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Tax law

Last year, Demo­c­ra­t­ic law­mak­ers took a sig­nif­i­cant step towards bal­ancing Wash­ing­ton’s upside-down tax code by tax­ing the sale and exchange of cap­i­tal assets. 

In pass­ing ESSB 5096, the Wash­ing­ton State Leg­is­la­ture artic­u­lat­ed the bill’s dual pur­pos­es: First, it stat­ed that the cap­i­tal gains tax is intend­ed to “fund K‑12 edu­ca­tion, ear­ly learn­ing, and child care, and advanc[ing] our para­mount duty to amply pro­vide an edu­ca­tion to every child in the state” and sec­ond, to make “mate­r­i­al progress toward rebal­anc­ing the state’s tax code.” 

Freeing our future: Artwork supporting a capital gains tax
Free­ing our future: Art­work sup­port­ing a cap­i­tal gains tax (Art­work on the grounds of the Wash­ing­ton State Capi­tol Cam­pus, pho­tographed by Bal­ance Our Tax Code)

These ambi­tions will come to naught if the pend­ing right wing chal­lenges to the law in Dou­glas Coun­ty Supe­ri­or Court are suc­cess­ful. 

Addi­tion­al­ly, the plain­tiffs’ view of the law, if accept­ed, would have sub­stan­tial impact on Wash­ing­ton beyond the case itself, dam­ag­ing the state’s abil­i­ty to effec­tive­ly respond to future pub­lic needs. 

This is because, if the plain­tiffs are to be believed, the state must yield to how oth­er gov­ern­ments think about their policies.

The plain­tiffs do not con­test the new cap­i­tal gains tax on only these grounds. 

The plain­tiffs have also alleged that the tax vio­lates the U.S. Con­sti­tu­tion, which is like­ly an attempt, if they fail in state courts, to exploit the will­ing­ness of the cur­rent con­ser­v­a­tive major­i­ty on the U.S Supreme Court to com­fort the com­fort­able. Per­haps doing dou­ble duty, these argu­ments fur­ther seem to col­lat­er­al­ly attack aspects of the state’s long-set­tled estate tax. 

At the cen­ter of the plain­tiffs’ claims is the asser­tion that, because states that tax income count cap­i­tal gains as income, and so does the fed­er­al gov­ern­ment, Wash­ing­ton must con­sid­er the cap­i­tal gains tax to be an income tax, too.

Because, under cur­rent Wash­ing­ton law, income is prop­er­ty, the plain­tiffs then posit that a cap­i­tal gains tax is a prop­er­ty tax that vio­lates the state Con­sti­tu­tion. To bol­ster this claim, the plain­tiffs go so far as to object to the state’s reliance on tax­pay­ers’ fed­er­al tax fil­ings and sup­port­ing doc­u­men­ta­tion to assess the tax, and its allowance for some, but not all, of the cap­i­tal loss­es for which the fed­er­al gov­ern­ment per­mits deductions.

Attorney General Bob Ferguson
Attor­ney Gen­er­al Bob Fer­gu­son’s office is respon­si­ble for the defense of ESSB 5096 (Pho­to: Andrew Villeneuve/NPI)

As a gen­er­al mat­ter, the state would be in trou­ble if it was required to accept the premis­es asso­ci­at­ed with all of the sources it relies on for infor­ma­tion. Addi­tion­al­ly, if the state required a redun­dant form, oppo­nents of the tax would sure­ly denounce the extra expens­es they would incur with com­pil­ing the infor­ma­tion for which it called. 

Fur­ther, the plain­tiffs are unable to explain why a cap­i­tal loss deduc­tion (which only lessens their tax bill) can­not in any instance be con­sis­tent with an excise tax. But, it appears one state’s admin­is­tra­tive effi­cien­cy is anoth­er person’s uncon­sti­tu­tion­al assessment.

While state courts can take ideas from oth­er states, accept­ing the plain­tiffs’ propo­si­tion would imper­mis­si­bly bind Wash­ing­ton to acqui­esce to the laws of leg­is­la­tures that are not our own, thus pre­vent­ing the state from gov­ern­ing itself in light of its unique chal­lenges, and — to para­phrase a for­mer Supreme Court jus­tice — from serv­ing as a lab­o­ra­to­ry of democ­ra­cy. 

Even if we were to accept the plain­tiffs’ argu­ment, the Attor­ney General’s Office has a salient rejoin­der: unlike Wash­ing­ton, the fed­er­al gov­ern­ment and most states con­sid­er an income tax to be an excise tax, not a prop­er­ty tax. Thus, tak­en to its ulti­mate con­clu­sion, the prin­ci­ple advanced by the plain­tiffs means a cap­i­tal gains tax still isn’t a prop­er­ty tax. 

And an income tax, if we had one, would­n’t be either. 

