Capital gains tax is legal in Washington, Supreme Court rules

OLYMPIA – Washington can tax the sale of stocks and other investments, freeing the state to collect more than $500 million a year to pay for child care programs, the state Supreme Court ruled on Friday.

The groundbreaking decision was hailed by Democrats as bringing balance to Washington’s tax system, which they long have argued favors the rich. Many Republicans said they worry the ruling will be used by Democrats to raise taxes further and chip away at Washington’s status as a state free of state income taxes.

The court ruled 7-2 that the new capital gains tax lawmakers approved in 2021 is legal. The decision reverses a Douglas County Superior Court decision last year that struck down the tax because the judge characterized it as an income tax, not an excise tax as argued by the state.

Gov. Jay Inslee has been pushing for a capital gains tax since he first became governor a decade ago. He said Friday was a historic day that will bring more fairness and justice to Washington, which has relied for years on the lowest earners paying “an unfair burden” in taxes.

“And this decision today, now to a significant degree, rights that great unfairness,” Inslee said.

In 2021, the Legislature approved a 7% tax on the sale of stocks, bonds, businesses and other investments, if profits exceed $250,000 annually. Exceptions include the sale of real estate, livestock and family-owned businesses. The new tax, which the state will begin collecting next month, would affect fewer than 1 in every 1,000 residents, but it is estimated to bring in about $500 million to be spent on child care and early learning.

Opponents say the tax applies to income, and because it does not tax everyone equally, would be unconstitutional under state law.

Previous Washington courts have said income is a type of property, which is defined in the state constitution as “everything, tangible or intangible, subject to ownership.” Under the constitution, taxes on property must be “uniform,” which has been understood to mean equal for everyone – or taxed at the same rate on all taxpayers.

It also requires that property taxes be limited to 1% annually.

Supporters, however, say the tax is an excise tax because it taxes the sale of capital gains, rather than the actual assets themselves, and therefore, does not need to follow the constitution’s uniform or levy requirements.

The court agreed with supporters.

In a decision written by Justice Debra Stephens, the court found the tax is consistent with precedent that recognizes excise taxes as those levied on actions associated with property ownership, such as selling or exchanging, rather than taxes levied on the property itself.

“One can own capital assets without ever owing the tax,” Stephens wrote.

And because the tax is considered an excise tax, as opposed to property or income tax, the court did not have to determine whether it followed the state constitution requirement for uniformity, which applies to property taxes.

Some Democrats had hoped this decision would give the court an opportunity to overturn long-held precedent that says graduated, nonuniform income taxes are unconstitutional, but the court did not go that far in their opinion.

The Supreme Court has shot down other attempts from the Legislature and voters to pass an income tax. In 1933, the state Supreme Court struck down a voter-approved graduated income tax because it considered income to be property, which needed to be taxed uniformly.

In the decision, Stephens cites historic cases, like the 1933 case, as leading Washington to become the most regressive tax code in the nation, where low earners pay a higher share of their income as compared to high earners.

“This court’s decisions from that era still shape Washington tax law today,” Stephens wrote in her brief.

The decision will have impacts on state budgets, which lawmakers are currently in the process of writing for the next two years.

The Senate Democrat proposal, released Thursday, assumed the capital gains tax is constitutional. Senate Ways and Means Committee Chair Sen. Christine Rolfes, D-Bainbridge Island, said in a statement Friday that the court’s decision provided certainty to budget writers.

“We are eager to expand support for working families, and today’s ruling locks in dedicated funding to increase access to affordable early learning and childcare,” she said.

Top Republican on the Senate Ways and Means Committee Lynda Wilson, R-Vancouver, said in a statement Friday that the taxpayers should be “on their guard” because Democrats may try to make this tax apply to more people over time.

“That is not what our state needs, especially with an economic downturn on the horizon,” Wilson said. “There’s too much government greed already.”

House Democrats will release their budget proposal on Monday.

Two justices, Sheryl Gordon McCloud and Charles Johnson, dissented. In a dissenting opinion, Gordon McCloud wrote that capital gains are considered income, and in Washington, income is considered property.

“A Washington ‘capital gains tax’ is therefore a property tax,” she wrote.

The tax is measured by the amount of income gained by a transaction, Gordon McCloud wrote, and therefore, it is an income tax.

Further, she said that it is not up to the court to determine how to make Washington’s tax structure less regressive. It is up to the Legislature or the people through a constitutional amendment.

“The duty of the judiciary when faced with a direct conflict between a statute and the constitution is to uphold the constitution,” Gordon McCloud wrote.

Opponents of the tax say the decision could lend itself to other income taxes in Washington.

The Freedom Foundation, one of the groups that sued over the tax, called the decision “stupefying.” The court has always previously ruled that income, even investment income, is property and should be taxed as such, following the uniform and levy requirements in the state constitution, the foundation said in a statement. Lawmakers could pass an income tax if they want through a constitutional amendment, according to the statement.

“The Legislature’s decision to slap a phony excise tax label on their product for no other reason than to circumvent the constitution fooled no one but the justices,” their statement read.

Jason Mercier, of the conservative Washington Policy Center, called the ruling “unreal.” Mercier said Washington’s capital gains tax is the “first standalone excise tax on capital gains income on the planet.”

“With this ruling, the rules surrounding income taxes in Washington are now unclear,” Mercier said. “What will be the next type of income tax to be redefined by lawmakers? It is up to the voters now to respond.”

Democratic lawmakers who pushed for the passage of the tax say they don’t have any plans to pass an income tax or expand the capital gains tax.

Sen. June Robinson, D-Everett, who sponsored the capital gains tax proposal in 2021, said there has not been conversation in the Legislature to expand the capital gains tax or create other similar excise taxes.

She added the court in its decision did not leave room for lawmakers to pass an income tax.

“I just think it’s conjecture, quite frankly, and fear, and I’m not seeing how that would actually come to fruition,” she said.

Supporters of the tax said the court’s decision was a win for children, as most of the revenue from the tax will go toward education, child care and early learning.

“We have a long way to go, but when we insist that everyone – including the wealthiest Washingtonians – pay what they truly owe in taxes, we begin to undo decades of racism and disinvestment that hurts families, communities and small businesses,” said Treasure Mackley, executive director of invest in WA Now, a progressive group that signed on in support of the capital gains tax.