Despite substantial state revenue growth, Governor Inslee is proposing a 9 percent income tax on capital gains. This is just one of several tax increases the Governor is pushing for in his massive 2019-21 budget proposal.
The Governor claims his new capital gains tax is an “excise tax” and not an income tax. He does this trying to avoid the state’s constitutional prohibition on graduated income taxes.
There is no debate on this point — a capital gains tax is an income tax. This according to the Internal Revenue Service (IRS), every state revenue department in the country, and just plain common sense.
In pitching his new income tax on capital gains, the Governor says Washington is one of just nine states without this type of tax.
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Prepare to be amazed. The states that don’t have a capital gains income tax are those states without a personal income tax. This is due to the fact that a capital gains tax is an income tax as explained by the 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."
Beside the fact a capital gains income tax is unconstitutional in Washington, imposing one would also be bad budget policy for the state. Washington currently has one of the most stable tax bases in the country (property taxes are very stable). A capital gains income tax, however, is one of the most volatile tax sources possible. To illustrate this fact, I would like to call California Governor Jerry Brown to the stand to testify.
In 2014, Governor Brown pushed for a constitutional amendment to restrict the use of capital gains for state spending. Heeding his warnings about the volatility of capital gains, California voters approved it.
The extreme volatility of capital gains income is well known throughout the country. California’s Legislative Budget Office (LAO) says, “Probably the single most direct way to limit the state’s exposure to the kind of extreme revenue volatility experienced in the past decade would be to reduce its dependence on the source of income that produced the greatest portion of this revenue volatility — namely, capital gains and perhaps stock options.”
LAO went on to say, “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.”
There was also this warning from the Washington Department of Revenue (DOR) on the 2012 capital gains income tax proposal (House Bill 2563): “Capital gains are extremely volatile from year to year. Revenue from this proposal will depend entirely on fluctuations in the financial markets and can be expected to vary greatly from the amounts presented here.”
If enacted, Washington would be the only state in the country with a stand-alone income tax on capital gains. Doing this would throw away what the state Department of Commerce says is not only a “competitive advantage” for the state but also “is great marketing” for Washington. If an income tax is imposed, Commerce warned that would mean “one less tool that we have in our economic development tool box.”
Not only is a capital gains income tax unconstitutional, adopting one would inject extreme volatility into the state’s budget. This could set up a constant push year after year to raise taxes even higher to balance the budget. Being unconstitutional and extremely volatile demonstrates an income tax on capital gains is a true twofer of bad policy and should be rejected.
On the one hand, you have the IRS and every state revenue department in the country saying a capital gains tax is an income tax. On the other hand, you have those who are trying to evade Washington’s constitutional prohibition on graduated income taxes. Who are you going to believe?
Jason Mercier is the Government Reform director for Washington Policy Center, a non-profit research organization with offices in Tri-Cities, Spokane, Seattle and Olympia. Online at www.washingtonpolicy.org