This com­pli­ca­tion aside, how­ev­er, the sole issue should be if the tax is an excise tax under Wash­ing­ton law. On this point, the plain­tiffs are wrong.

In con­flat­ing the cap­i­tal gains tax with an income tax, the plain­tiffs rely in places on mis­in­ter­pre­ta­tion, and in oth­ers on conjecture.

The plain­tiffs cite prece­dent, for exam­ple, that “the mere right to own and hold prop­er­ty can­not be made the sub­ject of an excise tax, because to tax by rea­son of own­er­ship of prop­er­ty is to tax the prop­er­ty itself.” How­ev­er, the cap­i­tal gains tax, in a prin­ci­ple the state grounds in an abun­dance of cas­es, does not tax the own­er­ship of prop­er­ty, but rather its disposition.

The few peo­ple poten­tial­ly liable for pay­ing the tax can keep their hold­ings free of it, and all they or their asset man­agers need to do is noth­ing (or, more specif­i­cal­ly, less than $250,000 a year of some­thing). How­ev­er, once they decide to sell or exchange assets which togeth­er equate to $250,000 or more in prof­it — the val­ue of the asset, and the mar­ket in which it trans­act­ed both fos­tered by the pro­tec­tions of the state — it is this trans­ac­tion from which the state col­lects a share to be able to con­tin­ue pro­vid­ing for the com­mon good.

To see this log­ic in action, con­sid­er Washington’s exist­ing estate tax, which is “a tax on the right to trans­fer prop­er­ty at the time of death.”

The line of prece­dent cit­ed by the plain­tiffs includes a num­ber of cas­es reaf­firm­ing the estate tax (or its rel­a­tive, the inher­i­tance tax) for the rea­son that it is an “impost or excise on the right to pass the estate and the priv­i­lege of the devisee to take.” And, as the Attor­ney Gen­er­al point­ed out, the Wash­ing­ton Supreme Court reaf­firmed in the last decade that the estate tax, as an excise tax, is a tax on “the hap­pen­ing of an event, name­ly, death, where the death brings about cer­tain described changes in legal rela­tion­ships affect­ing property.”

An author­i­ty that can under­stand a tax on some­thing so pro­found to be a tax on the trans­fer of prop­er­ty, but not the prop­er­ty itself, can under­stand this new state cap­i­tal gains tax on the wealthy, which tax­es the right to dis­pose of assets that have ben­e­fit­ed from an increase in val­ue, to be of a sim­i­lar nature.

(As an aside, the plain­tiffs also claim that, because indi­vid­u­als can­not always con­trol when an asset is sold, the cap­i­tal gains tax can­not be an excise tax. But, some­one, some­where, is mak­ing the choice to sell or exchange the asset, and, as the estate tax shows, a vol­un­tary choice isn’t strict­ly necessary.)

Nowa­days, inno­va­tion is often just anoth­er word for dereg­u­la­tion. But, in rec­og­niz­ing the legislature’s pol­i­cy­mak­ing pre­rog­a­tive, the courts should allow the peo­ple’s elect­ed rep­re­sen­ta­tives to exper­i­ment with improve­ments to the tax code. 

As with any tax, there may be instances in the future where this one is invalid­ly or improp­er­ly assessed, but that does not spell doom for the tax as a whole; in those instances, the valid­i­ty of the spe­cif­ic assess­ment will be deter­mined by estab­lished admin­is­tra­tive and judi­cial processes.

The Wash­ing­ton Supreme Court once wrote, when uphold­ing the state’s long­stand­ing busi­ness and occu­pa­tion tax:

Man in a state of nature gained his sus­te­nance by his strength or cun­ning, or both, and that which he so gained might, and no doubt often was, tak­en from him before he could use and enjoy it by some­one stronger and more cun­ning. Hence, the estab­lished state enact­ed laws for the pro­tec­tion of human rights, the rights of prop­er­ty, and to pre­vent the weak or the cred­u­lous from becom­ing the help­less vic­tims of the force or fraud of the strong and the cunning.

In a his­to­ry lit­tered with chal­lenges to what is prop­er­ly con­sid­ered an excise tax, the cur­rent law­suits are only the lat­est attempt to deny this rela­tion­ship, and to pre­vent the state from adopt­ing a more equi­table tax code. The courts should decline to let them.

Edi­tor’s Note: NPI alum Patrick Stick­ney is an attor­ney and the author of Mis­sives, a newslet­ter focused on Wash­ing­ton out­side of the Seat­tle area. All views are his own, and do not nec­es­sar­i­ly reflect the views of any­one else.

Sched­ul­ing note: Oral argu­ment in the legal chal­lenge to Wash­ing­ton’s new state cap­i­tal gains tax on the wealthy has been sched­uled for Feb­ru­ary 4th, 2022, in Dou­glas Coun­ty Supe­ri­or Court. If you’d like to read the briefs that have been filed in the case, NPI has begun post­ing them on this microsite.

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