Research & Commentary: Washington State Should Reject Illegal Capital Gains Tax Proposal

Published November 7, 2018

In an effort to increase education funding, Washington State Superintendent Chris Reykdal included in his 2019–21 budget proposal a new capital gains tax. Capital gains levies tax individuals and corporations on their capital gains—profits that are realized when investors sell a capital asset for a net gain. Currently, 43 states tax capital gains. Because taxes on capital gains are paid by investors and businesses, they slow capital formation and reduce wages for workers.

Reykdal’s capital gains taxes would impose a new 8 percent levy on long-term capital gains. Reykdal estimates the tax would raise $1 billion annually. The new funds would be used to decrease the state’s property tax by 35 cents per $1,000 of assessed valuation. Under the new tax law, single-filers making more than $25,000 from capital gains annually and couples who earn more than $50,000 would pay state taxes on those gains.

Opponents of the proposal question its legality. The Washington State Constitution mandates property must be taxed at a uniform rate. The Washington Policy Center (WPC) points out the state Supreme Court has ruled on several occasions that income is property.

Additionally, Washington voters have roundly rejected on four occasions efforts made by the legislature to redefine an income tax as an “excise tax.” Capital gains taxes have been widely accepted to be a form of income tax. The Internal Revenue Service includes capital gains in its list of income types on IRS Form 1040, and according to the WPC, every state revenue department calls capital gains income, not an excise tax.

Although proponents of the new tax claim it is necessary to improve the quality of Washington’s public education system, evidence demonstrates more education funding often does not improve educational outcomes. For example, real spending per student nationwide has increased by 23.5 percent over the past decade, but education outcomes have not improved. Scores on the National Assessment of Educational Progress test have remained stagnant despite record spending.

Instead of throwing more money at the problem, Washington residents should demand educational choice. Overwhelming evidence shows that education freedom not increased funding, produces better outcomes. This can be accomplished through a variety of measures. One solution is education spending accounts (ESA), which are private accounts managed by parents that are used on educational expenses for their child. Parents can use the funds to pay for online classes, private school tuition, personal tutors, books and other curricular materials, or even used to save for higher education. ESAs would allow all Washington families to meet their child’s educational needs—and to do so at a lower cost.

States should focus on implementing tax policies that encourage capital formation and investment in their markets, not punish successful businesses, investors, and entrepreneurs.

The following documents examine capital gains taxes in greater detail.

The Capital Gains Tax Is Back in Washington—and It’s Still an Income Tax
In this article for the Tax Foundation, Jared Walczak examines the multiple attempts made by lawmakers in Washington State to create a capital gains tax. Walczak also describes how all these attempts have failed to address the core issue: Capital gains taxes are a kind of income tax, which the Washington State Constitution disallows.

Lawmakers Again Propose Capital Gains Income Tax
Jason Mercier of the Washington Policy Institute argues that no capital gains tax should be allowed under the Washington State Constitution and efforts to redefine the tax are distorting what capital gains truly are. “Every state revenue department in the country calls capitals gains income. No state has an ‘excise tax’ on capital gains. Every state with a capital gains tax does so via an income tax. None of the states without an income tax has a tax on capital gains,” wrote Mercier.

The Effect of the Capital Gains Tax Rate on Economic Activity and Total Tax Revenue
This study by the Institute for Research on the Economics of Taxation identifies how taxpayers and investors react to capital gains tax rates: “The tax treatment of capital gains and dividends greatly affects the quantity of capital created and employed. The quantity of capital affects the productivity, wages, and employment of labor. Output and incomes are lower at higher levels of taxation of capital. Raising the tax rate on capital by increasing the tax rate on dividends and capital gains from current levels would shrink national income across the board.”

The Economic Costs of Capital Gains Taxes
This study from the Fraser Institute outlines the effects of capital gains taxes: “Unfortunately, the cost of capital gains taxes is not limited to the amount of tax collected. Capital gains taxes impose additional costs on the economy because they reduce returns on investment and, thereby, cause individuals and businesses to alter their behaviour.”

Corporate Dividend and Capital Gains Taxation: A Comparison of the United States to Other Developed Nations
Robert Carroll and Gerald Prante compare in this study the tax rates on dividends and capital gains in the United States to those imposed by other developed countries and discusses the policy concerns that have caused other countries to impose lower tax rates on capital gains and dividends.

A Capital Gains Primer
In this Review & Outlook piece from the Wall Street Journal, the authors argue that increasing capital gains tax rates is both counterproductive and could have damaging effects on financial markets. “Moving rates higher has damaging effects. Economist Allen Sinai estimates in a report for the American Council for Capital Formation that raising the capital gains rate to between 20% and 28% would reduce U.S. employment by between 231,000 and 602,000 jobs a year, and that with slower growth and a weaker stock market “the federal budget deficit actually ends up larger.”

Capital Gains Taxation: Federal and State
This Research piece from the Minnesota House of Representatives examines which states use a capital gains tax, how the capital gains tax is used, how they are charged and why.

Does Spending More on Education Improve Academic Achievement?
Dan Lips and Shanea Watkins of The Heritage Foundation discuss the rising cost of education and whether increasing education spending has improved education outcomes. “Taxpayers have invested considerable resources in the nation’s public schools. However, ever-increasing funding of Education has not led to similarly improved student performance. Instead of simply increasing funding for public Education, federal and state policymakers should implement Education reforms designed to improve resource allocation and boost student performance,” wrote Lips and Watkins.

School Spending and Student Achievement in Michigan: What’s the Relationship?
In this report, Ben DeGrow and Edward C. Hoang of the Mackinac Center for Public Policy examine the relationship between school spending and student achievement in Michigan. “The results suggest that there is only a very limited correlation between these two factors. Only one out of the 28 academic outputs analyzed showed a result that was positive and statistically significant, or different from zero,” the authors reported.


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