Washington Research Council Blog

Why it's a mistake to increase capital gains taxes

In an earlier column, I pointed out that several problems with proposals to tax capital gains in our state. With key legislators, including the Senate Ways and Means chair, still promoting the idea, I wanted to call attention to a recent blog post from the American Enterprise Institute. Some very effective debunking of prevalent myths.

 As a new study from Ernst and Young shows, taking into account both the corporate and investor level taxes on corporate profits and state level taxes, the United States has among the highest integrated tax rates among developed countries. 

RTWT

Cities continue to block B&O tax simplification backed by business, governor

For years, business groups have sought a way to simplify the state's myriad municipal business and occupation tax regimens. AWB president Don Brunell devoted his column this week to the issue, indicating support for Gov. Gregoire's tax simplification proposal.

B&O taxes are assessed on a business’ gross income, regardless of profit. The state imposes a B&O tax, but local jurisdictions do as well. The amount of the local B&O taxes, as well as how they’re calculated, varies from one jurisdiction to the next.

...Under the governor’s proposal, the state of Washington would be the single collector of all local and state B&O taxes, and the state would rebate to each local jurisdiction their share of the tax -- similar to how the state currently handles state and local sales taxes.

Five major cities opposed the plan. AWB's Jason Hagey writes at the Olympia Business Watch blog that the opponents so far are unwilling to compromise. He reports that the cities' objections have been solidly rebutted.

Early in the session, cities were complaining about the governor's original proposal, claiming it would cost them millions of dollars.

That prompted a detailed rebuttal from the Department of Revenue, knocking down virtually all of the concerns. It is clear, officials said, that the cities misconstrue the impacts from some parts of the proposal.

Regulatory reform and tax simplification are two positive steps the state can take that will boost business activity. We documented many of these issues in our Thrive Washington series and other WRC reports over the years. It's time to act.

New Brief: Nation's Seventh-Best Business Climate?

Last week, the Tax Foundation released its annual ranking of state business tax climates.  Washington--largely thanks to our lack of an income tax--ranks seventh in the nation.  In a policy brief, we discuss the ranking and what it means for Washington.  This brief builds on a post from Dick last week.

Machinery & Equipment Exemption Key to Keeping Jobs, Investments in Washington

Manufacturing continues to be a strength of Washington's economy. We have published a Policy Brief on the machinery and equipment exemption, which contributes to that strength by encouraging the capital investments that anchor manufacturing here.

Tax Foundation: WA has nation's 7th best business tax climate. There's more.

The Tax Foundation, a respected national tax policy research group, released its annual report ranking the business tax climate in the 50 states. As it has in the past, the group gives Washington generally high marks. This year, the state comes in No. 7, up one from last year's 8th place ranking. 

Here's the TF news release, blog post, and full study.  

Although we've been critical of the TF methodology in the past (see here, for example), we believe the study provides an abundance of good information about state tax policy and its impact on business. Moreover, they have consistently improved their methodology. Our criticism focuses on two issues:

1. It's not clear to us that it is possible to rank states fairly on a single business tax climate index. There's simply too much variation in how tax policy treats different sectors for the ranking to be as clean as most analysts would like.
2. The TF methodology gives extraordinary weight to income tax issues. The top 10 states in this year's ranking are, in order, Wyoming, South Dakota, Nevada, Alaska, Florida, New Hampshire, Washington, Montana, Texas and Utah. 

TF explictily accepts the charge of overweighting the absence of a major tax.

It is obvious that the absence of a major tax is a dominant factor in vaulting many of these 10 states to the top of the rankings. Property taxes and unemployment insurance taxes are levied in every state, but there are several states that do without one or more of the major taxes: the corporate tax, the individual income tax, or the sales tax. 

Several of these states, including Washington, have also been high growth states. As noted in our analysis of Initiative 1098, states with steep progressive income tax rates have been substantial losers in the competition for jobs and investment. In that policy brief, we cited the 2010 TF report,

No matter what the average rates are, the high marginal rates will affect the state’s position in several prominent national business climate rankings. Washington ranks 9th best in the Tax Foundation’s 2010 State Business Tax Climate Index. The overall index bends five major components indexes: corporate tax, individual income tax, sales tax, unemployment insurance tax and property tax. Washington ranked 33rd, 1st, 50th, 26th, and 21st respectively in these components. The state’s high overall ranking was largely dueto the lack of an income tax, which resulted in the “number one” ranking in that component.

