Every state has its customs and every institution its rituals. In Washington state, the push-and-pull over income taxes — lawmakers want them, voters don’t — is so routine as to become a tradition, and each new year yields, like a rite of spring, another legislative effort to chip away at the income-tax issue by imposing a capital gains income tax. Like so many disputed rituals, it is ultimately a fight over words and what they mean.

The rite has an established form. Lawmakers introduce a tax on capital-gains income, creatively designed to avoid troublesome words like “income,” as if the state constitution’s constraints on income taxation are a taboo that can be sidestepped by tiptoeing around certain words and phrases. Critics argue against the substance of the proposal, questioning why lawmakers would want a tax imposed especially on investment and querying whether such a volatile revenue source is suitable to proponents’ aims. But they also question how such a bill could possibly pass constitutional muster in a state where graduated income taxes are prohibited. The bill fails, the earth completes its transit around the sun, and the ritual begins anew.

But this year, the ritual has become more palpable, with Senate Bill 5096 passing its chamber of origin with a one-vote margin and proceeding to the House. Should it pass that chamber, which is likely, it will unquestionably secure the signature of Gov. Jay Inslee, who has long championed the proposal. Just as inevitable? Litigation.

Whatever your opinion about a state capital-gains tax, it’s constitutional

Washington courts have repeatedly struck down attempts to impose income taxes due to a provision in the state constitution that requires that taxes be uniform on all classes of property and that these taxes in aggregate not exceed 1%, while — crucially — defining property broadly as “everything, whether tangible or intangible, subject to ownership.” This is not a standard definition of property, but it is Washington’s, enshrined in the state constitution — and courts have repeatedly held that the definition is broad enough to encompass income.

Some proponents of a capital gains income tax contend that the courts are wrong about this and would like to challenge it yet again. Others believe the courts are right but the constitution is wrong and would like to see it amended. But most, for now, argue that a tax on capital gains income does not run afoul of the constitution because it isn’t an income tax at all: it is an excise tax on the privilege of earning capital gains.

Advertising

Lawmakers are treating words with the spirit of a poet rather than the spirit of a jurist. T.S. Eliot wrote that “last year’s words belong to last year’s language, and next year’s words await another voice,” and lawmakers, unhappy with the constitutional constraints under which they labor, want to give them that new voice. But the law lacks the flexibility of poetics, and words like “excise,” “property,” and “income” have discernible meanings that do not change from year to year.

Excise taxes, according to the Internal Revenue Service (IRS), “are taxes that are imposed on various goods, services and activities,” sometimes on volume and sometimes on sale price. They are usually designed to establish a user-pays system or to internalize some social cost, though they can become pure revenue-raisers. Common examples include the gas tax (a user-pays system for roads), the cigarette tax (internalizing the public-health costs of smoking) and the real estate excise tax (taxing the total sale price of a home). Proponents say they have designed something new in the world of tax: a capital gains excise tax, on the privilege of buying or selling an asset.

Their tax, though, is not imposed on the asset transfer itself, or even on the transaction price. It is based instead on net capital gains income as reported for federal income tax purposes. It even includes an exemption of $250,000 of capital gains income so that the tax only falls on high-net-worth individuals, hardly a characteristic of an excise tax. In fact, despite being styled a tax on transactions, state tax collectors would not even know how many transactions took place, let alone attempt to tax them. Whether the net gains reported to the IRS — and then taxed in Washington — came from one transaction or 100, Washington’s tax would be the same.

Were a capital-gains tax an excise tax, it would fall on the entire sales price (or a specific price per transaction), not just the net gain. It would be imposed on each transaction, not the aggregate of gains and losses. There is no question that the net proceeds from the sale of an asset are income, or that this money in an investor’s possession is — per Washington courts’ definitions — intangible property subject to ownership. By the logic proponents employ, they might just as easily get around the income tax prohibition for wage earners by imposing a tax on the privilege of employment, measured by wage income.

During Alice’s journey through Wonderland, she met Humpty Dumpty, who told her that when he uses a word, “it means just what I choose it to mean — neither more nor less.” Alice protests, asking whether he can make words mean different things. “The question is,” Humpty replies, “which is to be master — that’s all.”

The constitution exerts mastery over lawmakers’ desire to impose an income tax — for now. But make no mistake: The sleight of hand that disguises a tax on capital gains income as an excise tax is employed just as easily to tax all income, including wage income. Lawmakers would amend the state’s constitution, not by appeal to the voters (who rejected income-tax authority as recently as 2010), but by making its constricting language mean only what they choose it to mean — neither more nor less. The courts, like Alice, may be more perplexed than amused.