Washington plummets in state business tax index over capital gains tax

Washington’s new capital gains income tax caused the Evergreen State to nosedive 13 spots from last year in the Tax Foundation’s 2023 State Business Tax Climate Index.

According to the Washington, D.C.-based think tank, the index is designed to show how well states structure their tax systems and provides a road map for improvement. The index considers corporate tax rates, individual income tax rates, sales tax rates, property tax rates, and unemployment insurance tax rates.

Last year, Washington was ranked No. 15 overall in the index, but tumbled to No. 28 in this year’s rankings. It was the largest drop by a wide margin. Georgia saw the second-largest drop, going from No. 29 last year to No. 32 this year.

The Tax Foundation attributed Washington’s precipitous slide in its rankings to the capital gains income tax the Democratically-controlled state Legislature passed and Gov. Jay Inslee signed into law last year. The measure adds a 7% tax on capital gains above $250,000 a year, such as profits from stocks or business sales.

“The state adopted a capital gains income tax on high earners which contains a sizeable marriage penalty and is not adjusted for inflation,” the Tax Foundation said of Washington’s new tax, which hasn't gone into effect.

The fate of the tax is in the hands of the state Supreme Court, which is expected to rule on the tax’s constitutionality next year.

On March 1, Douglas County Superior Court Judge Brian Huber ruled the tax on capital gains was “properly characterized as an income tax…rather than as an excise tax as argued by the State” and thus struck it down. The Washington State Constitution’s uniformity clause does not allow income to be taxed at different rates.

Washington Attorney General Bob Ferguson then asked the state Supreme Court to take up the case on direct appeal. This summer, the high court agreed to do so.

The Tax Foundation was critical of efforts to do away with Washington’s no-income-tax advantage in attracting new businesses to the state.

“Washington, with its unenviably aggressive gross receipts tax and high-rate sales tax, has always been buoyed on the Index by forgoing an income tax,” the Tax Foundation said. “With the loss of this distinctive, the state plummeted in our rankings.”

The state’s ranking in individual taxes ran the gamut. The index ranked Washington as follows: corporate tax rates (No. 37), individual tax rates (No. 8), sales tax rates (No. 49), property tax rates (No. 22), and unemployment insurance tax rates (No. 25).

Washington’s Pacific Northwest neighbors fared better in the index’s overall rankings. Oregon was ranked No. 24 and Idaho was ranked No. 15.

The top five states in terms of business tax climate are:

1. Wyoming

2. South Dakota

3. Alaska

4. Florida

5. Montana

The bottom five states in terms of business tax climate are:

50. New Jersey

49. New York

48. California

47. Connecticut

46. Maryland

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