This year, we rank 30th in corporate tax, 1st in individual income tax, 48th in sales tax, 18th in unemployment insurance and 22nd in property tax.

It's important to read the Tax Foundation report as one useful barometer of business tax climate. Another, complementary, approach is taken by the Council on State Taxation. We reported on the COST business tax study in a blog post last summer. The crux:

COST finds that state and local business taxes in Washington amount to 5.4 percent of Gross State Product, significantly higher than the US average of 5.0 percent. 

In my column this morning, I write about legislative proposals for a new personal and business income tax, a capital gains tax, and extending the sales tax to personal and professional services. Each of these proposals would exert a drag on our business tax climate. I'll not go into detail here. Please read the column. I should note this finding from the TF report:

States with the worst scores on the [sales tax]  are Hawaii, New Mexico, Washington, South Dakota and North Carolina. Their tax systems hamper economic growth by including too many business inputs, excluding too many consumer goods and services, and/or excessive rates of excise taxation.

Keep that in mind when you hear charges of "excessive" use of tax incentives in this state. 

We and others have been critical of business taxes here. There's room for improvement. And there are some things we're getting right. It would be a tragic mistake to use the good news to promote bad business tax proposals. 

Proposed capital gains tax would add volatility to state tax structure

State Rep. Laurie Jinkins, D-Tacoma, has proposed a new, 5 percent capital gains tax. Introduced as HB 2563, the measure has picked up 26 Democratic sponsors and will doubtless generate a bit of buzz. At least the think tank that germinated the idea is pleased. Here's what the Washington State Budget and Policy Center has to say about it today:

House Bill 2563, which would create a new 5 percent excise tax on high-end capital gains in Washington, would tap this highly concentrated economic resource in order to restore public investments in health care, education, and other public structures proven to foster job-creation and broadly-shared prosperity.

The Center displays a graph based on Congressional Budget Office data showing that capital gains are increasingly more concentrated among the nation's wealthiest taxpayers. The graph ends at 2007, as do most of the media reports of the growing wealth disparity in this country. It reminded me to check back on this Alan Reynolds op-ed in in the Wall Street Journal. 

Looking at the CBO's report on income inequality, Reynolds writes:

...here's a question: Why did the report stop at 2007? The CBO didn't say, although its report briefly acknowledged—in a footnote—that "high income taxpayers had especially large declines in adjusted gross income between 2007 and 2009."

No kidding. Once these two years are brought into the picture, the share of after-tax income of the top 1% by my estimate fell to 11.3% in 2009 from the 17.3% that the CBO reported for 2007.

The larger truth is that recessions always destroy wealth and small business incomes at the top. Perhaps those who obsess over income shares should welcome stock market crashes and deep recessions because such calamities invariably reduce "inequality."

Setting aside the unanswerable "fair share" questions, let's consider what taxing capital gains might mean to the state's revenue stream. As Reynolds points out, incomes at the top tend to be volatile. California serves as a poster child for the hazards of overreliance on taxes that fall most heavily on the wealthy.

Stateline.org reports: 

With a revenue system that's heavily dependent on income taxes on the wealthy, California's budget has a history of unexpected booms and busts that reflect the vagaries of the national economy. In that context, it's notable that the state Legislative Analyst's Office (LAO) has declared that "revenue estimates are an even bigger question mark than usual for the Legislature this year."

Sure, there's the uncertainty associated with taking a tax plan to the voters. But even clearing that hurdle doesn't solve the problem. Capital gains taxes are tricky.

Forecasting capital gains is notoriously difficult. That's partially because all economic forecasting is imprecise, but also because capital gains can rise and fall suddenly, independent of the expansions and contractions of the economy as a whole...

The very wealthy tend to claim a greater proportion of their income in capital gains. For that reason, the revenue from Brown's income tax plan depends heavily on the capital gains number. By targeting the rich, Brown's plan would make California's tax code more progressive, but also potentially more volatile. 

That "potentially" is a nice, but unnecessary, qualifier.  

Capitol Weekly has this.

Gov. Brown’s latest budget reflects California’s risky, roller-coaster reliance on uncertain revenues generated by wealthy taxpayers. And there’s no immediate end in sight, given that the governor wants voters’ permission to raise those taxes further in November.

