Senate Democrats Killed the Capital Gains Tax. Here's What Happened.

Have fun paying zero state taxes the next time you sell $1 billion worth of stock, Mr. Bezos. ALEX WONG / GETTY IMAGES

This year was supposed to be the year Democrats passed a capital gains tax . They had healthy majorities in the House and the Senate. The bill, having already done seven tours through the House, was so carved out that only 42,000 of the wealthiest households in Washington state would have been affected. Governor Jay Inslee fully supported the cause. When I asked him what he planned to do about Washington's tax code, which has the distinction of being the most regressive one in the country, balancing its burden unfairly on the backs of low-income residents and small businesses alike, he said, "We're going to pass a capital gains tax!"

And yet, when the gavel dropped 18 minutes before midnight to close out the session, the capital gains tax was dead. What the fuck happened?

The Senate happened. That's what.

"I strongly believe we had the votes in the House," said Rep. Noel Frame. "They didn’t have the votes in the Senate."

Part of the problem was the disparity between each chamber's capital gains tax proposal. Though both proposals would have raised $780 million over the course of two years, Senate Democrats wanted to use the revenue to cut some sales and property taxes while House Democrats wanted to dump the money into the state's education legacy trust account.

The space between these differing proposals shows you how much the two chambers talk to one another before they do things like drop giant progressive tax measures, but that's a subject for another day.

Senators Mark Mullet (D-Issaquah), Dean Takko (D-Longview), Steve Hobbs (D-Lake Stevens), and Guy Palumbo (D-Maltby) blocked the capital gains bills to varying degrees, according to two sources familiar with the negotiations.

Sen. Palumbo was open to voting for the Senate's version of the bill, but he was holding out for funding for a transportation project in his district. "People want it to go to something they can point to. People wanted a tangible tradeoff," said Sen. Joe Nguyen.

Some senators were willing to make that trade, but Palumbo and others also didn't want to tie revenue from capital gains taxes to "constitutionally mandated programs like K-12 education," says Nguyen. Since the tax will likely face a legal challenge, Senate lawmakers didn't want to risk funding a necessary program with money that might not be there in two years.

Nguyen agreed with this line of reasoning, "I don’t think it's a wise thing to do because we might get sued and [the legal defense for a capital gains tax] might lose," he said. Nguyen still wanted capital gains for tax cuts, though.

Palumbo, who told me two weeks ago I was "on the list" for criticizing a charter schools amendment he tried to hang on the levy lid lift bill, and who said he wouldn't give me a comment on that because all I wanted to do was make him "look dumb," declined to comment for this story.

Takko and Hobbs didn't respond to requests for comment.

In a recent interview, Mullet, who has always been a hard "no" on capital gains, told me the only way he would ever vote for new taxes is if he couldn't make "the puzzle" of the budget fit without them. This year, he wanted to make the puzzle fit by chipping at the plan to fund the School Employee Benefits Board (SEBB), which would establish a health care exchange market for educators, and ultimately give part-time state employees the same health benefits as full-time state employees.

Though the capital gains tax failed, Nguyen points to new taxes on "oil companies, big tobacco, multinational corporations, the progressive REET, and big banks" as reasons why it's hard for him to be disappointed.

The bills he's talking about are Senate Bill 5998, which establishes a graduated Real Estate Excise Tax (REET); Senate Bill 5993, which taxes oil companies to pay for toxic waste cleanup projects around the state; Senate Bill 6016, which closes a loophole for investment companies; House Bill 2167, which increases the business-and-occupation tax on big banks by 1.2%; House Bill 2158, which increases the B&O tax on large companies to pay for higher education (which Microsoft signed off on); and House Bill 1873, which is a tax on vapes.

Combined, those bills will raise just over $1 billion, according to data from Senate staff.

This slate of taxes was also a point of contention between the House and the Senate. "The House wanted to have one big tax vote and not five little ones," Nguyen said.

Despite the resistance from conservative Democrats and the disagreements with the House, Nguyen "feels more optimistic" about passing a capital gains tax next year.

Rep. Frame, however, buys exactly none of this reasoning from the Senate and does not feel optimistic about passing capital gains next year.

Frame says the Senate's fear of potentially blowing holes in the budget is a bad excuse, and adds that such arguments are "made by people who don't understand tax policy, or who are choosing to be ignorant to support their political argument."

Frame says the House was fully aware of the fact that the capital gains tax will likely go to court and/or be subject to referendum, but they built that assumption into their budget by not funding anything with the revenue until the second year of the biennium. The extra year will allow for the lawsuit or referendum to be dealt with.

Citing several lawsuits over the years that have upheld excise taxes, and dismissing Republican attempts to brand the capital gains tax as an income tax as "cute," Frame says she feels confident the capital gains tax won't lose in court.

And though the House did tie the money to education funding, they didn't specifically tie it to constitutionally mandated K-12 programs. The money would be deposited in the state's education trust fund, and it could have gone to early learning programs or to higher education.

As for that slate of taxes on big businesses et al? With the exception of the tax on big banks, "they weren’t progressive," Frame said. "Increases on B&O taxes are weirdly regressive because they're based on gross receipts." Property and sales taxes hit middle- and low-income people the hardest.

"To me, this is all just tinkering around the edges," Frame said. "They’re great policies, but they’re built on top of a system that is fundamentally broken."

The current tax code is based on the way the economy worked in the 1930s. But Frame wants to build one based on the way the economy works now, one that doesn't force people with low income to spend six times more of their income on taxes than wealthy people do, one that isn't riddled with loopholes for big corporations, one that is, you know, not the most regressive one in the entire country.

To that end, the particular piece of legislation she is optimistic about is House Bill 2157, which would completely restructure the tax code. The bill went down in committee this year, but the budget writers included the proposal's tax structure workgroup as a proviso.

The bill sets up a bipartisan, bicameral workgroup composed of lawmakers and experts on the economics of artificial intelligence, automation, and trade. They're all going to come up with a bunch of alternative tax structures, which will be analyzed by the Department of Revenue. After that analysis is available, during the 2021 session, lawmakers will meet with stakeholders—"small, low-margin, and new businesses, and low- and middle-income taxpayers"—to ask for input. After the session ends, the lawmakers will take the various alternative tax structures on the road and present them at little town halls all over the state. They'll report on feedback from that trip during the 2022 session, so that legislative proposals to restructure the code can be ready by 2023.

Frame thinks this public-centered approach will help gain the trust of taxpayers. "All previous efforts have been a bunch of lobbyists sitting around a table in Olympia," she said. "They have not tried public engagement as a strategy. The public needs to be brought along on this, and they need to understand what the code is."

Frame spent part of last summer on a listening tour, asking people what they thought of the tax code and talking about alternative models. "96 percent of people on the road wanted us to keep doing the work," she said. "More and more people understand the code is a relic of 1935, and it needs to be rebalanced."