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Capital Gains Hike Would Hurt
Low-Income Taxpayers Most, Cost Millions in Capital Spending and Local
Revenues
June
1999
In
1994, the Massachusetts legislature passed a cut in the tax on long-term
capital gains (assets held a year or more). [1]
The rate, then 6%, was lowered to 5% for assets held 1-2 years, 4% for
2-3 years, 3% for 3-4 years, 2% for 4-5 years and 1% for 5-6 years.
The rate was to go to zero for assets held six or more years.
The
Fiscal Year 2000 budgets approved by the Massachusetts House and Senate
would rescind the planned reduction in tax rates on assets held five
years or more. This would, in effect, raise rates on these assets, creating
a minimum 2% tax on capital gains. [2] See Table 1.
Table
1: Current and Proposed Taxes on Long-Term Capital Gains
Years
Held |
Current Tax Rates |
Proposed Tax Rates |
At
Least |
But Less Than |
(%)
|
(%)
|
1
|
2
|
5
|
5
|
2
|
3
|
4
|
4
|
3
|
4
|
3
|
3
|
4
|
5
|
2
|
2
|
5
|
6
|
1
|
2
|
6
|
|
0
|
2
|
The
House and Senate proposals would require Massachusetts investors to
pay an additional $131.2 million in capital gains taxes in 2002. The
additional revenue amounts to about .6% of the budget.
Highest
Tax to Fall on Lowest Income Group
There
is a perception that government should raise the capital gains tax because
it falls almost entirely on the rich. That perception is, however, wrong.
Taxpayers at all ends of the income spectrum realize capital gains and
pay capital gains taxes. Moreover, the increase in the capital gains
tax rate brought about by the House and Senate budget proposals would
fall far more heavily on capital gains filers in the lowest income
group than it would on capital gains filers in the highest income
group.
Here
are the facts: Of the 684,268
Massachusetts
taxpayers who reported capital gains or losses in 1997 (the latest year
for which data are available), 46% were taxpayers with an adjusted gross
income (AGI) of $50,000 or less. Only 24% had an AGI of $100,000 or
more. Notably, the largest fraction (21%) fell in the lowest income
group (under $20,000) and the smallest fraction (8%) fell in the highest
income group ($200,000 or more). [3] See Figure 1.
Figure
1: Fraction of Massachusetts Capital Gains Filers by AGI Group, 1997
Source:
U.S. Internal Revenue Service, Statistics of Income Bulletin,
Spring 1999. See footnote 3 for details.
Insofar
as low-income filers reporting capital gains or losses realize high
capital gains relative to their taxable income, a rise in the capital
gains tax will impose a relatively heavy economic burden on those taxpayers.
It turns out that the House and Senate budgets impose just such a burden.
The
new law would raise the average tax rate on capital gains by .52 percentage
point by 2000 and by 1.08 percentage point by 2001. By applying this
tax increase to state taxpayers reporting capital gains or losses, it
is possible to determine, by income group, the increase in the tax rate
that these taxpayers would bear under the new law. Figure 2 shows the
increase in tax for each income group.
As
shown, the lowest income group would suffer the highest tax hike. Taxpayers
reporting capital gains with an AGI less than $20,000 would pay .54%
more of their taxable income in taxes, whereas taxpayers reporting capital
gains with an AGI of $200,000 or more would pay only .38% more. [4]
Put differently, the tax increase would be 42% greater for the low-income
taxpayers than it would be for the high-income taxpayers.
While
this result might seem counter intuitive, it is easily explained. Low-income
households often sell assets in order to support themselves over periods
of economic hardship (unemployment, for example). If a household sees
its income fall, say, from $40,000 per year to $20,000 per year, it
is not
Source:
U.S. Internal Revenue Service, Statistics of Income Bulletin,
Spring 1999. See footnote 3 for details.
likely
to reduce its consumption by half. Rather, it is likely to finance part
of its consumption out of capital gains, on which it will be compelled
to pay taxes. Raising the capital gains tax imposes a greater burden
on this household than it would on a wealthier household that might
realize capital gains in the course of everyday market trading.
