A Capital Gains Tax Cut Would Worsen Maine’s Budget Gap and Make the Tax System Even More Unfair

February 19, 2013 by

Just when you thought that Maine lawmakers might be getting the message that a majority of Mainers want the wealthy to pay their fair share of taxes, the legislature’s taxation committee voted Friday on a bill that would yet again cut taxes for the wealthy and stick everyone else with the tab.

Last week, the taxation committee heard public testimony and voted on legislation that would dramatically cut the tax rate on capital gains income. It’s a bad idea that would cost the state another approximately $40 million per year at a time when we have a two-year budget gap rapidly approaching a billion dollars— roughly 16% of the state’s general fund. The bill, LD 65, would reduce the tax rate for people who make their money buying low and selling high and would require everyone else to make do with fewer essential public services or pay more taxes to pick up the tab. And despite claims by proponents of the legislation, there is little reason to expect it to stimulate the state’s economy, create jobs, or increase wages for working Mainers.

Income from capital gains is derived by selling assets for a price that’s higher than what you paid for them. The most common types of assets that yield capital gains are property (although primary residences are exempt from capital gains tax), and financial assets like stocks and bonds. Capital gains are taxed like any other form of income in Maine. In most cases, that means they are taxed at the top marginal rate of 7.95%, since that rate kicks in at a relatively low income level—about $21,000.

LD 65 would separate capital gains from other forms of income and tax them at a flat rate of 3%.

Under LD 65, wealthy investors who earn large portions of their income not through wages and salaries but rather through the buying and selling of assets would get preferential treatment under Maine’s income tax code. LD 65 would make a state and local tax system that already favors the wealthy even more unfair.

At the federal level, capital gains are given this sort of preferential treatment­—they are taxed at 15-20% while regular earned income is taxed at rates up to 39.6%—is why billionaire investor Warren Buffett pays a lower tax rate than middle-class Americans working for wages and salaries. LD 65 would create a similar scenario for investors reaping capital gains in Maine.

Of course, this isn’t exactly how the proponents of this legislation are framing their support for the bill. They claim that cutting taxes for the “investor class”—the exact phrase used by a proponent of the legislation during debate last week—will create jobs and grow the economy. And despite the initial estimated $40 million price tag for the bill, the bill sponsor actually claims that it will produce a net revenue gain for the state, after all of the “dynamic effects” are accounted for.

This is where the conversation has little basis in fact. Proponents of tax cuts have been extolling the virtues of “dynamic” estimates of the fiscal impact of proposed legislation for many years now. They claim, for example, that the estimated $40 million that LD 65 would cost the state’s general fund is only a “static” estimate that doesn’t account for the increase in economic activity that would result from a special lower tax rate for capital gains income.

Dr. Michael Allen, Associate Commissioner of Tax Policy, gave testimony clearly indicating that the chance of the state realizing a revenue increase from the proposed capital gains tax cut was virtually impossible. In order for the “dynamic” effects of the tax cut to offset the $40 million “static” loss in revenue, capital gains income in the state would have to double. Looking back at historic revenue data, Dr. Allen told the taxation committee that has never happened.

In reality, dynamic estimates of the fiscal impacts of tax cuts are usually small- 20% of the static impact at most, but usually closer to 10%. Arizona’s state legislature found that the dynamic effects of cuts to individual income taxes were usually around 5-6%.

Unfortunately for those wishing to use dynamic revenue impact estimates to push for tax cuts like LD 65, the dynamic impact of a tax cut is more complex than they describe. Since Maine constitutionally requires a balanced budget, a dollar spent on tax cuts is a dollar that can’t be spent on providing public services—investing in research in development, training workers, educating kids, and purchasing affordable health care for elderly and disabled persons or low-income families. That dollar of public spending has “dynamic” effects as well. In fact, public dollars are more likely to stay in the state since they are spent on locally-provided services like education and health care. A dollar spent on tax cuts is more likely to be spent on imported goods or invested outside the state. That “leakage” factor is one of the reasons that the dynamic impacts of tax cuts aren’t nearly as big as tax cut advocates like to think they are.

The committee report on LD 65 was divided (8-5 ought not to pass; 5-8 ought to pass as amended), so we will likely see a vote on the floor of the House, where it originated.

Let’s dispense with the faith-based approach to growing our economy and creating jobs—cutting taxes for the wealthy and waiting for magic to happen—and instead make the investments in people, transportation, and technology that are proven to create jobs and grow the economy.

3 Responses to “A Capital Gains Tax Cut Would Worsen Maine’s Budget Gap and Make the Tax System Even More Unfair”
  1. Joel, the reduction of the capital gains tax rate on individuals is good tax policy because the tax results in the double-taxation of income. Corporations first pay the corporate income tax. As such, the return on stocks and bonds is already reduced by the amount of corporate taxes paid.

    Therefore, the capital gain realized by investors has already been taxed once at the corporate level. The capital gains tax at the individual level is another layer of taxation. In Maine, that results in an effective capital gains rate of up to 16.88 percent (8.93 corporate and 7.95 percent individual).

    The “rich” are already being soaked which is why there are so fewer of them in Maine costing the state up to $400 million per year in lost revenue.

  2. Joe says:

    UNBELIEVABLE! Talk about VOODOO Economics!

  3. Joel Johnson says:

    Scott, your point about double-taxation is peripheral to the issue. The total amount of taxes paid per dollar of income is what matters. Is it double-taxation when you pay sales tax on building materials for a new addition to your house and then pay new property taxes on that addition? Is it double-taxation when businesses pay income tax on profits, sales taxes on inputs, and then sales taxes are levied on the final product? These are trivial questions.

    What matters is the effective tax rate- the total amount of dollars paid per dollar of income. At the household level of analysis, we know from Maine Revenue Services that the top 1% of Mainers, which disproportionately includes folks earning capital gains, pays a significantly lower effective state and local tax rate than middle-income folks. And that includes an imputed tax burden from Maine’s corporate income taxes. The most fortunate families in Maine pay less per dollar of income than everybody else.

    All of this doesn’t even touch the fact that many corporations pay extremely low effective tax rates on their profits; way below what the statutory marginal rates would suggest. That’s in part because the rules aren’t consistent or fair – corporate tax loopholes and offshore tax havens have made it possible for some of the world’s largest corporations to pay no income tax in some years.

    The special treatment of capital gains income at the federal level is another example. It’s why Warren Buffet pays a lower effective tax rate than middle class families. Your back-of-the-envelope calculations using marginal tax rates say very little about what actually happens at the end of the day. We have to look at how much people actually pay per dollar.

    Your analysis of why Maine doesn’t have as many rich people as New Hampshire fails to account for the fact that over three-quarters of New Hampshire residents live in Greater Boston and benefit from all the opportunities that one of the wealthiest metropolitan areas in the country offers its residents.

    Anybody can find an anecdote about rich people fleeing the state because of taxes, but finding empirical data is much harder. What the data does show is balanced trade of residents and their income between Maine and New Hampshire. If rich Mainers were leaving because of high taxes, wouldn’t we expect a lot of them to turn up in New Hampshire. The IRS data don’t show it, as I wrote in a post last year.

Leave a Comment