As the campaign season develops, some urban and Western Washingtonians may be hearing talk of a capital gains tax or a progressive income tax. Because legislative proposals for these measures have fared poorly in recent years, the talk may be likely to remain just that: talk. Yet it’s important to understand the problems either tax would cause, according to critics. Just in case.
The ground is shifting. The state legislature might in 2017 consider imposing a capital gains tax, in the belief that it’s needed to adequately fund basic education as part of the state Supreme Court’s 2012 McCleary ruling. The crux of the ruling is that the legislature must somehow shift to the state the basic ed funding burden now borne by local school districts. The political impetus has not been much slowed by admitted confusion on how much districts really spend for this purpose.
If advocates do beat the long odds and implement measures either for a capital gains tax or to advance a progressive income tax, tech industry leaders say that could wreak economic havoc and send poor signals to potential investors in Washington’s economy.
Tax Landscape Already Filled With Activity
Understanding the terminology and tax landscape is helpful. Capital gains are profits paid by individuals and businesses from the sale of capital assets such as land, buildings and machinery, and can include stock, copyrights and commodities derivatives. Capital gains taxes are already in the federal tax code. According to The Tax Foundation, Washingtonians pay an effective top rate of 25 percent in federal capital gains taxes, but Washington – at least for now – is one of nine states with no additional state-level capital gains tax.
Washington notably has no general income tax, but does assess state, county and local sales taxes. Property taxes add up too and are taken by the state, counties, cities, schools, transit and other taxing districts. In numerous Washington cities, additional voter-approved property tax levies for special services are common. As well, Washington residents who own and operate businesses do pay a business income tax on gross receipts, regardless of whether the business makes a profit or not. It is known as the Business and Occupation (B&O) tax.
Some Lawmakers Expect Tax Proposals In 2017
Despite the hefty array of taxes already paid by Washingtonians, some lawmakers see new tax proposals of some sort on the horizon for next year, tied to K-12 education funding.
As supplemental budget negotiations moved into overtime this year, State Rep. Larry Springer (D-45) said of next year’s biennial spending plan, “I think the budget battle is shaping up to be the mother of all budgets. The numbers there are going to be really big. And most of us down there do not think you can meet the McCleary decision without new revenue.” He did not specify what sources might drive new revenue.
State Rep. Cary Condotta (R-12), who has served on the House Finance Committee for 12 years, said, “We’ve pushed issues to the point where they have to be solved.” Task groups are currently working to prepare two or three tax reform proposals for January 2017. Condotta expects that at least one of the proposals to the House Finance Committee will include an income tax.
Economy And Tech Sector Would Suffer
Entrepreneurs and business leaders say either a capital gains tax or a targeted income tax would hurt the business climate in the innovation hot-house of Central Puget Sound. The region is the hub of the state’s $37 billion information and communication technology industry.
Adding either of those taxes would make sense only “if the state wanted to kill entrepreneurship and innovation” said Martin Tobias, a Seattle-based serial entrepreneur and investor. A former Microsoft employee, Tobias has started four companies and invested in 70.
“I really think a lot of small business people would leave” if either of these taxes were implemented, he said.
Even if some small businesses remained, entrepreneurs interested in creating a startup would either move to other states or avoid Washington entirely, he added.
Inrix President Bryan Mistele told Lens he would have started the company somewhere else had a capital gains tax been in place at the time. Co-founded by Mistele and Craig Chapman in 2004, the Kirkland-based tech company provides real-time traffic information through automated data collection.
A capital gains tax would be devastating for the tech sector in particular because states like California already offer other competitive advantages for tech startups, such as more venture capital opportunities, said Mistele.
Indirect And Induced Jobs Would Take A Hit, Too
A loss of tech sector companies would hurt other Washington industries. A 2015 study by the Washington Technology Industry Association found that for every tech job there were at least seven additional jobs created.
The report also found the industry is primarily one of small businesses more than 90 percent of the 8,610 tech companies in the state had 20 or fewer employees.
Washington’s lack of a capital gains tax and income tax also makes it attractive to established companies like Amazon and Microsoft, says Matt McIlwain. McIlwain is the managing director for Madrona Venture Group, a venture capital firm that works with technology entrepreneurs.
“We are becoming recognized as one of the centers for innovation and success because of the choices made legislatively and entrepreneurially,” he said at a Washington Policy Center summit in Bellevue on May 19.
Capital Gains Taxes Aren’t Stable Revenue Source
Aside from its impact on business, a capital gains tax would have a hard time meeting the stipulation of the McCleary ruling that a new funding source for basic education be stable.
A March 2015 report by the Pew Trust Foundation and the Rockerfeller Foundation found that capital gains taxes were the “most volatile” of any income taxes because they are “largely contingent on an unpredictable stock market as well as other factors, such as investor behavior, that are difficult to anticipate.”
In 2007 the state of California collected $11 billion in capital gains tax revenue. After the Great Recession the tax revenue fell to just $2 billion, an 81 percent drop, according to the report.
The problem is one that Ways and Means Committee Chair Andy Hill (R-45) brought up at the April 2015 public hearing after committee staff said capital gains have a 35-40 percent volatility.
“Does that fall under a dependable regular source of income?” he asked.
It doesn’t, according to Jared Walczak, a policy analyst with the Center for State Tax Policy at the Tax Foundation.
“The only thing we can reliably foresee about a capital gains tax is that we cannot foresee what revenue they will generate,” he said at the May 19 WPC summit.
Trouble For Tax Proposals In Recent Years
Proposals for a capital gains tax and progressive income tax in Washington have had trouble gaining traction.
SJR 8214 introduced during the 2016 legislative session by Sen. Maralyn Chase (D-32) would have amended the constitution to allow for a progressive income tax. It failed to get a vote in the Ways and Means Committee.
During the same session, two bills first floated in 2015 were reintroduced but neither of them got out of the Ways and Means Committee. SB 6102 and SB 6104 would have authorized a seven percent capital gains tax.
Sen. Jim Hargrove (D-24) was one of SB 6102’s cosponsors. At a Ways and Means Committee public hearing in April 2015 he said the capital gains tax proposal would “not affect very many people in the state and yet still raise a bunch of money” for basic education spending currently financed through local levies.
In December 2014 Governor Jay Inslee called for a capital gains tax as part of his 2015-17 budget proposal but the legislature rejected it.
In 2010, voters overwhelmingly opposed I-1098 which would have amended the state constitution to allow for a progressive income tax.
I-1098 opponents included Amazon CEO Jeff Bezos and The Washington Roundtable, a nonprofit organization made up of senior executives of major private sector employers in the state.
According to Condotta, businesses provide 51% of tax revenue to the state including both B&O taxes and property taxes. The B&O tax has over 400 credits and rate adjustments attempting to address variations in the marketplace intended to reduce unfairness, maintain revenue and encourage specific industries.
If the State Senate’s current fiscally-conservative majority holds through the November elections, the odds will remain scant for passage of legislation to advance either capital gains or progressive income tax.
It’s also worth remembering that while Washington’s electorate is socially liberal on the whole, it retains a strong fiscally conservative streak. No less than five times since 1993 they’ve approved voter initiatives for a two-thirds supermajority requirement to raise taxes. Each time, lawmakers or the state Supreme Court have invalidated the voters’ decisions.
That hasn’t built a lot of trust.
Reporting and writing by TJ Martinell and Matt Rosenberg. Additional reporting by Sue Lani Madsen.