Taxpayers are challenging the constitutionality of Washington state’s capital gains tax in the U.S. Supreme Court after it was upheld by the state’s supreme court.
Unlike most states, Washington state has no income tax on individuals or corporations.
Limited-government advocates fear that the capital gains tax, which has an extraterritorial effect, could open the door to a graduated income tax in the state.
The Olympia-based Freedom Foundation, a good-government group and think tank, filed with the nation’s highest court after the Washington Supreme Court reversed a lower court ruling that agreed with the foundation’s argument that the two-year-old tax violated requirements in the state constitution that property and income taxes be assessed uniformly.
The capital gains tax, which is backed by Washington Gov. Jay Inslee, a Democrat, reflects the mindset of liberal state lawmakers who “have long lamented the absence of an income tax in the state and sought ways to generate additional revenue by taxing high earners at a higher rate than those earning less,” the group says.
The state “instead has traditionally raised revenue through taxes on various in-state activities, such as sales taxes, excise taxes, and its unique ‘business and occupation ... tax,’ a gross-receipts tax on businesses operating in the state,” the taxpayers stated in court documents.
Democratic state lawmakers, on the other hand, say the state’s tax system is economically regressive, by which they mean the burden of paying for roads, schools, and other public programs falls disproportionately on low-income residents.
Democrat state Sen. Joe Nguyen has written that Washington “has the most regressive tax structure in the nation.”
“Households who earn less than $25k a year pay 17% of their income in taxes while those over $500k pay less than 2%,” he wrote.
Democrats justified the capital gains tax as a means of making the state tax system fairer.
The Washington Supreme Court found that the tax, which levies a 7 percent assessment on capital gains above $250,000, is exempt from state constitutional restrictions because it’s an excise tax on the sale of assets rather than a tax on the income resulting from the transaction.
But the Freedom Foundation is arguing that the capital gains tax violates the Commerce Clause of the U.S. Constitution, which reserves to Congress—not states—the power to regulate interstate commerce.
As currently constituted, the tax applies not to the sale of capital assets in Washington state, but to the sale of capital assets by Washington residents. This means that Washington’s tax could apply to the sale of capital assets held in other states by Washington residents, and the sale could also be taxed by the state in which the sale takes place, the group says.
If the U.S. Supreme Court decides to hear the case and concludes that the tax violates the Commerce Clause, it could do away with the entirety of the tax and even open the door for the refunding of taxes already paid.
Eric Stahlfeld, the Freedom Foundation’s chief litigation counsel, said he was optimistic about the case.
“The framers of the Washington state Constitution recognized that earning should be encouraged, not punished, because economic success benefits everyone,” he said, adding that “more than 100 years of court precedent have supported that view. “
In carving out a justification to avoid the limits of state law, the lower court may have resolved a state law problem but in the process created a federal law problem.
“Had this case been heard by a federal court instead of state court, it would already have been thrown out,” Mr. Stahlfeld said.
“It violates the ‘dormant’ Commerce Clause. States simply have no power to interfere with another state’s power over activities within that sovereign state.”
This tax applies to all Washington residents or people who live in the state for more than 183 days a year, and “it taxes all of their long-term gains even if those gains came from a transaction which had no ties whatsoever to Washington state,” he told The Epoch Times.
“That’s what we argue is unconstitutional because Washington is extending its tax and regulation authority into the jurisdictions of the other 49 states.”
“This would be potentially the first time any state has squarely tried to do this,” he said.
“Rather than getting involved in a taxing war, where other states try to do the same thing back to Washington state, the courts should recognize that this is fundamental to all 50 states, to their sovereign powers, and take this opportunity initially to say you just simply cannot do this. You can’t tax transactions that have no connection to Washington state.”
The Building Industry Association of Washington and the Washington Retail Association have criticized the tax.
“Washington’s unique, unprecedented and unconstitutional tax on capital gains will discourage our state’s resident entrepreneurs and investors from investing in new and expanded businesses in our state,” the two groups reportedly said in a friend-of-the-court brief filed when the case was before the Washington Supreme Court.
“It will also cause significant numbers of individual business owners to leave Washington to avoid the new tax.”
Washington’s Department of Revenue refused to comment on the new petition.
“Given the taxpayers’ pending Petition for Certiorari with the United States Supreme Court, the Department of Revenue will have no comment on this case,” Mikhail Carpenter, communications manager at the agency, told The Epoch Times by email.