That assessment from the Legislature’s nonpartisan fiscal adviser is at the heart of its analysis of the governor’s draft budget for the 2012-13 fiscal year which he hastily unveiled last week amid a staff mix-up. The year begins July 1.

“Already, California's budget is dependent on volatile income tax payments by the state's wealthiest individuals,” the Legislative Analyst noted.

I understand that lawmakers here are interested in some new revenue. If they're serious about long-term sustainability, capital gains taxes should be the last place they look. No need to take that roller coaster ride.

A longer-term look at state budget gaps

Sunday the Seattle Times editorial board released a series of reforms necessary to guide the state back to a sustainable budget. It's a smart list, including a number of ideas that we have written about in the Thrive Washington series and in various WRC policy briefs.

As important, the editorial examines the growing gap between available revenues and projected spending. This is an issue framed early by Sen. Jim Kastama (D - Puyallup) in an informative video. The WRC has taken a look at the trend lines, and using information from the state budget office, updated the information. The trends are, as Kastama noted, alarming. The Times editorial includes our graph.

When a trend cannot continue, goes Stein's law, it must come to an end. Sooner, rather than later, we hope.

Perspective on changes in state revenue collections

In my column this morning, I discuss how and why state revenues have fallen as a share of the economy. 

State revenues have fallen as a share of the economy. But it's mostly because taxpayers rejected the higher burdens.

Please go to the column for context. And, yes, revenues have even fallen since 1995 on an inflation-adjusted per capita basis. 

Also worth noting, the National Association of State Budget Officers recently released its annual fiscal outlook. 

Despite these recent relative gains [in tax collections and spending], aggregate state revenues and spending figures remain below their prerecession levels.  

...total enacted general fund spending in fiscal 2012 is still $20 billion, or 3.1 percent, less than the pre-recession high of $687 billion in fiscal 2008.

Stateline.org has more.

“Two years after very significant tax increases at the state level, this report shows the first actual decrease since 2007, and part of this is due to factors like the expiration of sales taxes in certain states,” NASBO Executive Director Scott Pattison tells Politico. “The findings do demonstrate the political will to increase taxes was lacking in 2011 and this is expected to be more pronounced in election year 2012.”

We'll soon find out.

State revenues recovering slowly - still below peak

After yesterday's forecast, we received some questions about how state revenues have performed historically. Kriss put together a graph showing Near General Fund State (NGFS) collections, including the forecast through 2013. These projections show tax receipts not climbing back to 2008 levels until the end of the biennium.

This chart, tracking NGFS spending since 2000, shows how stimulus spending from the feds filled the gap last biennium. 

Discuss.

Will Washington voters approve higher taxes? It's a tough sell.

In my column this morning, I take a look at recent election results and the state revenue collections report to consider the likelihood of voter approval of new taxes to balance the state budget. It's never risky to bet against tax hikes. Good times or bad, voters are reluctant to part with their money. 

Colorado and San Francisco voters turned thumbs down on tax increases for education, public safety and social services. Seattle voters rejected a $60 car tab increase while they approved property tax hikes for a families and education levy.

KING5 reports Gov. Gregoire will release her proposed spending plan next Monday, identifying at the same time her ideas for raising revenues to buy back some of the cuts. (Link and video here.)  

Meanwhile, a new KING 5 poll finds state residents are not necessarily excited about raising taxes, despite the threat of serious budget cuts. When asked if the state should raise taxes to reduce the impact of the governor’s proposed cuts, 64 percent said the state should not raise taxes, while 27 percent said they’d support a tax increase.

Tough odds. And as AWB president Don Brunell points out, small businesses in the state are already struggling with high costs. The budget crisis is also an opportunity to make it a little easier to create jobs and investment here.

The point Gov. Gregoire and lawmakers can't lose sight of is Washington is a high cost state and they need to find ways to lower costs for workers' comp, unemployment insurance, regulations and permits, stormwater charges and health care--and not just settle for raising taxes and fees. 

The conclusion from my column:

Hiking taxes while cutting spending poses a special challenge. There's no appetite for paying more for less. Legislators will have do two things: identify the tangible benefits gained from the revenue boost and demonstrate that they've accomplished substantive, enduring government reform. Before casting an affirmative vote -- an unlikely event at best -- a skeptical public will want proof.

The official revenue forecast comes out tomorrow. There will be no upside surprise. Special session starts November 28.