WA Supreme Court rules capital gains tax is constitutional

In their 7-2 ruling on Chris Quinn v. State of Washington, the high justices held that the 7% tax, which applies to profits from the sale of stocks and some other capital assets that exceed $250,000, is not a tax on income. That is a key distinction, since the court has previously ruled that income can be considered property, and that by state law property must be taxed at the same rate, no matter its value.

“The capital gains tax is appropriately characterized as an excise [tax] because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves,” wrote Justice Debra Stephens in the majority opinion. “This understanding of the tax is consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself.”

Friday’s decision reversed a lower court ruling, made last year, that deemed the capital gains tax unconstitutional. At the same time, the Supreme Court decision avoided reconsidering a 90-year-old court order that struck down a tax on personal income. That 1933 court order sparked a continuing fight over how state residents should be taxed and what government services could be funded with their tax dollars.

The ruling also relieves state lawmakers from having to scramble to shore up the state budgets that they are currently drafting in the 105-day regularly scheduled legislative session. The capital gains tax, passed in 2021, has been expected to bring in roughly $500 million per year to fund early learning and child care programs.

In a news conference Friday morning shortly after the decision’s release, Gov. Jay Inslee called it “truly a historic day.”

“There has been an invisible injustice for over a century now in the state of Washington, where most of the people who are bearing an unfair burden for paying for our schools and everything that they hold dear," said Inslee, who first proposed a capital gains tax in December 2014, one of the earlier proposals of the policy. “This decision today, to a significant degree, rights that great unfairness.”

In a statement, Rep. April Berg, D-Mill Creek and chair of the House Finance Committee, said Friday’s ruling “not only confirms the state’s position that the capital gains tax is an excise tax, but it also provides the clarity needed to move forward with this significant reform to our tax structure.” 

Friday’s decision came as a blow to conservatives, who have long argued that the capital gains tax is unconstitutional, and that it could eventually lead to a personal income tax, which voters have repeatedly rejected.

Collin Hathaway, president of the Opportunity for All Coalition, which helped challenge the capital gains tax in court, said the group was disappointed: "We were hoping for victory, and this is sort of bizarre."

Hathaway questioned how Washington can collect an excise tax on items like stocks and bonds where transactions can occur outside state boundaries, he said, and the coalition is “going to evaluate whether there's a federal challenge to take it to the U.S. Supreme Court level.”

"There's no precedent for pursuing state excise tax beyond state boundaries," added Hathaway.

The fight for a progressive tax

Washington is one of a handful of states without a personal income tax after the state Supreme Court struck one down in the 1933 decision in Culliton v. Chase. The 90 years since that ruling have seen a continuing — and unsuccessful — battle by some elected officials to implement a more progressive tax system.

That ruling – and failures since then to impose taxes on income – has made the state largely dependent on business and sales taxes, as well as property taxes, to fund government. With that mix of taxes, people who make less money ultimately pay a higher share of their income in taxes than higher earners.

A chart released in 2021 by Inslee’s office shows that the lowest 20% of earners in Washington generally pay 17% of their income on taxes. By contrast, the top 1% of earners generally pay 3% of their income in taxes, and the next 4% of earners after that pay about 4.7% in taxes, according to the figures, which were compiled from state data.

Later that year, lawmakers in the Democratic-controlled House and Senate approved — and Inslee signed into law — the capital gains tax to fund early education and child care programs. 

Friday’s ruling follows arguments before the Supreme Court in January. Opponents have argued that the new capital gains tax is unconstitutional, while supporters have contended that the law is structured like an excise tax, which the Supreme Court has upheld on other occasions.

Last March, a Douglas County Superior Court judge ruled that the capital gains tax violated the state constitution. Judge Brian Huber deemed the law unconstitutional because it doesn’t apply uniformly to every Washington resident, but instead only to those whose profits are above the $250,000 starting point for the tax.

The 7% tax applies only to the profits from sales of stock, mutual funds, and other capital assets that clear a $250,000 threshold by a married couple or an individual. For example, if a couple or individual earns $260,000 in profit by selling stocks in any given year, only $10,000 would be taxed, and the tax owed would be $700.

Under the law, capital gains do not apply to retirement accounts or the sale of real estate, small businesses, livestock and timber.

The ruling frustrated Republicans, who are already warning that Democratic lawmakers could expand the capital gains tax to make it apply to more residents.

“We know Democrats were hoping the court would rule in a way that would enable them to try for a full-blown income tax in our state,” said Sen. Lynda Wilson, R-Vancouver, in a statement. “I don’t see how this decision gets them there, and that is a relief. But taxpayers clearly need to be on their guard — we should expect the Democrats to start adjusting the parameters of this tax so it applies to more and more people over time, which means more and more of their money going to government.”

Meanwhile, within hours of the ruling, the Washington State Republican Party sent a fundraising email based on the court decision.

"Now, more than ever, we must come together to elect Republicans who will stand against the Democrats' efforts to impose a progressive income tax statewide," according to the fundraising email. "We need to protect the hardworking families of Washington State from unnecessary tax burdens!"

In the news conference with Inslee, Sen. June Robinson, D-Everett and sponsor of the capital gains tax law, said she was “very grateful” for the court’s decision and that Washington families will benefit from the funding.

“It brings us relief to know that we are able to count on the revenue from a capital gains tax in our budget that is just being finalized in the next month,” she said.

In his remarks, Inslee noted the work by lawmakers and advocates over the years to make Washington’s tax system more progressive.

“It's very difficult to be humble when you've had an historic achievement," said Inslee. “We've done our best, I’m not sure we've succeeded.”

Correction: A previous version of this article misstated the number of years since the 1933 state Supreme Court ruling on an income tax.