Washington state's capital gains tax upheld

Why it matters: The 7% capital gains tax, which Washington's Legislature approved in 2021, is projected to raise about $500 million per year for public education and child care programs.

The tax applies to profits from selling capital assets, such as stocks and bonds, if those profits exceed $250,000 per person (or per married couple) in a year.

• Sales of retirement accounts, real estate and certain small businesses are exempt, and the tax applies only to the portion of capital gains that exceed the $250,000 threshold.

Flashback: Democrats — who control both chambers of Washington's Legislature — argued the capital gains tax was necessary to help balance the state's tax code, which relies heavily on sales taxes and doesn't tax personal income.

• Democrats have long criticized that system as highly regressive, meaning it leads to lower-income people paying a higher share of their income in taxes than wealthier people.
• Republicans, meanwhile, argued the capital gains tax is an income tax that violates the state constitution.

What's happening: In its 7-2 decision, the court agreed with the state's assertion that the capital gains tax is instead an excise tax that isn't subject to the same constitutional restrictions.

• At the same time, the court declined to reconsider a 1933 legal precedent that considers income to be property, which the state constitution says must be taxed uniformly and limited to a 1% rate.
• That means state lawmakers will likely still be restricted from enacting graduated income taxes, in which a person's tax rate is based on their income.

What they're saying: Christine Rolfes (D-Bainbridge Island), the lead budget writer in the state Senate, said in a prepared statement that the ruling "locks in dedicated funding to increase access to affordable early learning and childcare."

• At the same time, she told Axios, she interprets the ruling to mean a constitutional amendment would be necessary to enact a graduated income tax.

The other side: Justices Sheryl Gordon McCloud and Charles Johnson disagreed with the majority's ruling, with Gordon McCloud writing in a dissenting opinion, "the tax is an income tax, regardless of the label placed on it by the legislature."

What we're watching: Whether the court's decision emboldens lawmakers to experiment with other types of taxes, such as a wealth tax, that target high-earners but are structured differently than traditional income taxes.

• In a prepared statement, state Sen. Lynda Wilson, the top Republican on the Senate budget-writing committee, warned that "taxpayers clearly need to be on their guard."
• She predicted Democrats would adjust the capital gains tax over time "so it applies to more and more people."

What's next: The capital gains tax took effect in January 2022, and the first payments are due next month.