedly be paid by only one-tenth of one percent of the population.
Last year, a Douglas County Superior Court ruled this tax was unconstitutional. The state (defending the law) appealed to the state Supreme Court, which has let the tax go into effect while the justices consider the appeal. Amicus briefs have been filed on both sides. The court heard oral arguments on January 26. During the court session, state Solicitor General Noah Purcell asked the justices for an expedited judgment, so that the tax’s constitutionality could be decided before April 18, the date by which capital gains tax payments – like federal income tax returns — are due.
Last December, Attorney General Bob Ferguson asked the court to reject the AMICUS brief filed by the Building Industry Association of Washington (BIAW) and the Washington Cattlemen’s Association because it insulted legislators. The court didn’t agree with Ferguson. The BIAW has alleged that “[t]he blatant illegality of [the tax bill] harms Washington businesses because it shows a disregard for the rule of law by Washington lawmakers.” Which is probably true – if you consider the new tax a constitutionally illegal income tax. But is it or isn’t it an income tax? That’s the flip side of whether or not it’s an excise tax — and the crucial question the court must elide or decide decide.
Taxing income has been a hot-button issue in Washington for more than 90 years. Once upon a time, in 1932, during the Great Depression, Washington voters approved a graduated income tax for the state. This was not a “progressive” ideological measure. The initiative was sponsored by the farm group, the Grange. The state relied on a property tax, and farmers had a lot of property but not a lot of money. They wanted someone else to pay. A majority of other voters wanted the same. After the measure passed, opponents sued. The tax never went into effect.
In the Culliton decision of 1933, the state Supreme Court — arguably misreading precedents that were flawed to begin with — ruled that income was a form of “property,” and since the state constitution said all similar classes of property had to be taxed equally, a graduated income tax would be unconstitutional.
That has been settled law ever since. A flat-rate income tax clearly would never have violated the constitution as interpreted by the Culliton court. But the people who want an income tax have always wanted a progressive, graduated tax. And the voters have never wanted any income tax at all. Income tax initiatives have repeatedly failed by wide margins.
The last failure came in 2010, when Bill Gates Sr. was the chief spokesman for the ill-fated Initiative 1098. That tax would have applied only to high earners. It would have been levied only on individuals earning more than $200,000 a year and couples earning over $400,000. It would have been balanced by reductions in other taxes. It would have funneled more money to education (as the capital-gains tax would) and to health care.
That tax would have applied only to high earners. It would have been levied only on individuals earning more than $200,000 a year and couples earning over $400,000. It would have been balanced by reductions in other taxes. It would have funneled more money to education (as the capital-gains tax would) and to health care.
But opponents didn’t trust it. “The cash being poured into the pro-1098 campaign aims to convince you,” An editorial in the Seattle Times explained, “if you earn less than $200,000, that you will not pay the tax. You may not, in the first years. But the tax will be expanded. Taxes always are.” A strong majority (64 percent) of the voters said “no.”
Politics aside, what about the legal issues? When the legal questions were discussed on January 26, state Solicitor General Noah Purcell sometimes made the argument sound like a dispute among medieval theologians: The new capital gains tax is based on income and triggered by gains reported on a federal income tax form, but it’s not an income tax. On the other hand, Purcell appealed very much to common experience and common sense: It’s just an excise tax on transactions, like the real estate excise tax you pay when you sell a piece of Washington property.
Former Attorney General Rob McKenna, now a corporate attorney arguing for the opposition, disagreed. It masquerades as a tax on transactions but you can have all the transactions you want unless you make a certain amount of money from them; therefore, it’s an income tax, McKenna contended.
The current unconstitutionality of a graduated income tax loomed over the argument. Everyone realizes that this case gives the Supreme Court an opportunity to scrap Culliton. Some people would love to see the court take the bait.
An “important benefit of passing a capital gains tax,” wrote state Senator Jamie Pedersen in a 2018 email quoted by Jason Mercier of the anti-tax Washington Policy Center, is that opponents will sue, which will “give the Supreme Court the opportunity to revisit its bad decisions . . . that income is property, and will make it possible . . . to enact a progressive income tax with a simple majority vote.”
On the January 26 court session, Paul Lawrence, representing the Washington Education Association and the Edmonds School District, invited the justices to do just that. Delare th capital gains tax a constitutional excise tax, he asked the court, but if you find it’s really an unconstitutional income tax, then get rid of Culliton once and for all.
Maybe the justices don’t have to grasp the hot potato Culliton at all – as an amicus brief by an ad hoc group of law professors makes clear. The “Court need not overrule Culliton . . . to uphold the capital gains excise tax,” the law professors say. The new tax “falls squarely within this Court’s longstanding definition of an excise tax, because [it falls] upon the act of transferring capital assets and not directly on the property itself.” They quote a 1952 decision in which the court proclaimed that “a tax upon the sale of property is not a tax upon the subject matter of that sale.”
The betting is that the justices won’t scrap Culliton just yet. All they really have to do is say, NARROWLY, that yes, this really is – or no, this really isn’t — an excise tax. By eliding the decision, the elected court would be off the hook for the politically toxic decision about an income tax.
The court nearly faced a similar question a dozen years ago. The failed 2010 “income tax” initiative took the same approach that the capital gains tax does. The initiative was discussed as an income tax, written about as an income tax, presumably voted on as an income tax, but the text said very clearly it was really an excise tax. The state wouldn’t be taxing income per se; it would be taxing the act of receiving income. Would the court have bought that? We’ll never know.
Is casting this new levy as an excise tax basically a legalistic scam? Of course. But is it a bad thing? Not necessarily. Will the justices buy it? Maybe so.
Opponents, including former Attorney General Rob McKenna, are right when they argue that no one else thinks taxing capital gains is anything but a way of taxing income. The IRS has taxed capital gains as income since 1913. (Of course, technically, the new tax would apply not to capital gains per se but to the act of receiving them. That delicate distinction is now widely made.) On the other hand, no one else thinks income is property. The Court has made Washington a legal outlier on the nature of income. Why shouldn’t the Court make Washington an outlier on capital-gains taxation, too?