Former Washington Attorney General Rob McKenna filed a lawsuit Thursday seeking to strike down the state’s new capital gains tax, arguing it is a stealthy and illegal income tax.
The lawsuit, filed in Douglas County Superior Court, was brought on behalf of several state residents, including owners of farms and manufacturing businesses, investors, and the Washington State Farm Bureau.
After years of attempts, Democrats who hold majorities in the state Legislature this year passed a capital-gains tax aimed at the state’s wealthiest residents. The measure adds a 7% tax on capital gains above $250,000 a year, such as profits from stocks or business sales. It would raise an estimated $445 million a year, starting in 2023.
The Legislature called the new tax an “excise tax” on “the sale or exchange of certain capital assets” — not an income tax. But the lawsuit argues that’s a masquerade.
“Every taxing authority in the country, including the IRS and all other state revenue departments, agrees that capital gains are income,” the lawsuit states.
The lawsuit cites a long history of decision by courts and voters rejecting income taxes in Washington. There have been 10 initiatives and referendums to allow an income tax, “and each and every one went down to substantial defeat,” the lawsuit says. Most recently, 64% of voters in 2010 rejected a proposed income tax on wealthy individuals.
Supporters of the tax, including education and child care advocates, denounced the lawsuit as an attempt to protect the state’s wealthiest residents from paying their fair share.
“As a teacher, most of the families I work with are struggling to buy food or pay the rent,” said Eric Pickens, a teacher at Franklin Elementary School and president of the Port Angeles Education Association, in a statement released by the Invest In WA Now coalition. “It’s not right that these families pay more in taxes than the wealthiest in our community.”
The new tax would be paid by fewer than 1% of state taxpayers.
Some capital gains tax supporters have said they hope a legal challenge will give the state Supreme Court a chance to overturn past rulings barring a progressive state income tax.
In an interview, McKenna called the continued efforts to push an income tax “incredibly disrespectful … how many times do voters have to say no?”
McKenna, a Republican, served two terms as state attorney general and ran unsuccessfully for governor in 2012, losing to Gov. Jay Inslee, who signed the capital gains tax into law this month.
Since leaving public office, McKenna has worked as a partner at the business law firm Orrick. Two other attorneys at the firm, Daniel Dunne Jr. and Amanda McDowell, were also listed as representing the lawsuit plaintiffs.
Those plaintiffs include several family farm owners, such as April Clayton, who grows apples and cherries at Red Apple Orchards in Orondo, Douglas County, and Rosella and Burr Mosby, who grow vegetables including cucumbers, zucchini and leeks, at Mosby Farms near Auburn.
The lawsuit names the state Department of Revenue and its director, Vikki Smith, as defendants, and seeks a court order to block implementation of the new tax.
Revenue spokesperson Mikhail Carpenter said in an email the agency “will move forward with the implementation process” pending the outcome of the lawsuit. “Delaying implementation could jeopardize the Department of Revenue’s ability to effectively administer the tax within the timeline laid out in the statute,” Carpenter said.
A nonprofit group backing the lawsuit, the Opportunity for All Coalition, previously sued successfully to strike down an income tax on high-income households passed by the city of Seattle in 2017.
Collin Hathaway, president of the coalition, owns Auburn-based Guardian Roofing and is CEO of Southwest Plumbing. He calls the new tax unconstitutional and unnecessary given the state’s booming tax revenues.
In an interview this week, Hathaway said the new tax will affect choices of where people invest, and even reside.
“To me it’s crazy after COVID — when people are more mobile than they’ve ever been — to put a tax on business owners or people with stock options,” Hathaway said. “It will affect decisions in all areas of business and business ownership.”
But Misha Werschkul, executive director of the Washington State Budget and Policy Center, a liberal think tank favoring the tax, called it a “modest tax” that will start to fix the state’s regressive tax code.
“These lawsuits are shortsighted, self-serving attempts to protect a racially inequitable system that’s been putting wealthy white people first for more than a century,” Werschkul said in a statement.
The lawsuit filed Thursday is the second to be brought against the capital gains tax. The Freedom Foundation, an Olympia-based conservative think tank, filed a lawsuit in late April, before the bill had been signed into law.
McKenna said he expects the two lawsuits will be combined and considered together by courts.