The Seattle Time’s Danny Westneat recently wrote a column in which he pointed to California’s budget surplus for the second year running. He states that California is no longer America’s Greece. Rather, Washington State appears on the verge of earning that unflattering distinction. Westneat writes,
“Washington state is the one heading into 2015 with big budget deficits — as much as $5 billion, or 13 percent of the two-year budget, depending on if state lawmakers choose to follow both voter and court orders to spend more on schools.”
What is the secret to California’s budget redemption? According to Westneat, California’s capital gains tax went along way to solving deficit problems. Alternatively, the tax does not exist in Washington State. Westneat,
“Some of California’s black ink has flowed from a tax we don’t have, and no, it’s not the income tax. Like 41 other states, California taxes capital gains — profit from the sale of stocks and investments. It’s volatile, so Brown joined it with a conservative policy that saves excess amounts from boom years in a rainy-day fund.
The Puget Sound area is so frothy with investment profits that a 5 percent tax on capital gains, with exemptions for the first $10,000 and the sale of primary homes, would raise $1.3 billion per biennium, the state estimates. Only 2 percent of the state’s 3.1 million taxpayers would pay it.”
But, has the capital gains tax really been the answer to all of California’s budget woes? After all, California is currently on a path toward hiking college tuition at a rate of 5% annually over the next five years. Or, is the notoriously volatile tax just a short-term fix which, ironically, creates long-term problems? Many top economists believe it to be the latter. Forbes,
“California’s top marginal tax rate of 33% is the third-highest tax rate in the industrialized world, behind only Denmark and France. That creates a bias against savings, slows economic growth, and harms U.S. competitiveness…
The lack of an adjustment for inflation makes it doubly painful. Your effective capital gains rate could be even higher. After all, much of the increase in the value of the asset might be due to inflation, not to real gains…
California taxes capital gains just like income, as high as 13.3%. You pay up to a 33% combined federal and state tax on capital gains in California. That means you’re paying more than virtually anyone else in the world. Experts say the impact isn’t just digging deeper at tax time…
In fact, such a high tax rate has long-term negative implications for the economy. People save less and invest less.”
A study conducted by the Tax Foundation found that our nation’s high capital gains tax—let alone an additional state capital gains tax—is “problematic, because the capital gains tax creates a bias against savings, slows economic growth, and places a double-tax on corporate profits.” Additionally, the Tax Foundation points out that “although these problems with the capital gains tax are well known, there is a more subtle issue with the tax that makes it even worse for taxpayers than these conventional concerns suggest.” The Tax Foundation,
“Under the federal tax code, the increase in an asset’s price is determined as the nominal amount (i.e., not adjusted for inflation). When an asset (often a stock) is sold above its purchase price, a gain is realized and is taxed. Any capital gain due to inflation is not accounted for, and the taxpayer is taxed on both their increase in income and on increases in prices economy-wide. As a result, the effective tax rate on the real (inflation indexed) capital gain has exceeded the statutory rate every year since 1950 and has averaged around 42 percent.
“In some instances, the practice of taxing the nominal gain can lead to an infinite effective rate on real capital gains when the increase in price is only due to inflation. In fact, if a taxpayer purchased an average stock in 1999, 2000, or 2007 and sold in 2013, they would be taxed entirely on inflation.”
Ultimately, the Tax Foundation found the capital gains tax to be “more damaging than other taxes because of the bias it creates towards consumption over savings and investment.” It concludes that repealing the capital gains tax is the best course of action in order to “stop the damaging practice of taxing individuals on inflation” and “produce positive long-term dynamic effects for the economy.”