In Olympia: Awaiting a Momentous Ruling on Taxes

One school of thought argues that the entire point of passing the capital-gains tax two years ago was to set up this week’s oral arguments in front of nine folks in black robes. 

The idea — deeply held for years on the left — is that a contemporary Washington Supreme Court largely appointed by Democratic governors and elected by increasingly D-leaning voters would seize the opportunity to toss out nearly a century of precedent that bars the kind of state income taxes that apply at the federal level and in most other states. 

Both sides of that argument may come away disappointed when the court rules, likely this spring.

The capital-gains tax was the most consequential piece of tax policy passed in Washington in decades, and the Supremes’ ruling could drastically reshape politics by putting other progressive taxes that have long been illegal here back on the table. Or not.

Start with some history. Way back in the Depression-era 1930s, voters in Washington both limited property taxes and instituted a graduated income tax. The double-barreled reform was driven by farmers alarmed at escalating property taxes and the growing political power of cities. Measure 69 — the income tax — got 70 percent of the vote in 1932.¹  

Soon opponents of the income tax sued, arguing that income is “property,” and therefore subject to the constitution’s limits on property taxes, which restrict such levies to 1 percent, and require that all property be taxed equally (as opposed to gradual taxes). In 1933, the way-back Supremes agreed, and thus Washington’s constitutional ban on progressive income taxes — “progressive” in this context means the graduated rate gets higher as you make more money — was born. Later iterations of the Supremes have upheld it in various ways several times since then. That ban is also a popular idea with voters, who have repeatedly spurned by wide margins ballot measures to change it. After all, those are your crisp $20 bills. Why should they not be considered your property?

In the recent past, an increasingly vocal and restive faction of the Democratic majorities in the Legislature has grown really, really tired of the Catch-22 of Washington’s semi-accidental regressive tax system. Raising taxes to provide more services to the needy citizens of the state involved raising existing taxes that hit those needy folks the hardest — the sales tax, the property tax, and steep excise taxes on weed, booze, and tobacco. 

Various attempts to address this by taxing the rich failed. In 2010, voters rejected a ballot initiative to impose an income tax on only the richest among us. In 2020, after the Seattle City Council imposed such a tax on its most well-heeled citizens, a lower court tossed it out and the Supremes declined to consider the appeal.² 

Finally, in 2021, after a subtle shift in the 2020 elections moved the Democratic majorities in the House and Senate just enough to the left, lawmakers finally found the votes to pass the capital-gains tax. They had, broadly speaking, two purposes. They wanted the money — some $500 million per year — to help pay for, among other things, a massive expansion of child care and other early learning programs. Secondly, some of them wanted to provoke a fight in front of the court. 

Now we get to a degree of subtlety. A frontal assault on the ban on progressive taxes might backfire by prompting the court to cleave to the 1930s precedents.³ That would not only slam the door on progressive taxation, but it would cost lawmakers all that sweet, sweet tax revenue from the capital gains tax. 

So advocates styled the capital gains tax not as an income tax, but as an excise tax on the transaction of most sales of stocks, bonds, and other securities. The 7 percent tax kicks in after the first $250,000 in gains, so it’s very much a tax on rich people. Opponents cried foul, noting that the tax is pegged to the federal capital gains tax, which appears on Form 1040, the federal income tax return. 

A lower court sided with opponents and tossed the tax as unconstitutional, but Gov. Jay Inslee, Attorney General Bob Ferguson, and other leading Democrats forged ahead, essentially arguing that it wasn’t over until the Supremes ruled. In the fall, the Supremes agreed, staying the lower court to allow the Department of Revenue to prepare to collect the tax this year.

We’ll leave the lawyering to the lawyers, but as realpolitik, the excise-tax dodge is an elegant argument that clearly gives the court a middle road: They can uphold the capital gains without dumping that century-plus of precedent. There are, as the state argues, examples elsewhere in the tax code. Most notably, when you buy a house, there’s an excise tax on the purchase. Many experts and court watchers⁴ expect this narrow outcome. In general, courts give the Legislature a fair amount of latitude, and the narrow path is politically safer for a justice inclined to cast a wary eye at the electorate.⁵  

That subtlety also sets up a weird dynamic. On one side are anti-income tax opponents — backed by prominent business groups — who argue the excise-tax language is an insufficiently large fig leaf that doesn’t cover up the obvious income-taxness of it all. They want the court to slam the door on the whole idea.

Then there are two sorta-competing camps of supporters of the tax. One, led by Attorney General Bob Ferguson’s crew, is making the it’s-an-exise-tax argument to protect the capital-gains tax itself. The other, representing a variety of interests — teachers, school districts, etc., who have ideas for how to spend a whole lot more rich folks’ money — is urging the court to sweep away the money-as-property thing entirely to clear the way for a more progressive system.

Proponents of the proposed capital-gains tax are optimistic it will survive, noting Chief Justice Steven González’s recent focus on racial and economic equity. Their written arguments have hit those chords repeatedly, noting that the money will go for things such as the Working Families Tax Credit and child-care subsidies.

But it’s entirely possible that most of the activists at either end of the spectrum will come away unhappy.

The Supremes tend to rule in their own sweet time, but there’s real urgency surrounding this ruling. Not only are thousands of wealthy maybe-taxpayers and their accountants⁶ uncertain about whether they’ll have to write a check, but the decision has significant implications for the budget the Legislature must crank out later this year.

As we noted last year in our Schrödinger’s Cat/Exploding Kittens piece last year, the Revenue Forecast Council currently bakes the money from the tax into the budget outlook for the next few years. The council is due to issue its next forecast on March 20. That’s the number budget writers typically use for the final version of the budget, which would typically come up for a vote in April as lawmakers are fixing to leave town.

Footnotes:

1. That vote happened in the Great Depression when the working poor faced double-digit unemployment and lives of grinding poverty unmitigated by the social safety net. Soaking the rich was an easier sell.

2. Several members of the court were staring the 2020 election in the face and apparently weren’t keen to carry Seattle’s water.

3. In an even wonkier wrinkle, it might have died a procedural death in the Senate. Lt. Gov. Denny Heck had to rule that the tax was constitutional before it could come up for a vote.

4. Most notable among these is University of Washington law professor Hugh Spitzer, author of the definitive paper on why the court should abandon the 1930s precedents.

5. No challenger has taken a legitimate hack at a sitting Supreme in decades, but no Supreme has ruled in favor of an income tax for a very long while.

6. The Woman Who Lets Me Live With Her is among said accountants; she’s cranky about all this uncertainty.

This article first appeared as part of a legislative summary in the author’s political website, The Washington Observer.