With WA capital gains case settled, what's next for tax reform?

Democratic lawmakers are celebrating last week's state Supreme Court ruling, but it's unclear where tax reform will go from here.

A picture of the Capitol building in Olympia on a cloudy day.

The Washington State Capitol Legislative Building. (Jovelle Tamayo for Crosscut)

It’s been a slow march for Washington Democrats who want to make the wealthy pay a higher share of state taxes. 

In 2012, state Rep. Laurie Jinkins, D-Tacoma and now House speaker, sponsored a capital gains tax, and Gov. Jay Inslee proposed one in December 2014. A version put forward by Sen. June Robinson, D-Everett, finally passed in 2021 and made it to Inslee’s desk for signature.

The Washington Supreme Court’s decision Friday – more than a decade after that early proposal – upheld the new 7% tax on profits from the sale of bonds and stocks above $250,000 as an excise tax and not a tax on income. 

This decision will reshape the conversation in Olympia about how to fund state government – and who should pay for it. Budget writers in the Democratic-controlled Legislature have already factored in the $500 million expected annually from the capital gains tax into the new state budgets being written this spring. The new tax dollars are intended to go toward child care and early-learning programs. 

But how the ruling in Chris Quinn v. State of Washington plays out in the coming years remains to be seen. In the short term, little is expected to change. Lawmakers in this year’s 105-day session aren’t moving forward with any immediate expansion of the capital gains tax to capture more tax dollars, or with other progressive proposals, such as a bill introduced to tax extraordinary amounts of wealth. 

With the court’s blessing, the new capital gains tax now joins another big, long-sought policy by Democrats – and more recently, Republicans – known as the Working Families Tax Credit. First passed in 2008, that tax credit program for low-income individuals was funded only in 2021. It is just getting up and running.

Invest in WA Now, an advocacy organization funded by educator and health-care unions and others, pushed for the capital gains tax and supported it in the court case. Treasure Mackley, executive director for that organization, called the new court decision “a huge win for Washington citizens and families.”

“That means that more kids in Washington will have access to more quality learning,” said Mackley. “And more parents will have access to child care and be able to get their kids into child care.”

The capital gains tax is considered a move toward a less-regressive tax system, because other state revenue streams, like sales taxes, demand a higher percentage of your income the less you earn. Some – both supporters and opponents – see a capital gains tax as the first step toward an income tax, which could be a bigger step toward making Washington’s tax system less regressive. But no one seems in a hurry to push forward an income tax anytime soon.

Conservatives who have opposed the measure – in part because it has been viewed as a path toward broader income taxes in Washington – have blasted the court’s decision. A leader for an advocacy organization opposing the new tax, the Opportunity for All Coalition, has already suggested a legal challenge may be filed in federal court.

But the 7-2 decision, authored by Justice Debra Stephens, avoided overturning a 90-year-old court decision that has essentially barred a progressive income tax on the basis that income is considered property, and that property, no matter its value, must be taxed at the same rate, according to the Washington Constitution. 

That 1933 ruling, known as the Culliton decision, overturned an income tax after it passed on a statewide ballot, and has since shaped a system that primarily relies upon taxes on sales, real estate and businesses to fund government operations.

In the generations since, Washington residents have rejected 10 other proposed income taxes at the ballot box – most recently in 2010, when 64% of voters said no.

By declining to overturn the 1933 Culliton decision, the court may have kept a progressive income tax beyond reach of Washington Democrats, according to David Frockt, a longtime state senator from Seattle who retired last year.

“I think Justice Stephens signaled that that change is only going to happen through the political process – a constitutional amendment process – and I don't think even with strong D control that is in the cards any time in the near future,” Frockt, who voted for the capital gains tax, wrote in an email. “I also think it may not be very good politics for the party.”

An attorney first elected to the Legislature in 2010, Frockt added that he thought “the court did back flips” not to reverse precedent on the income tax, a very different approach from the conservative-tilting U.S. Supreme Court that recently overturned constitutional protections for abortions.

“That signals to me that even this progressive court is hesitant to overturn the established law and make themselves a direct political actor – a liberal mirror of what the U.S. Supreme Court did in Dobbs,” he wrote.

Jeffrey Gramlich, a professor of accounting at Washington State University, criticized the court decision, saying it puts Washington state at odds with "the rest of the world."

"Everyone in the rest of the world views gains on capital assets as an income," said Gramlich, director of the Hoops Institute for Taxation Research and Policy. He added: "I think when you have a ruling like this ... it makes us kind of weird, in the eyes of the business world."

It will be worth watching whether Washington’s wealthiest business people, like Steve Ballmer and Jeff Bezos, decide to stay in Washington, said Gramlich, who co-authored a paper examining the new capital gains tax.

Gramlich said that the structure of the new tax might hurt state residents in other ways. One example: By not taxing capital gains in real estate, wealthy individuals could choose to invest there, rather than in stocks and bonds.

“As a result, some investors will sell securities and use the proceeds to bid up the price of real estate,” Gramlich and his co-authors wrote in the research paper published in 2021. “The price bid-up is called ‘implicit tax.’ Higher real estate costs would burden potential homeowners by further pricing them out of homeownership and tenants, who will likely see rent increases.”

Legislators and Inslee this year are entering the last stages of approving a new two-year state operating budget. Expected to come in around $70 billion – about $11 billion more than the budget approved two years ago – the operating budget funds everything from K-12 schools and higher education to parks, prisons, mental-health services and economic assistance.

Democrats have stayed away from big tax proposals this year, although one bill to increase the real estate excise tax, known as the home sellers tax, remains on the table to fund affordable housing, according to House Majority Leader Joe Fitzgibbon, D-West Seattle. That is seen as an alternative to Gov. Jay Inslee’s proposed $4 billion housing-construction bond plan, which would need approval by state voters. Although legislators acknowledge a systemic statewide shortage in housing that grows worse by the year, it remains to be seen whether they have the appetite to approve either proposal.

Meanwhile, with the capital gains tax sanctified by the court, progressives are beginning to eye other tax proposals.

One idea is what’s known as an extraordinary wealth tax. Championed by Sen. Noel Frame, D-Seattle, a version proposed this year would create a 1% tax on financial intangible assets – such as cash, stocks and bonds – over $250 million.

Neither Frame’s Senate Bill 5486 nor its companion bill by House Democrats – sponsored by Rep. My-Linh Thai, D-Bellevue – have advanced this year.

But in a statement reacting to the Supreme Court decision, Frame said, “Our next step is to ensure parity in taxation on wealth.”

“The proposed Washington State Wealth Tax would ensure parity in property taxation between the working families who already have to pay property tax on their wealth — their homes — and the richest people in the world, who don’t pay a dime in property tax on the financial assets that make up their wealth,” she added.

Please support independent local news for all.

We rely on donations from readers like you to sustain Crosscut's in-depth reporting on issues critical to the PNW.


About the Authors & Contributors