House version of cap gains tax blocks a referendum, sets up a faster court fight

New tax could be before the state Supremes soon

Paul Queary

Apr 22, 2021

With one sentence, House Democrats may have set up a long-awaited constitutional confrontation over taxing Washington state’s wealthiest citizens more heavily.

When the house voted 52-46

for Senate Bill 5096 to impose a new tax on capital gains, they restored a form of the “emergency” language that the Senate removed from the bill before passing it last month.

“The tax … is necessary for the support of the state government and its existing public institutions.”

Note that the word “emergency” does not appear, because the notion of an emergency is laughable. The tax wouldn’t even be collected until January 2022. But the effect is the same. It can’t be challenged by a citizens’ referendum, which could help it wind up before the Washington Supreme Court sooner rather than later.

The bill would impose a 7 percent tax on capital gains from the sale of stocks, bonds, and other assets in excess of $250,000. So if a founding Microsoftie unloads $10 million in stock he got for $100,000 back when Bill himself was writing code, he would owe $675,500 in tax on his $9.9 million gain.

Retirement accounts, real estate, farms, and forest land would be exempt. It would bring in roughly $500 million a year from a few thousand of the state’s wealthiest households. The money, at least in theory, is earmarked for big new spending on a tax break for the working poor and a major expansion of state spending on child care and preschool.

Along with the prosaic goal of raising money, it’s designed as a start on revamping a tax system that falls heavily on the poor and lightly on the rich. Progressive groups have been running aggressive campaigns encouraging lawmakers to pass it. If you follow #waleg on Twitter, your feed has been full of this:

This particular piece is apparently designed to embolden lawmakers from the Vancouver area, where folks have traditionally preferred to keep this kind of thing south of the river.

That campaign, which describes itself as “a movement of educators, working families, and everyday Washingtonians advocating for progressive revenue solution,” has so far spent more than $200,000 this year on advertising, polling, and other tactics, according to its filings with the Public Disclosure Commission. It’s one of the larger “grassroots,” campaigns in play this year, on a scale with these oil industry campaigns we wrote about recently.

It’s not clear exactly where the money comes from, but the people involved and the downtown Seattle address listed on the site point to progressive-leaning labor groups.

The most obvious reason for an emergency clause is to protect the bill from a referendum challenge on the November ballot. As we reported after the Senate’s action, that’s not likely to actually keep the bill off the ballot because opponents can, and likely will, run an initiative campaign against it. It would be more expensive and difficult to win than a referendum, but thousands of people have hundreds of millions of reasons to try.

But there’s another angle. Without an emergency clause, a bill subjected to the referendum doesn’t take effect until after the election. That’s important here because a law that hasn’t taken effect usually can’t be challenged in court, and judges are typically loath to wade into anything that the voters are scheduled to decide.

Progressives are transparently hungry for this particular court fight, under the theory that today’s state supreme court justices, all appointed by Democratic governors and/or elected statewide in a heavily Democratic state

, would rule differently than the 1932 court that found income was property, and therefore subject to the state constitutional requirement that property has to be taxed uniformly. That effectively outlawed income taxes in Washington.

Leaving out the emergency language could set up a worst-case scenario for progressive taxation fans: No court decision and a stinging defeat from the voters in November, which would likely kill momentum on any tax overhaul for years to come. Why go to all the trouble for that?

The capital gains tax’s backers are being coy about picking this fight by calling the capital gains tax an excise tax instead of an income tax, but it’s clear that they want both the tax money in the short term and the freedom to further overhaul the tax system. And calling it an excise tax raises some interesting possibilities when and if it gets to court. Bear with us while we once again venture out onto the thin ice of journalists practicing law to look at the options.

A lower court could adopt the excise tax fig leaf and let the tax stand. If the Court of Appeals and the Washington Supreme Court declined to hear the case or affirmed the lower court, then the tax would stand as written. At a minimum, that would leave open the door to an expansion of the capital gains tax to include not just the insanely wealthy, but also the dignified old money, the gaudy nouveau riches — we’re looking at you, Tesla Roadster dude — and the merely affluent.

The lower court could rule it an income tax and throw it out. That’s what happened with the first iteration of Seattle’s high-earners income tax, which a King County Superior Court judge found illegal under a 1984 statute outlawing local income taxes. Then the Court of Appeals overturned the statute using an unusually stringent reading of the single-subject rule

but wasn’t bold enough to overturn the 1932 constitutional precedent. However, they practically begged the Supremes to fire up the Wayback Machine and throw down with their Depression-era counterparts.

But the Supremes weren’t having it, not to indulge the Seattle City Council, and most certainly not in an election year. They took a demure pass.

That decision came down in April 2020, just a few weeks before the filing deadline in an election year when four justices would be on the ballot. Now nobody’s taken anything resembling a serious hack at an incumbent Supreme in decades, but throwing out nearly 90 years of constitutional protection from an income tax might have changed that game a bit. Two of those four justices didn’t draw an opponent at all last year; the other two, both recently appointed by Gov. Jay Inslee, won handily.

But a statewide tax adopted by the Legislature is a different matter, and the fact that the Supremes didn’t take it up in the election year bolsters the idea that they’re inclined to overturn the 1932 ruling, which is why progressive lawmakers are hungry for the fight — it brings a third outcome into play.

The new tax winds up in court AND on the ballot, the Supremes overturn the 1932 version of themselves, and the initiative to repeal it falls short. That’s a nightmare for anti-tax conservatives, but it’s the promised land for would-be progressive reformers — the old precedent is swept away, and the voters issue a mandate to tax the rich.

With just a few days left in the Legislature’s session, it’s not clear the House version gets past the Senate, which has to agree to the change before Sunday’s adjournment. The capital gains tax passed the Senate by the narrowest margin, 25-24, and the Observer is told getting rid of the emergency clause was essential to that vote.

The endgame of a Legislature is a complex and high-stakes game, with lawmakers angling to pass their bills and win big chunks of billions in state spending for favored constituents and causes, so it’s entirely possible that one of those reluctant votes can be bought or bullied into voting for the tax in return for something they care about more.

“People are basically playing chicken,” said a Democratic Senator instrumental in passing the Senate version of the capital gains tax.

We’ll see who blinks.

A reminder from our canine correspondent to enjoy spring

Sometimes a dog just needs to plop down in a shady spot and cool off.

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For those of you keeping score, four Democrats in swing districts voted no on the tax: Dan Bronoske of Lakewood, Mike Chapman of Port Angeles, Dave Paul of Oak Harbor, and Alicia Rule of Blaine.

Justices Charles Johnson, Barbara Madsen, Susan Owens, and Sheryl Gordon McCloud were initially elected statewide. Chief Justice Steven Gonzalez and Justice Debra Stephens were initially appointed by former Gov. Chris Gregoire and later re-elected. Justices Mary Yu, Raquel Montoya-Lewis, and G. Helen Whitener were appointed by Gov Jay Inslee and later re-elected.

The single-subject rule essentially says that bills have to address just one thing, a rule that is, shall we say, loosely applied by the Legislature. Under the standard the Court of Appeals applied a great many things could be invalidated.

There’s also the real possibility that the court rules for the tax and voters reject it, but that’s a muddle for another day.