The lie that a capital gains income tax is really an excise tax

In their ongoing quest for “progressivity,” House Democrats in Olympia announced new taxes to pay for their budget proposal, which spends more than the Senate Republicans’ budget.

Notably absent was any sort of carbon tax. Despite a Democrat-controlled House and a governor anxious to sign anything with the word “carbon” in it, the votes just aren’t there.

Instead, House Democrats are proposing:

  • A 20% hike in Business & Occupation taxes
  • Changing the current flat-rate real estate excise tax of 1.28% to a progressive rate, with property sales of less than $250,000 levied a .75% rate, while those of $5 million or more will top out at 2.5%.
  • Pitched as “fairness” for in-state businesses, customers may still blanch at one House D proposal that Lens describes as requiring out-of-state online retailers to “report taxes owed by Washington customers for online purchases.”
  • A 7% tax on income from capital gains

If the first and last proposals on that list seem awfully familiar, they are. B&O increases are more politically palatable for legislators, who would rather have business owners mad at them than the general electorate. A capital gains income tax has been a slightly tarnished Holy Grail for Olympia Democrats in recent years. Only a regular income tax is held in greater reverence.

Whether House Democrats actually have the votes to pass these tax hikes is unclear; they haven’t voted on any of them. Senate budget chair John Braun (R-Centralia) said that tactic “makes it very hard to get to a deal when they won’t show what’s politically possible.”

Republicans and Democrats remain divided on how much state government should grow. Sen. Dino Rossi (R-Sammamish) argued that “we already proved that you don’t actually have to raise taxes. The public’s already spending $3 billion more in this budget than we had in the previous budget.”

Word games
Those pushing for an income tax on capital gains are playing a game of semantics. Sure, it taxes income from selling securities and other investments and is defined in the bill as covering the capital gains that have to be reported on your federal income tax return, but it is not an income tax, they say.

How is that?

They insist a capital gains tax is actually an excise tax. This strategy is intentional: The Washington constitution requires that property be taxed uniformly, disallowing progressive rates. Case law establishes that under the state constitution, your income is your “property.” The only way to justify the progressive rate of this capital gains tax proposal is to state that it’s not really an income tax.

But is it actually an excise tax? An analyst at the Tax Foundation obliterated this argument. If it doesn’t walk, talk, or squak like an excise tax, it isn’t an excise tax.

The indispensable Jason Mercier from the Washington Policy Center decided to check with a few neighboring states’ revenue departments to see if they describe capital gains taxes (or the lack thereof) as income taxes or excise taxes. Here are the answers he received:

  • California DOR: “California taxes capital gains as an income tax and they are taxed at the same rate as ordinary income.”
  • Oregon DOR: “If it’s a capital gain for your personal income tax then it would be taxed under your Oregon personal income tax.”
  • Nevada DOR: “Nevada does NOT have a capital gains tax similar to federal income tax.”

By describing it as an excise tax, House Democrats are using a definition that apparently no one else uses. This is an Orwellian use of language where the words mean just what these legislators tell you they mean.

Which way do they want it?
The House Democrats’ goals are at counter-purposes here. On one hand, they want a test case to take to the state Supreme Court, hoping that today’s court will declare that income is not your “property” and does not have to be taxed uniformly.

On the other, they want a capital gains income tax to escape court scrutiny by calling it an excise tax, so they can use the revenue to pay for the higher spending in their budget…spending that is required to be “reliable” under the McCleary decision (and capital gains taxes aren’t reliable).

Maybe they’re hoping for a ruling similar to the U.S. Supreme Court’s Obamacare decision, where the individual mandate that Congressional Democrats insisted was not a tax was declared one by the court. In the legislative Democrats’ ideal world, the state Supreme Court would declare that their “excise tax” is obviously, in effect, an income tax, but that court precedent is wrong and income is not “property” that must be taxed at a flat rate.

A dream come true for them, not so much for us.
-Rob McKenna

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Rob McKenna
Rob served two terms as Washington’s Attorney General, from 2005 to 2013. He successfully argued three cases before the U.S. Supreme Court and negotiated three of the largest consumer financial protection settlements in national history, all involving mortgage lending and servicing. He is a recognized leader in the development of consumer protections on the internet, in data protection and privacy regulation.