As we wait for the Governor’s 2021-23 budget proposal due in December and the 2021 Legislative Session, discussions of imposing a capital gains income tax continue to intensify. Since there appears to be some confusion about what type of tax this is and the motivations for it, here is important background information to consider.

The federal Internal Revenue Service (IRS) say this about capital gains income taxes:

“This is in response to your inquiry regarding the tax treatment of capital gains. You ask whether tax on capital gains is considered an excise tax or an income tax? It is an income tax. More specifically, capital gains are treated as income under the tax code and taxed as such."

Washington’s Department of Revenue previously acknowledged this fact. Per public records from DOR: 

• “The federal capital gains tax is characterized as an income tax. One potential challenge to a capital gains tax proposal is that opponents may characterize the Washington capital gains tax as an income tax and argue that it is not allowed under the Washington constitution”;
   
• "The IRS considers taxes on investment income (dividends, a tax on net gains from the sale or exchange of a capital asset, or tax on the net taxable income of an unincorporated business) an income tax";
   
• “susceptible to constitutional challenge as an income tax prohibited by the Washington state constitution”;

What are the motivations behind the capital gains income tax proposals? Thanks to public records we know the goal is to set up a lawsuit in hopes of imposing a graduated income tax without a constitutional amendment. For example, here are emails that Sen. Pedersen sent discussing his support for a capital gains income tax:

• April 30, 2018: “But the more important benefit of passing a capital gains tax is on the legal side, from my perspective. The other side will challenge it as an unconstitutional property tax. This will give the Supreme Court the opportunity to revisit its bad decisions from 1934 and 1951 that income is property and will make it possible, if we succeed, to enact a progressive income tax with a simple majority vote.” (emphasis added)
   
• December 15, 2018: “I personally believe that adopting a capital gains tax is one of the best things we could do to help advance the possibility of an income tax in our state, because it could help resolve the legal uncertainty about whether an income tax is a ‘property tax’ subject to constitutional limitations. Until that happens, it would take 2/3 majorities in the legislature (and a vote of the people) to adopt an income tax, which makes it very unlikely to happen." (emphasis added)

About that supposed legal “uncertainty,” here is what the state Supreme Court said about income taxes in 1960:

"The argument is again pressed upon us that these cases were wrongly decided. The court is unwilling, however, to recede from the position announced in its repeated decisions. Among other things, the attorney general urges that the result should now be different because the state is confronted with a financial crisis. If so, the constitution may be amended by vote of the people. Such a constitutional amendment was rejected by popular vote in 1934."

The voters have already rejected 6 constitutional amendments to allow a graduated income tax. The state Supreme Court this year also refused to hear the Seattle income tax case that was trying to challenge these prior court rulings.

Legality aside, are capital gains income taxes stable funding sources?

After contacting every state Revenue Department in the country, not a single state with a capital gains income taxes describes this type of tax as dependable or stable. Instead, here are a few examples discussing the extreme volatility problems inherent with taxing this type of income:

• Delaware: “In Delaware, capital gains are taxed under the personal income tax as all other income. As in every other state, capital gains are extremely volatile and unpredictable. This is particularly problematic toward the end of market cycles, when they represent a greater share of personal income tax revenues.”
   
• Massachusetts: “For the Commonwealth of Massachusetts, taxes on capital gains are among the most volatile and unpredictable major sources of revenue. Obviously, that is very much in line with the experience of other states."
   
• California: "California's tax revenues have numerous volatile elements, but among the more significant sources of revenue volatility are the state's tax levies on net capital gains through the personal income tax."
   
• Virginia: “Capital gains is the most volatile tax source that any state has to forecast. It is not dependable or stable.”

During a tax panel at the Association of Washington Business 2018 Policy Summit, the state Department of Commerce said the lack of a state income tax, including no capital gains income tax, "is great marketing" for Washington. If an income tax is imposed, Commerce said that would mean "one less tool that we have in our economic development tool box."

This statement should come as no surprise. For years the Washington Department of Commerce has made the state's lack of an income tax a major selling point for its "Choose Washington" campaign: 

"We offer businesses some competitive advantages found in few other states. This includes no personal or corporate income tax."

Let’s hope state officials keep these facts in mind the next time someone asks them to throw away our "competitive advantage" with talks of a highly volatile capital gains income tax.

UPDATED 10/23

Here are a couple of clips from my KOMO radio interview on the proposals for a capital gains income tax: https://www.washingtonpolicy.org/…/audio…/Cap-Gains-CJW1.mp3 and https://www.washingtonpolicy.org/…/audioL…/Cap-Gain-CJW2.mp3.

Additional Information
A Capital Gains Tax IS an Income Tax: Irrefutable Proof in About Two Minutes (short video)
BAD POLICY: An Income Tax on Capital Gains for Washington (short video)