December 13, 2018

Capital gains tax rate creep is alarming

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Today’s proposal from the governor to enact a 9 percent capital gains tax continues the trend of ever-larger capital gains tax proposals, justifying the concerns of skeptics who fear that whatever the rate starts at, it will soon escalate rapidly.

Take a look at the history.

· In 2015, the House Democrat Finance Chair proposed legislation with a 5 percent tax on capital gains income.

· In 2017, the House Democrat Finance Chair proposed legislation with a 7 percent tax on capital gains income.

· In 2018, the Superintendent of Public Instruction proposed an 8 percent rate.

· Today, the Governor proposes a 9% rate.


Opponents of the income tax have frequently criticized the capital gains tax proposal for its lack of safeguards. They worry that nothing prevents increases in the rate, expansion of the tax base—including to income that is not from capital gains—elimination of the exemptions, or lowering of the deductions.

Afterall, those who have capital gains are a convenient political target. Once this tax is established, this will be the go-to revenue source when new funds are needed—and it seems like they are needed every biennium. The majority party in Olympia is clearly very seriously considering massive new taxes in a time of nation-leading economic growth, and above average revenue growth in this State. Per the Washington Research Council, “Washington’s recent revenue growth has bene strong by national standards. Indeed, Washington’s state and local tax growth from 2015 to 2016 was the nation’s highest.”

Beyond the alarming rate creep in the capital gains tax proposal, it has always been concerning to hear lawmakers propose an unconstitutional and highly volatile new tax source to supply the revenue they want for their spending programs and state employee salary increases.


Capital gains income taxes are unconstitutional in Washington because our state constitution defines “property” to include “everything, whether tangible or intangible, subject to ownership.” This would certainly include stocks and bonds, and the net gain on sales of those stocks and bonds. Our constitution requires taxes on property to be uniform and levied at a rate no greater than one percent. (Wash. Const. Art. VII, Sec. 1). To get around this, we see lots of verbal gymnastics used to describe this income tax as an “excise tax” on the privilege of selling long-term capital assets. No other state describes their capital gains tax as an excise tax—these are taxed within the income tax code as a part of an income tax return. No other state taxes capital gains separately from individual income. The IRS describes the tax treatment of capital gains as an income tax. Even though the proposals have come every biennium now for a capital gains income tax, we must guard against becoming desensitized to just how extraordinary it is to engage in the rhetoric of capital gains taxation as an “excise tax”.


As noted by the nonpartisan Tax Foundation in testimony at the Washington state legislature last year,  "During the Great Recession, the realization of capital gains slid 71 percent. They slipped 55 percent in 1987 and 46 percent in 2001. Now, very few revenue sources do well during a recession—but traditional tax bases don’t have three-quarters of their value evaporate in a single year. Even in more typical years, outside of recessions, capital gains realizations are highly volatile.” In characterizing the volatility of this tax as “extreme”, he called on lawmakers to remember, “In every other state where capital gains are taxed, they are but one part of a broader income tax, so the radical swings are absorbed, somewhat, into the broader revenue trends. Here, the intention is to create a stand-alone capital gains tax to generate recurring revenue for key state priorities.”

A certain amount of tolerance for rhetorical flourish and posturing could be understood when it was clear that Democrats did not have the votes to pass a capital gains tax. Today they have the votes. Serious proposals for a capital gains income tax should really incorporate calls for a constitutional amendment to authorize the tax, and have a cap on the rate and limits on what can be included in the tax base. But, one would hope we would have an even more serious debate first about why the costs of government are outpacing our impressive economic growth, and what the risks are to our competitiveness and business climate from new taxes at this time.