Among
Massachusetts taxpayers who would be affected by the tax hike, there
are many more in the lowest AGI group than there are in the highest
AGI group. Of Massachusetts taxpayers who reported taxable income and
whose AGI was less than $20,000, 142,985 reported capital gains or losses.
The figure for taxpayers with an AGI of $200,000 or more was 52,569.
There were therefore almost three times as many low-income as high-income
taxpayers reporting capital gains or losses. The capital gains hike
is far larger for low-income than for high-income taxpayers and
falls on far more low-income than high-income taxpayers.
Economic
Effects on Massachusetts
As
mentioned, the House and Senate proposal would raise the effective capital
gains tax by 1.08 percentage point. This would exert adverse economic
effects on the state economy. Because Massachusetts is a high cost-of-living
state, a rise in the capital gains tax or any tax deters
people from working and investing in the state. That, in turn, deters
business from spending on new capital factories, computers, office
buildings, warehouse space and other equipment and structures. The further
result is a shrinkage in tax revenue from other sources, including the
revenue collected by local governments on commercial property.
As
a result, by 2002, there would be $920.9 million less in capital construction
than there would have been under the current rate schedule. Local governments
would collect $8.92 million less in tax revenue. See Table 2.
Table
2: Effects of Rescinding Current Capital Gains Law
|
Effect
on Average
Tax Rate on Capital
Gains
|
Effect
on State Tax
Revenue*
($ millions)
|
Effect
on
Capital Stock**
($ millions)
|
Effect
on Local Property
Tax Revenues**
($ millions)
|
2000
|
+
0.52 |
+
31.6
|
-
446.6
|
-
4.33
|
2001
|
+
1.08 |
+
97.2
|
-
923.0
|
-
8.95
|
2002
|
+
1.08 |
+
131.2
|
-
920.9
|
-
8.92
|
*
Fiscal year (all other changes are shown by tax year).
**Differences
between the 2001 and the 2002 numbers stems from a projected decrease
in the relative importance of capital gains in 2002 as a fraction
of unearned income.
The
proposed rise in the capital gains tax would therefore fall with particular
severity on low-income taxpayers and would impose substantial losses
on the economy. It would also create a climate of uncertainty about
the after-tax return that investors can expect to realize on their assets.
The addition to state revenues that would be realized appears not to
justify the cost, measured in terms of both equity and economics, that
it would impose.
The
Beacon Hill Institute at Suffolk University is a nonprofit, nonpartisan
research organization that performs economic analysis on public policy
issues of importance to Massachusetts voters and taxpayers. The estimates
provided here were obtained by using BHI's State Tax Analysis Modeling
Program (STAMP). Details on the application of STAMP to this BHI
FaxSheet and further methodological details are available on request.
Footnotes
[1]
In December 1994, in conjunction with a legislative pay raise package,
Governor William F. Weld signed a bill cutting the state's capital gains
tax rate (see State House News Service, Roundup-December 15,
1994).
[2]
Given that this change would (by Massachusetts Department of Revenue
estimates) affect 56% of all assets, it would cause a substantial rise
in the effective tax rate on capital gains (computed by weighting the
rate applicable to each holding period by the fraction of assets held
over that period). This, in turn, would have a large and negative impact
on Massachusetts capital spending and on tax revenues collected by local
governments.
[3]
U.S. Internal Revenue Service, Statistics of Income Bulletin,
Spring 1999, Total File, All States, Individual Income and Tax
Data, by State and Size of Adjusted Gross Income, Tax Year 1997.
See http://www.irs.ustreas.gov/prod/tax_stats/soi/ind_agi.html, 97IN54CM.EXE.
We used data on federal individual income tax returns for Massachusetts
taxpayers.
[4]
Ibid. The methodology underlying these estimates is as follows: Let
CG be the ratio of total capital gains to the number of filers
reporting capital gains or losses in a given income group. Let TI
be the ratio of total taxable income to the number of all filers in
that income group. Then the tax rate rises by (.0108*CG/TI)*100
percentage point. This assumes that average taxable income is the same
for taxpayers reporting capital gains as it is for all taxpayers in
a given income group.
Comments:
fconte@beaconhill.org.
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