One Governor Hopes To Pile Onto Joe Biden’s Capital Gains Tax Hike With A State-Level Cash Grab

Despite an economic contraction in the U.S. not seen since World War II, with annual GDP declining 3.5% year over year, 2020 saw significant stock market gains. The Dow rose 7.3% in 2020, the S&P 500 was up 16.3%, the Russell 2000 increased 18.4%, and the Nasdaq
NDAQ
ended the year up 43.6%, its strongest rally since 2009. 

Washington State Governor Jay Inslee (D) now wants to tax those gains, which were a rare economic bright spot for many individuals and families in what was an otherwise tough year for many households’ finances. If Governor Inslee is successful, his constituents are looking at the prospect of a capital gains tax double whammy in 2021, as President Joe Biden is also calling for a federal capital gains tax increase that, if enacted, would result in the U.S. having the highest capital gains tax rate since Jimmy Carter was in office. 

“I’m gonna double the capital gains rate to 40%,” President Biden remarked on the campaign trail. “So every single solitary person, their capital gains are going to be treated like real income and they are going to pay 40% on their capital gains tax,” Biden said of his goal. 

Many Washington State taxpayers will be facing a capital gains tax rate exceeding 50% if both the President and their governor get their way. Governor Inslee is calling for the imposition of a 9.0% state tax on investment income exceeding $25,000 for individuals and $50,000 for couples. Governor Inslee’s proposal has been filed in the state legislature as Senate Bill 5096.  

“If enacted, this would be the first stand-alone income tax on capital gains in the country,” Jason Mercier, Director of the Center for Government Reform at Washington Policy Center, writes of SB 5096. “No other state without a personal income tax taxes capital gains, and those states that do tax this type of income collect it through their state income tax code.”

“This is the wrong direction for our state to go,” Mark Johnson of the Washington Retail Association said of Governor Inslee’s tax proposal. Others in the Washington State business community have spoken out against Governor Inslee’s capital gains tax.  

Wayne Lunday, who represents the National Association of Insurance and Financial Advisers, called the proposed 9% tax on the sale of his company a “killer,” describing Inslee’s capital gains tax as “devastating” for his and many other businesses.

Rep. Drew Stokesbary (R), the Washington House Appropriations Committee’s ranking member, says the capital gains tax sought by Inslee is “just bad economic policy, especially right now.”

“If we’re telling people who have the capital to invest that it’s going to cost them to do so, they’re less likely to stay here and do it,” Rep. Stokesbary added.

Senator Lynda Wilson, the leading Republican on the Washington Senate Ways & Means Committee, predicted in December that Inslee’s proposed tax would likely be approved by lawmakers, but then subsequently subject to a court challenge. Aside from removing Washington from the list of no-income-tax states, Sen. Wilson argues that relying on a capital gains income tax would put the state on less stable financial footing, calling it the “most volatile revenue source that there is.” 

While the ultimate fate of Governor Inslee’s capital gains tax may end up being decided by a judge, the federal capital gains tax increase pushed by President Biden is a sure thing to happen later this year so long as Democratic lawmakers are able to hold together and include it in one of their budget reconciliation bills, the vehicles through which federal taxes can be raised despite lockstep GOP opposition. 

The proposed rate increase isn’t the only way President Biden is proposing to raise capital gains tax liabilities. President Biden’s call to eliminate step-up in basis on inherited assets would impose substantial paperwork and cost burdens on many taxpayers, including middle income households and small businesses. Immediately upon receiving an inherited asset, a taxpayer would instantly owe a capital gains tax. 

“When someone dies and the asset transfers to an heir, that transfer itself will be a taxable event, and the estate is required to pay taxes on the gains as if they sold the asset,” the Tax Policy Center’s Howard Gleckman said of Biden’s proposal.

Forbes contributor Robert W. Wood explains how Biden’s proposal would work in practice: 

“Everybody gets a stepped-up basis on death, for income taxes. But Biden says maybe no longer…Biden’s proposal would tax an asset’s unrealized appreciation at transfer. You mean Junior gets taxed whether or not he sells the business? Essentially, yes. The idea that you could build up your small business and escape death tax and income tax to pass it to your kids is on the chopping block. Biden would levy a tax on unrealized appreciation of assets passed on at death. By taxing the unrealized gain at death, heirs would get hit at the transfer, regardless of whether they sell the asset.”

President Biden has a long history of pushing for higher tax rates on capital gains. During George W. Bush’s first term, Biden voted against the 2003 reduction in the capital gains rate from 20% to 15%. Biden then voted against extending the 15% capital gains tax rate in both 2005 and 2006.

Then-Vice President Biden and President Obama insisted the cap gains rate increase to 20% throughout 2012. Biden and Obama did enact an additional 3.8% capital gains surtax in 2009 — referred to as the Net Income Investment Tax (NIIT) — which was one of numerous tax hikes included in Obamacare. The 3.8% surtax took effect at the start of 2013. 

Depending on income level, long-term capital gains are currently taxed at 0%, 15%, or 20%. Obamacare’s 3.8% Net Income Investment Tax has families who are hit by it paying a 23.8% rate. 

Under President Biden’s cap gains proposal, taxpayers paying the NIIT will be subject to a 43.4% rate. If Governor Inslee’s proposal is also enacted and survives legal challenge, Washington State residents would face a capital gains tax rate exceeding 52% should Biden also get a bill sent to his desk that includes his proposed tax increase. 

“The last thing you want to do is raise taxes in the middle of a recession because that would just suck up, take more demand out of the economy and put businesses in a further hole,” then-President Obama once remarked. President Biden ran on a tax plan that goes against the advice of his former boss and he has a Democratic-run Congress that can now help him enact it. Not only that, Governor Inslee has demonstrated, as have his counterparts in Illinois and New York, that many Americans also face the prospect of state level tax increases in 2021 to go along with the federal tax hikes that President Biden hopes to sign into law later this year.