Former Washington AG: Proposed capital gains tax is income tax in disguise

There is a proposal for a capital gains tax to raise more money for the state currently in the state Legislature. It’s being styled as an excise tax for the purpose of not violating the state’s constitutional prohibition on a graduated income tax.

Capital gains tax makes progress as lawmakers continue bid to tax state’s wealthiest residents

Former state Attorney General Rob McKenna is an opponent of this proposal, but explained the difference between an excise and an income tax on Seattle’s Morning News.

“An excise tax is an indirect tax charged by the government on the sale of a particular good or service,” he said. “So, for example, when you sell your house, you pay a real estate excise tax, or if you sell any property, you pay a real estate excise tax. When you buy gasoline, you pay a tax on it. That’s an excise tax. So excise taxes or duties apply to specific goods and services.”

“An income tax is well-understood. Capital gains are form of income, so every jurisdiction in the country — state, local, and federal — treats capital gains taxes as income taxes because that’s in fact what they are,” McKenna continued. “But in Olympia, they’re trying to style their proposed capital gains tax as an excise, in other words, a tax on a specific type of transaction, like the sale of stocks or bonds.”

Excise taxes are often characterized as a tax on a privilege, McKenna explained, like that of selling real estate or of operating a business. The B&O tax, as an example, is an excise tax.

“Historically, and today, everyone treats taxes on capital gains as a kind of income,” McKenna said. “It’s a passive form of income, as opposed to income you earn on your W-2.”

But yet the state of Washington charges a real estate excise tax, which is based on the selling price of the house.

“Whether you make money on it or not, you’re going to pay the excise tax,” McKenna said. “So … think about it as a privilege to own property. That’s kind of a fancy way of saying, look, the reason that you can sell your house and to someone who can know that you have title to it is that we have an entire governmental system to record and protect property rights.”

“It’s always been understood that it is kind of a privilege to be able to hold property and sell it,” he added. “It’s also a right.”

Without some kind of government agency, though, as Dave pointed out, your claim to own stock wouldn’t be worth the paper it’s printed on. So why couldn’t you make that comparison?

“Well, … the business that you own stock in is paying excise taxes in Washington,” McKenna said. “That’s a business and occupation tax. Businesses pay all kinds of other excise taxes.”

“So, you’re right. You can’t have a business without the rule of law, without government enforcing the rule of law,” he added. “But in fact, excise taxes are collected, and that’s also justification for imposing excise taxes on all kinds of specific products and goods, like gasoline and other products that we’re familiar with.”

But, McKenna continues, for whatever reason, no one has treated stock ownership or stocks as the kind of products that would be subject to an excise tax.

“It’s never happened anywhere in the country, and the federal government certainly doesn’t treat it that way,” he said. “If you ask the IRS they’ll say, ‘Oh, no, capital gains on selling stock? Clearly an income tax.’ Subject to income tax, not an excise tax.”

If the Legislature passes this tax, which McKenna calls the “capital gains income tax,” he believes it will be subjected to a legal challenge on the grounds that it’s not an excise tax and that it’s an unconstitutional tax on income.

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