Gov. Inslee Proposes a Washington State Capital Gain Tax

Governor Inslee's 2015-17 budget has an anticipated deficit of just under $2 Billion (expected revenue of $37.1B, Inslee budget of $39B in expenditures).

To compensate, Governor Inslee proposes several tax increases including a brand new 7% Washington State Capital Gains Tax.

This is a brand new income tax, currently Washington State does not have any form of income tax. As previously discussed, Washington State's lack of income taxes has helped to establish its edge over many other states in tax competitiveness. Washington's lack of income tax has helped it achieve the lowest State marginal tax rate for pass-through entities, gain 11^th place on the 2015 State Business Tax Climate Index, and rank 4^th among the states for mature retail stores & call centers.

Inslee's Capital Gains Tax Proposal Key Facts (drawn from FAQ on HB 1484/SB 5699)

• Capital Gain Rate of 7%
• Applies to Long Term capital gain income above $25,000 (single) $50,000 for married couples. Generally, based on gains as reported on federal tax returns.
• Exemptions:
  • Retirement Account gains
  • Family Home sale exemption (only if (1) IRC § 121 otherwise applies or (2) the home has been owned for 20 years and used as personal residence for at least 10 years).
  • Agriculture Property
    • Exemption only applies to sale of "cattle, horses or breeding livestock" (if more than 50% of taxpayers gross income is from farming/ranching)
    • Exemption for sale of agricultural land: exemption only applies to land held for at least 10 years (assuming taxpayer has "regular, continuous and substantial involvement in the operation of the agricultural land")
  • Timber
• Credits
  • Individual can take a credit for capital gains taxes paid in other states for gains subject to the Washington Tax.
  • No credit for federal capital gains taxes paid.

Conclusions

Imposing any form of income tax will bring Washington State down in its tax competitiveness with other states. As reported by the Washington Policy Center, capital gains tax is an extremely volatile revenue stream for governments and Governor Inslee proposes to allocate these revenues solely to education spending. Additionally, the Washington Policy Center questions the constitutionality of Governor Inslee's proposal and cites to former Washington State Supreme Court Justice Phil Talmadge's 2010 legal analysis of Initiative 1098 (2010 Initiative to impose and income tax, that initiative ultimately failed 64.15% against, 35.85% in favor).

Washington State: Lowest Marginal Tax Rates for Pass-Through Businesses

According to the Tax Foundation, Washington State has the lowest marginal tax rate for "pass-through businesses." A "pass-through" business includes sole proprietors, S Corporations, limited liability companies (LLCs) and partnerships.

The Tax Foundation calculates Washington State's "Top Marginal Tax Rate" for Sole Proprietorships and Partnerships (including LLC's which have no made an "S election") at 42.6%. It calculates the "Top Marginal Rate" for S-Corporations at 39.6%.

The rates calculated for Idaho are 48.2% for Sole Proprietorships and Partnerships and 45.3% for S-Corporations. The rates calculated for Oregon are 49.8% for Sole Proprietorships and Partnerships and 46.8% for S-Corporations. 

The reason that Washington rate is lower than other states is because Washington State does not have an income tax.

Additionally, the Tax Foundation reports that 95% of businesses nationwide are "pass-through" entities. This means that Washington State has a significant edge over other states. 

The Tax Foundation's report can be found here.

Washington State: Ranked 11th on State Business Tax Climate Index

The Tax Foundation has recently released its 2015 State Business Tax Climate Index. The full report can be found here.

Washington State ranked 11^th overall on the index for best State Business Tax climate nationwide.

The purpose of the index is to enable "business leaders, government policymakers, and taxpayers to gauge how other states his tax systems compare."

In making its rankings, the Tax Foundation surveys each State's tax system comparing over 100 different variables in five areas of taxation (corporate, individual, sales, unemployment insurance and property). Then it compiles those results to create its final overall rankings.

However despite the fact that Washington scored well overall, it has one of the highest combined state and average local sales tax: at 8.88%.

Washington has the highest tax rate on spirits ($35.22 per gallon).

Looking at the corporate tax component alone, Washington ranked 28^th.

Looking at the individual income tax component alone, Washington ranked 6^th.

Looking at the sales tax component alone, Washington ranked 46^th.

Looking at the property tax component alone, Washington ranked 23^rd.

Looking at the unemployment insurance tax component alone, Washington ranked 19^th.

U.S. is in bottom 10% of OECD Countries for Tax Competitiveness

The Tax Foundation has recently issued its 2014 International Tax Competitiveness Index (ITCI) for the 34 OECD countries.

Overall, the United States ranked as 32^nd most competitive out of the 34 OECD countries (i.e. the bottom 10%). The ITCI notes that the largest factors behind United States's poor score are:

1. The US has the highest corporate income tax rate in the developed world (39.1%) (OECD average 25%),
2. The US is one of the only countries in the OECD that does not have a territorial tax system (the top 5 all have territorial tax systems),
3. The US has a relatively high progressive individual income tax (combined top rate 46.3%) which taxes both dividends and capital gains.

The top 5 and bottom 5 overall OECD Scores under the ITCI are:

	Country Name	ITCI Overall Score
1.	Estonia	100.0
2.	New Zealand	87.9
3.	Switzerland	82.4
4.	Sweden	79.7
5.	Australia	78.4
30.	Spain	50.8
31.	Italy	47.2
32.	United States	44.6
33.	Portugal	42.9
34	France	38.9

Within the OECD, the United States has the 3^rd worst tax environment as calculated by the ITCI. This puts it in the bottom 10% of the OECD. This has tremendous implications for long-term investment and job growth within the United States. Congress needs to address this reality and make our tax code more competitive with the rest of the OECD. As stated in the report:

In today's globalized world, capital is highly mobile. Businesses can choose to invest in any number of countries throughout the world in order to find the highest rate of return. This means that businesses will look for countries with lower tax rates on investments in order to maximize their after-tax rate of return. If a country's tax rate is too high, it will drive investment elsewhere, leading to slower economic growth.

Washington State Sick & Family Leave Laws

The House Labor & Workforce Development Committee passed two bills yesterday mandating paid sick leave and paid family and medical leave. HB 1457 would entitle a worker to up to 6 months of paid leave in any one year. If these laws are passed, they will have a significant negative impact on all business owners, and especially small business owners, and thereby significantly reduce Washington State job creation.

From the Washington Policy Center:

HB 1313 would extend the paid sick leave ordinance passed by Seattle last year to employers across the state. The bill would require employers with 5 or more employees to pay employees for 5, 7 or 9 days of sick or safe leave per year, depending on the size of the company. Only one other state (Connecticut) mandates paid sick leave.

HB 1457 would significantly expand the current paid family leave law that was passed in 2007 but never implemented because a funding source was never agreed upon. The new bill would provide up to $1,000 per week for 12 weeks for a child's birth or adoption or for a family member's "serious health condition," and another 12 weeks of paid leave for the individual's "serious health condition." Workers could apply for both benefits in the same year, meaning they could receive 24 weeks of paid leave in one year. Employees would be eligible for the paid leave upon working 6 months or 650 hours.

[…]

Unlike its weaker predecessor, SHB 1457 does identify a funding source—a new payroll tax. The tax would be paid by employers with the option to charge employees half of the tax, and the program would be administered by the Employment Securities Department. Only two states (California and New Jersey) have laws mandating paid family leave.

The fiscal note for HB 1457 is staggering. According to OFM it will cost employers and workers $97 million in new taxes in 2013-15, $342 million in 2015-17 and $387 million in 2017-19.