Governor Inslee says capital gains tax not an income tax. Rest of the country disagrees


December 24, 2020

Despite the budget being balanced, billions in reserve, and projected revenue growth of 7.2% the Governor is yet again proposing an income tax on capital gains in his new budget. Here are the details on his proposed 9% capital gains income tax. The Governor, however, claims that this type of tax isn’t an income tax. What does he know that the IRS and every other state across the country doesn’t?

IRS: “You ask whether tax on capital gains is considered an excise tax or an income tax? It is an income tax. More specifically, capital gains are treated as income under the tax code and taxed as such.”

Nonpartisan legislative staff: “Most states do not have separate capital gains tax rates. Instead, most states tax capital gains as ordinary income subject to the state’s income tax rates.”

Do states without personal income taxes tax capital gains? No. For example:

•Florida: “There is currently no Florida income tax for individuals and, therefore, no Florida capital gains tax for individuals.”

•Alaska: “No personal capital gains tax. Alaska currently does not have a personal income tax.”

•Nevada: “Nevada does NOT have a capital gains tax similar to federal income tax.”

•Texas: “No capital gains tax. Texas does not have a state income tax.”

•Wyoming: “No capital gains tax because Wyoming does not have an income tax.”

Not a single state with an income tax on capital gains describes this type of tax as dependable or stable. Instead, here are a few examples discussing the extreme volatility problems inherent with taxing this type of income:

•“In Delaware, capital gains are taxed under the personal income tax as all other income. As in every other state, capital gains are extremely volatile and unpredictable. This is particularly problematic toward the end of market cycles, when they represent a greater share of personal income tax revenues.”

•“For the Commonwealth of Massachusetts, taxes on capital gains are among the most volatile and unpredictable major sources of revenue. Obviously, that is very much in line with the experience of other states.”

•”California’s tax revenues have numerous volatile elements, but among the more significant sources of revenue volatility are the state’s tax levies on net capital gains through the personal income tax.”

•Virginia: “Capital gains is the most volatile tax source that any state has to forecast. It is not dependable or stable.”

What are the motivations behind the Washington income tax on capital gains proposals? Thanks to public records we know the goal is to set up a lawsuit in hopes of imposing a graduated income tax without a constitutional amendment. Consider the following emails from Sen. Jamie Pedersen:

•“But the more important benefit of passing a capital gains tax is on the legal side, from my perspective. The other side will challenge it as an unconstitutional property tax . . . make it possible, if we succeed, to enact a progressive income tax with a simple majority vote.”

•“. . . adopting a capital gains tax is one of the best things we could do to help advance the possibility of an income tax in our state . . . Until that happens, it would take 2/3 majorities in the legislature (and a vote of the people) to adopt an income tax”

Washington’s Department of Revenue (DOR) says: “The federal capital gains tax is characterized as an income tax. One potential challenge to a capital gains tax proposal is that opponents may characterize the Washington capital gains tax as an income tax . . .”

More from DOR on capital gains tax: “susceptible to constitutional challenge as an income tax prohibited by the Washington state constitution . . .”

On September 13, 1960 the state Supreme Court issued a unanimous one-page ruling with this sage advice: Don’t ask the Court to reverse its numerous rulings prohibiting a graduated income tax; instead amend the constitution.

The voters have already rejected 6 constitutional amendments to allow a graduated income tax. The state Supreme Court this year also refused to hear the Seattle income tax case that was trying to challenge the prior income tax ban court rulings.

Washington’s Department of Commerce has made the state’s lack of an income tax a major selling point for its “Choose Washington” campaign: “We offer businesses some competitive advantages found in few other states. This includes no personal or corporate income tax.”

Excise taxes are transaction taxes that apply at point of sale on price or volume. Taxes applied on income from a transaction are not excise taxes. Prepare to be amazed, they are income taxes. This is why every tax agency outside of Washington says a capital gains tax is an income tax.

2020 has taught us that there are many things in life that are uncertain. A capital gains tax being a highly volatile income tax is not one of them. This is not a debate unless you are trying to circumvent Washington’s constitutional prohibition on graduated income taxes.

IRS: “You ask whether tax on capital gains is considered an excise tax or an income tax? It is an income tax.”

–Mercier is Director of Center for Government Reform Washington Policy Center, Tri-Cities office.


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