Policy Documents

Research & Commentary: State Capital Gains Taxes

October 31, 2012

As Congress decides whether to allow the national capital gains tax rate to increase at the beginning of next year, states across the country are debating whether to change their own capital gains taxes. These are taxes paid by individuals and corporations on their capital gains, or profits realized when investors sell a capital asset for a net gain. Currently 43 states charge some form of capital gains tax. These taxes hold down capital formation and reduce wages for workers. 

Washington, one of the few states with no capital gains tax, recently considered a bill to impose a 5 percent excise tax on capital gains over $10,000 a year ($5,000 for individuals). Relying on capital gains tax revenue is risky because it applies to a relatively small base and can fluctuate wildly based on market changes, thus making it an undependable revenue source. 

Arizona became the most recent state to cut its capital gains tax rate, following the lead of New Mexico, which in 2003 cut its capital gains tax in half and has since experienced a boom in venture capital and substantial job growth. Before passage of the Arizona bill, the Goldwater Institute noted a high capital gains tax places a state at a disadvantage to neighboring states because companies and investors can easily move to states with lower taxes. 

Capital gains tax hikes remain popular because of the perception the taxes apply only to wealthier taxpayers while not affecting those with lower incomes. This is not the case. The Wall Street Journal noted capital gains taxes lower workers’ paychecks and cost many their jobs. “Even on class-warfare grounds, it is counterproductive to raise taxes on capital. Most of the returns on investment in a business benefit workers (not shareholders), because they become more productive with more modern factories, computers and equipment made possible with investment capital,” the writers noted. 

States should implement tax policies that encourage capital formation and investment in their economies. Ideally, capital gains taxes should be eliminated altogether, and states’ efforts to lower them are a step in the right direction. 

The following articles examine state capital gains taxes from multiple perspectives. 

Research & Commentary: Capital Gains Taxes Update
http://heartland.org/policy-documents/research-commentary-capital-gains-taxes-update
Matthew Glans and John Nothdurft of The Heartland Institute examine the proposed hike in the federal capital gains tax rate and its expected effects on investment and the economy. “An increase in the capital gains tax rate, combined with a hike in dividend taxes and high inflation, dramatically increases the effective tax rates paid by taxpayers. With the U.S. economy still struggling to crawl out of the economic downturn, it’s important to avoid policies that hinder capital formation and investment in U.S. markets, as raising capital gains tax rates would do.” 

Testimony in Favor of Reducing Oregon’s Capital Gains Tax Rate
http://cascadepolicy.org/news/2011/04/20/testimony-in-favor-of-reducing-oregon%E2%80%99s-capital-gains-tax-rate/
Steve Buckstein, senior policy analyst and founder of the Cascade Policy Institute, testifies before the House Committee on Revenue in favor of reducing Oregon’s capital gains tax rate: “So, rather than trying to pick winners and losers, in this case trying to direct more capital to Oregon businesses through favors in the tax code, simply ensure a level playing field and then trust in the market’s ability to evaluate good deals and invest in them. The more attractive you make Oregon as a place to do business, the more business and investment capital will flow here.” 

Seeking Economic Boost, Arizona Cuts Capital Gains Taxes
http://www.pewstates.org/projects/stateline/headlines/seeking-economic-boost-arizona-cuts-capital-gains-taxes-85899386385
Josh Goodman of PewStates examines Arizona’s efforts to cut its capital gains tax rates and the efforts of other states to change their taxation of capital gains, including Washington’s efforts to create a new capital gains tax. 

State and Federal Individual Capital Gains Tax Rates: How High Could They Go?
http://heartland.org/policy-documents/state-and-federal-individual-capital-gains-tax-rates-how-high-could-they-go
The American Council for Capital Formation’s Center for Policy Research highlights the effects of increased federal tax rates on long-term individual capital gains when federal, state, and, in some cases, local taxes are combined. The study found a low capital gains tax rate is important in fostering economic growth. 

The Effect of the Capital Gains Tax Rate on Economic Activity and Total Tax Revenue
http://heartland.org/policy-documents/effect-capital-gains-tax-rate-economic-activity-and-total-tax-revenue
The Institute for Research on the Economics of Taxation identifies how taxpayers and investors react to capital gains taxes: “The tax treatment of capital gains and dividends greatly affects the quantity of capital created and employed. The quantity of capital affects the productivity, wages, and employment of labor. Output and incomes are lower at higher levels of taxation of capital. Raising the tax rate on capital by increasing the tax rate on dividends and capital gains from current levels would shrink national income across the board.” 

The Economic Costs of Capital Gains Taxes
http://heartland.org/policy-documents/economic-costs-capital-gains-taxes
The Fraser Institute outlines the effects of capital gains taxes: “Unfortunately, the cost of capital gains taxes is not limited to the amount of tax collected. Capital gains taxes impose additional costs on the economy because they reduce returns on investment and, thereby, cause individuals and businesses to alter their behaviour.” 

Corporate Dividend and Capital Gains Taxation: A Comparison of the United States to Other Developed Nations
http://heartland.org/policy-documents/corporate-dividend-and-capital-gains-taxation-comparison-united-states-other-develo
Robert Carroll and Gerald Prante compare the tax rates on dividends and capital gains in the United States with those imposed by other developed countries and discuss the policy concerns that have caused other countries to lower their tax rates on capital gains and dividends. 

The Folly of State Capital Gains Tax Cuts
http://itepnet.org/pdf/pb13capg.pdf
This policy brief from the Institute on Taxation and Economic Policy argues against state capital gains tax cuts.

A Capital Gains Primer
http://online.wsj.com/article/SB10001424052702303753904577452260437934858.html
In this Review & Outlook piece from the Wall Street Journal, the authors argue that increasing capital gains tax rates is counterproductive and could have damaging effects on financial markets: “Moving rates higher has damaging effects. Economist Allen Sinai estimates in a report for the American Council for Capital Formation that raising the capital gains rate to between 20% and 28% would reduce U.S. employment by between 231,000 and 602,000 jobs a year, and that with slower growth and a weaker stock market ‘the federal budget deficit actually ends up larger.’” 

Capital Gains Taxation: Federal and State
http://www.house.leg.state.mn.us/hrd/pubs/ss/sscapgain.pdf
This short research document from the Minnesota House of Representatives identifies which states use a capital gains tax and examines how the tax is used, how different states charge it, and why. 

Capital Gains Tax Hike will Hurt State Coffers
http://thehill.com/blogs/congress-blog/economy-a-budget/228649-capital-gains-tax-hike-will-hurt-state-coffers
Margo Thorning, senior vice president and chief economist for the American Council for Capital Formation, writes in The Hill about the effect of a federal capital gains tax hike on state revenue. She points out many states rely on capital gains tax revenue, which may be an unreliable source. “A hike in the federal rate will be bad for states and those trying to govern them, as well—especially in those areas that rely on individual capital gains taxes to pay for services,” she writes. 

Oregon’s Capital Gains Tax is Too High
http://www.oregonlive.com/opinion/index.ssf/2012/09/oregons_capital_gains_tax_is_t.html
In this house editorial in the Oregonian, the editors contend Oregon’s capital gains tax, which is among the nation’s highest, should be lowered to keep citizens from moving out of the state: “The rates imposed by individual states matter because people may move freely, and taxpayers can time their capital gains. Don’t want to pay the tax? Don’t sell your asset until you’ve established residency in a more hospitable state—like Washington, which, like eight other states, does not tax capital gains.”

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the FIRE Policy News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.