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OLYMPIA — Gov. Jay Inslee laid out an aggressive tax-and-spending proposal Thursday unlike anything that has come out of the governor’s office in recent years, staking out a solidly liberal agenda likely to be a hard sell in a closely divided Legislature.

In response to what his budget office estimates is a $2.35 billion budget shortfall, the Democratic governor proposed a new capital-gains tax on profits from sales of stocks and bonds affecting 1 percent of Washingtonians.

That new tax, plus a proposal to charge major polluters for carbon emissions, forms the core of Inslee’s proposal to raise more than $1.4 billion in new revenue for the state over the next two years. He also seeks to raise taxes on cigarettes, bottled water and oil refineries.

Overall, Inslee’s $39 billion 2015-17 budget plan would boost state spending by $5 billion — a 15 percent increase over the current biennium. Nearly $3 billion of that would come from natural growth in tax collections.

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Inslee’s proposal breaks his 2012 campaign pledge to veto new taxes, which he then called “the wrong direction” for the state. As a candidate he repeatedly contended economic growth would bring in sufficient tax revenues if combined with closing some corporate tax breaks.

But Inslee was singing a different tune Thursday, arguing what other Democrats and their allies have said for years — that new taxes are necessary to meet the state’s legal and moral obligation to adequately fund schools, mental-health services and other needs.

When asked by reporters about his broken tax vow, Inslee blamed the Legislature for failing to repeal tax breaks and said more money was needed to pay for schools and other needs.

“We simply have not been able to generate the revenue necessary,” he said. “I have tried to avoid this route. But we now have an obligation to our children.”

Critics take aim

Inslee’s budget was criticized by Republicans and business groups. In a statement, Sen. Andy Hill, R-Redmond, described Inslee’s proposals as a “massive tax increase on residents and small businesses.”

“Tax increases should be the last resort, not the first response,” said Hill, the chief Republican budget writer in the Senate.

Kris Johnson, president of the Association of Washington Business, said in a statement that the group shares Inslee’s goals of investing in schools, “but we cannot support $1.4 billion in new taxes as he proposed today.”

Johnson argued that lawmakers should prioritize and fund schools first, and called Inslee’s proposal to charge polluters a tax increase “on every family that puts gas in their car, heats their home and purchases products.”

“Should be applauded”

The Washington Policy Center, a conservative think tank, noted the capital-gains tax is a wildly volatile funding source that could evaporate in a recession.

But Inslee’s proposals got points for boldness from some longtime political observers. Former state Democratic Party Chairman Paul Berendt credited Inslee for taking a more imaginative approach than some previous governors and legislatures.

“Yes, it’s liberal,” he said. “But when there is no political will for the fallback positions that historically we have taken — namely increasing the sales tax — they need new ideas, and the governor should be applauded.”

Education’s share

It’s rare for a governor to flat-out propose entirely new taxes, said Chris Vance, former chairman of the Washington State Republican Party.

“These are the first new ideas I’ve seen in my entire career in terms of revenue,” said Vance, who currently does some work with the state Office of Superintendent of Public Instruction.

Much of the increased spending would go toward the governor’s proposed $2.3 billion education plan, aimed largely at complying with the state Supreme Court’s 2012 McCleary ruling requiring better funding of K-12 schools. The court in September held lawmakers in contempt for not making enough progress toward fully funding education ahead of the court-imposed 2018 deadline to fulfill the McCleary decision. Inslee also would spend about $1 billion for pay raises for teachers and state employees.

Inslee’s overall spending plan includes about $400 million in savings and cuts to existing programs.

His proposed capital-gains tax — announced a day after he called for generating revenue by charging the state’s biggest polluters — would target wealthy Washingtonians, imposing a 7 percent tax on capital gains above $25,000 for individuals and $50,000 for couples. The tax — which would exempt profits from retirement accounts, most home sales, farms and forestry — would raise an estimated $798 million in fiscal 2017.

Washington is one of nine states that do not tax capital gains, according to Inslee’s budget office. In recommending the capital-gains tax, Inslee was taking a page from the progressive wing of the Democratic Party, arguing the state’s budget woes are fundamentally a result of a flawed tax code that favors the rich. The tax system, Inslee said Thursday, is “grossly unfair” and “state revenue collections no longer keep pace.”

“We’ve got to buck up and invest in our state,” he said.

Studies have ranked the state’s tax code as the most regressive in the nation, because it taxes the poor and middle class at a higher rate than the rich. And Inslee’s office presented charts Thursday showing state tax collections have shrunk over the last two decades when measured against personal-income growth.

Income tax next?

Matt McIlwain, a prominent Seattle venture capitalist, criticized Inslee’s capital-gains tax as just another effort to impose an income tax in Washington, arguing it would eventually be expanded to everybody.

McIlwain, managing director of Madrona Venture Group, added in an email that Inslee’s tax would hurt “entrepreneurs and innovators” who take risks and create jobs.

Despite its $5 billion in new spending, Inslee’s plan took heat from one quarter — the state teachers union — for not spending enough.

Inslee’s proposal does not fully fund Initiative 1351, the measure voters approved in November to decrease K-12 class sizes. While its total cost is projected at about $2 billion in the two-year budget cycle, Inslee only plans to fund the part that overlaps with the McCleary decision.

Kim Mead, president of the Washington Education Association, pointed out that language of I-1351 included basic education, meaning it should be considered part of the McCleary mandate. Mead was joined by about a dozen teachers outside the governor’s conference room.

“The governor makes a nice down payment, but it’s not fully funding 1351,” said Pam Kruse, one of the teachers.

Inslee’s plan also calls for raising taxes on cigarettes by 50 cents a pack, taxing e-cigarettes, repealing or limiting tax breaks for software royalties, used-car trade-ins and oil refineries, and applying the sales tax to bottled water.

His plan also assumes $380 million from his proposed cap-and-trade program to combat climate change, which would charge oil refineries and other big polluters for their carbon emissions.

At the same time, Inslee is proposing to extend several corporate tax breaks, including those for high-tech research and development.

Inslee’s proposal is only the start of what is likely to be a protracted budget battle when the Legislature convenes in January. The Republican-controlled state Senate and Democrat-controlled state House will submit their own budget proposals in the coming months.

Rep. Ross Hunter, D-Medina, said it will be politically hard to find enough votes to suspend I-1351 and spend some of the state’s reserves — another of Inslee’s proposals.

“I need 60 percent (of votes in the Legislature) to use the rainy-day fund,” said Hunter, chairman of the House Appropriations Committee. “I need two-thirds to modify 1351. Those are going to be hard.”

But, said Hunter, “It’s a starting point.”

The Associated Press contributed to this report. Jim Brunner: 206-515-5628 or jbrunner@seattletimes.com. On Twitter @Jim_Brunner. Joseph O’Sullivan: 360-236-8268 or josullivan@seattletimes.com. On Twitter @OlympiaJoe