Republicans have staunchly opposed the tax, which applies to profits from the sale of assets, such as stocks and bonds. They say it will make Washington a less attractive place to do business. GOP lawmakers also criticized it as a step towards broader income taxation.
Democrats, meanwhile, called the capital gains tax a necessary step to make the state’s tax system fairer, especially in a state like Washington, which does not tax income.
Now, with the capital gains tax on the verge of becoming a reality, it faces legal challenges that could undermine Democrats’ vision of imposing higher taxes on the wealthy.
Here’s a look at what the tax does, who will pay, and where it is legally.
How the tax works
The 7% capital gains tax applies to profits from the sale of long-term assets, such as stocks and bonds.
For the tax to take effect, an individual’s or a married couple’s profits from these types of sales must exceed $ 250,000 per year.
Even then, the tax only applies to capital gains above the $ 250,000 threshold. This means that if you made $ 260,000 selling stocks in any given year, you would pay tax on $ 10,000 of that amount, making a total capital gains tax payment of $ 700.
The $ 250,000 exemption threshold is expected to increase each year based on the rate of inflation.
Although the tax goes into effect on January 1, the first payments will not be due until early 2023.
Most likely not you.
In addition to the tax that applies only to capital gains greater than $ 250,000 per year, many transactions are fully exempt. These include sales of real estate, retirement accounts, timber and livestock used in agriculture or ranching. Sales of family businesses also benefit from a special deduction.
For these reasons, the state Department of Revenue estimates that only about 0.2% of Washington taxpayers would actually pay tax. That makes 7,000 people.
What he will pay
The tax money is supposed to fund an early education bill, The Fair Start For Kids Act.
This law, which the legislature also approved in 2021, increases the amount the state reimburses to child care providers to better match the actual cost of providing child care services.
The new law also aims to make child care more affordable by reducing co-payments and opening up publicly funded child care spaces to more people.
State Senator June Robinson D-Everett said state lawmakers for years had wanted to make big investments in early learning, but lacked a steady stream of income to do so. to arrive. She called spending tax dollars on preschool and early childhood programs “the best investment a state and a country can make.”
“There is really solid research that shows the link between quality early learning and high school graduation, completion of education beyond high school, less involvement with the criminal justice system – just all of these good things, ”said Robinson, who was the main sponsor of the capital gains tax bill in the legislature.
Initially, the capital gains tax is expected to generate around $ 500 million per year, which can only be used for K-12 education and early learning programs. Tax revenues over $ 500 million must be placed in a school construction account, which pays for school buildings. The amount of money set aside for education programs is expected to increase each year according to the rate of inflation.
Legal argument against the tax
Previous court rulings in Washington state have classified income as a type of property. And the state’s constitution states that property should be taxed evenly – for example, not to charge people different rates based on their income level.
Today, two lawsuits are underway aimed at overturning the capital gains tax, arguing that it is an unconstitutional income tax. These two lawsuits, both filed in Douglas County Superior Court, have been consolidated and are moving forward together.
Former state attorney general Rob McKenna represents a group of plaintiffs challenging the capital gains tax. He said the tax is essentially a progressive income tax, as it targets a group of people with high incomes, but exempts others. This type of tax is unconstitutional, McKenna said, because it does not tax income at a fixed, flat rate.
Additionally, McKenna said, voters in Washington state have repeatedly rejected income taxes, including those that target the wealthy. Several of these measures would have changed the state’s constitution to allow for progressive income taxes.
McKenna and many Republican lawmakers see capital gains tax as a way for Democrats to test whether the court will reverse past opinions, opening the door to broader wealth and income taxes.
“There is nothing new here,” McKenna told Crosscut in an interview last week. “People keep recycling the same ideas to get around the fundamental problem that the voters in this state do not want income tax.”
Legal argument for the tax
Lawyers for the state, on the other hand, argue that the capital gains tax is not an income tax, but an excise tax, which applies to the sale or transfer. of property. These types of taxes are legal in Washington state – and the capital gains tax is no different, according to state legal documents.
The state also argues that the legislature was rightly concerned about the unfairness of Washington state’s tax system when it passed the capital gains tax earlier this year. Because Washington’s tax code relies heavily on sales and property taxes, it is very regressive, meaning low- and middle-income people pay a higher share of their income in taxes than the very rich.
“By imposing capital gains tax on those who have the greatest capacity to pay, [the tax] is a small but important step towards rebalancing the state’s tax code, ”the state wrote in its court record.
A hearing on the consolidated capital gains tax lawsuits is scheduled for early February. After that, a Douglas County judge will make a ruling on tax constitutionality – but that shouldn’t be the end of the case.
The state will almost certainly appeal the lower court’s decision. The case is expected to be decided by the state Supreme Court.
This process will probably take several more months.
If the tax is ultimately canceled, state lawmakers will need to find another source of funding for the newly approved investments in early childhood education.
But it’s something they probably won’t have to deal with until 2023, at the earliest.
While state lawmakers are expected to hold a 60-day session starting Jan. 10, the final capital gains tax decision will not come until long after their 2022 session is adjourned, which is expected. run until March.