The fight over a capital gains income tax

    The fight over a capital gains income tax
    The Jan. 16 public hearing for Governor Jay Inslee’s capital gains income tax proposal may be the start of a long fight over whether the proposal clears the legislature. Created by Dooder - Freepik.com

    The Jan. 16 public hearing regarding Governor Inslee’s capital gains income tax proposal rehashed many ongoing arguments for and against the idea. Remarks by key Democratic leaders and testimony warning of its impact on the state’s business climate indicate that SB 5129 still has a long road ahead.

    “There’s going to be all sorts of actions in this committee,” Chair Christine Rolfes (D-23) told colleagues. “This is just the start.”

    One of the major hurdles for supporters will be justifying a new tax at a time when the state is taking in record surplus revenue. In the 2018 fiscal year, the state brought in $23.9 billion, according to the state Department of Revenue. That’s an 8.4 percent increase from the previous year, and $8.8 billion more than what the state collected in 2010.

    However, Inslee’s Office of Financial Management (OFM) argued during a Jan. 14 public hearing in House Appropriations that the $3.2 billion in revenue the capital gains income tax would collect is needed to meet new state obligations in part due to the McCleary compromise made by lawmakers in 2017 to fully fund basic education.

    If passed, the bill would implement a nine percent tax on capital gains, starting next year. The first tax returns would be due in 2021. The bill provides certain exemptions, such as certain residences, retirement savings, livestock or agricultural land. The bill would also increase the business and occupation tax (B&O) on service-related activities from 1.5 to 2.5 percent.

    When asked about a capital gains income tax during an interview with TVW, House Appropriations Chair Timm Ormsby (D-3) said that “the House Democratic Caucus is very interested in pursuing a more equitable tax structure,” but “it’s a challenge to do structural tax reform.”

    Although Inslee and others are calling the capital gains tax an “excise” tax, critics say it’s hard to see it as anything other than an income tax and thus subject to the state constitution’s one-percent cap on property – evidence that is challenging to dismiss. All states with capital gains taxes classify them as part of their income tax. The Internal Revenue Service (IRS) has publicly stated that a capital gains tax is an income tax.

    While the bill digest says the tax is imposed “for the privilege of selling or exchanging long-term capital assets,” the bill’s definition of capital gain reads: “’Federal net long-term capital gain’ means the net long-term capital gain reportable for federal income tax purposes.”

    Also, an excise tax is imposed on a transaction, while SB 5129 says that “if an individual’s Washington capital gains are less than zero for a taxable year, no tax is due under this section.”

    Some view the proposal as a way to challenge the long-standing state prohibition on a progressive income tax. It was partly with that intent that the city of Seattle passed its income tax ordinance in 2017, but statutory prohibitions make it unlikely the high court would take up the constitutional question if they ever review the ongoing lawsuit.

    However, if a state capital gains income tax bill was passed and challenged, the argument would go directly to the debate over whether income is property.

    Aside from the constitutional debate, there’s the impact to the state’s business climate. In a Jan. 14 interview with TVW, Republican State Treasurer Duane Davidson said “one of the reasons Washington state is doing so well, is the fact that we do not have a state income tax.” That view is reflected on the state Department of Commerce’s Choose Washington website, and Commerce officials have said that the lack of a capital gains tax has been a “selling point” when trying to entice businesses to locate or open in Washington.

    Opponents testifying at the Jan. 16 public hearing said the proposed tax would hit small business owners who rely on the sale of their businesses for retirement. High Cascades Insurance owner Wayne Lunday told panel members that he plans to sell to his son the business that he started 40 years ago and, if the bill is passed, will lose out on much of the money he had hoped to collect.

    “It’s the retirement of all the NAIFA (National Association of Insurance and Financial Advisors) members that are out there building those small agencies and small business,” he said. “It’s going to devastate them if they’re going to write a check for nine percent of what their business is worth to the governor.”

    He added that the proposal “is starting down a very slippery slope trying to impose an income tax in this state, because we the people have told them time and time again to stay away from it.”

    Mark Johnson, head of the Washington Retail Association, agreed with that. “We feel this is taking this state in the wrong direction. Often times a small retailer will put in their blood, sweat and tears building up their business as their retirement. When it comes time to retire and live the golden years, they sell their business, and now you’re telling them they have to pay an extra nine percent on top of that when they retire.”

    Bellevue-based business broker Gary Franke told panel members that the tax would “reduce structurally the value of a business. Business owners work extremely hard for what they do. For what we work on, this is what we retire with.”

    No further action is scheduled for SB 5129 at this time.

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