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The
Massachusetts legislature wants to raise the tax on capital
gains. The new tax would yield about $131 million in new revenue.
And there’s a worthy cause: The new revenue could be
used to fund school construction.
Listening
to talk about capital gains taxes is an eye-glazer for most
people – the kind of thing that excites only the bean
counters among us. More important, there is the impression
that capital gains taxes are paid mostly by high-income taxpayers.
The majority of us are thus not much affected by increases
in capital gain tax rates.
If
you believe that, please read on.
Under
the budget approved by the Massachusetts House and Senate,
state taxpayers making less than $20,000 per year will pay
a new tax equal to .54% of their taxable income. Taxpayers
making more than $200,000 per year will pay only .38%. This
is a tax increase that hits lower-income taxpayers the hardest.
How
can this be? The answer lies in the increasing democratization
of the equity markets. With the boom in stocks, more and more
individuals from across the economic spectrum own equities.
In 1998, 43% of all U.S. household owned mutual funds. Among
households with incomes less than $50,000, 27% owned mutual
funds.
The
Internet is making the stock market more accessible for small
investors. And stock ownership is an increasingly attractive
form of employee compensation. Massachusetts companies like
Lotus, Raytheon, Office Max, EMC, Home Depot, Wal-Mart, and
Polaroid routinely offer their employees company stock at
a discount. Stock ownership is no longer the exclusive domain
of the corporate executive.
Lower-income
people are likely to sell stock to tide themselves over economic
hardship, should it arrive. A household in which the principal
breadwinner becomes unemployed could easily see its income
drop to $20,000 a year or less. One way to weather the crisis
is to sell stocks.
There
are far more taxpayers at the lower end of the income spectrum
than at the higher end. In 1997, for every Massachusetts taxpayer
reporting capital gains or losses who had an income of $200,000
or more, there were three such taxpayers who had an income
of $20,000 or less. Capital gains represented about half of
the taxable income of taxpayers in the lower-income group
who reported capital gains or losses.
There
are other issues to be considered. Under current law, the
capital gains tax goes to 1% on assets sold after five years
and to zero on assets sold after six years. The proposed budget
would change the law so that assets sold after five years
were taxed at 2%.
Investors
want to know what taxes, if any, they will have to pay on
the sale of an asset. If the law says they won’t have
to pay any tax by holding the asset for six years, then that’s
a reason to buy and hold onto the asset. Turning around five
years later and raising the tax to 2% is a double cross –
the kind of thing that will make the same investors think
twice before buying another asset.
Besides
the negative consequences for individual investors, hiking
the capital gains tax will have negative consequences for
the Massachusetts economy. It will eliminate $921 million
dollars in spending on capital equipment and structures, including
factories, warehouses, office buildings, computers and delivery
trucks. Local governments will lose $8.9 million in property
taxes as a result of the reduced construction.
Finally,
there’s the matter of trust in government. Five years
ago, the legislature got a substantial and controversial pay
raise. The political justification was that taxpayers got,
in return, a reduction in capital gains taxes, part of which
the legislature now wants to rescind.
Most
policy issues involve tradeoffs. In the end, we hope there
are more winners than losers. When it comes to this tax hike,
there are no winners. It’s a loser for low-income households,
for the state economy and for the taxpayers who were betrayed
by the legislature.
No
matter how worthy its motives, the legislature should find
some other way to raise new revenue. The state, moreover,
stands to run up another big surplus, from which it could
easily squeeze out another $131 million in revenue. This triple
loser should strike out.
David Tuerck is Executive Director of the Beacon Hill Institute
at Suffolk University in Boston where he also serves as Chairman
and Professor of Economics.
This
article first appeared in Mass High Tech on July 12, 1999.
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