The debate over capital gains taxes taking place on the national stage in the run-up to this year’s presidential elections could have major implications for local and state governments in the Washington region, economists say, particularly if the Bush tax cuts are allowed to expire.
Capital gains are not just a key source of income for the wealthy, one that critics say allows them to pay lower taxes, but they are a big source of revenue for the District, Maryland and Virginia.
“We have a lot of wealthy people here, and wealthy people have a lot of capital gains,” said Marty Sullivan, an economist at Tax Analysts.
Comprised of profits from investments such as stocks, bonds and real estate, capital gains have fallen in recent years as the stock market plunged and the housing market soured. The ailing economy, coupled with lower tax rates for capital gains has led to “tens of millions” of dollars of lost revenue for the District alone, said Fitzroy Lee, deputy chief financial officer at the District’s Office of Revenue Analysis.
In 1997, then-President Bill Clinton lowered the tax rate for capital gains to 20 percent from 28 percent. Six years later, President George W. Bush trimmed the rate further to 15 percent. Bush’s tax cuts are slated to expire on Jan. 1, 2013, unless Congress intervenes.
Revenue from “capital gains [has] really suffered after the tax cuts,” said Anirban Basu, chairman of Sage Policy Group, an economic policy firm in Baltimore. “The impact of reduced capital gains has been huge, particularly for state and local government budgets.”
Increased federal tax revenue from capital gains would trickle down to local and state jurisdictions in a variety of ways, ranging from infrastructure projects and local grants, Basu said.
“It’s often thought that the job of a congressman is to bring home the bacon,” he said. “When capital gains taxes go up, there’s more bacon to bring home.”
Some analysts worry that raising tax rates on capital gains could hamper investment, hurting stock prices and creating a new drag on state revenue rather than boosting them.
But Basu said the benefits would likely outweigh the risks.
“It’s probably the case that if capital gains taxes went up, capital gains revenue would go up, too,” he said.
And he’s not alone.
“Fifteen percent is very low,” said Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities. “Lots of wealthy people are paying way too little.”
Capital gains have figured in the presidential debate because the people who have them tend to be more affluent than those that don’t, helping them to reap the benefits of the lower taxes rates than if their wealth came from ordinary income. For instance, most of Republican contender Mitt Romney’s annual income comes from dividends and capital gains. President Obama has offered a variety of proposals over the years—including increasing the capital gains rate on the wealthy—that would require the well-to-do to shoulder a larger burden.
Revenue from capital gains has dropped considerably in recent years — as much as 70 percent from one year to the next in the District. In Maryland, where many counties have “piggyback” income taxes, economists say the blow is magnified even further.
“Capital gains are very important to the District’s economy,” Lee said. “It causes very big swings in our revenue.”
Revenue from non-withholding taxes, which include capital gains, as well as estimated payments and refunds, accounted for about $100 million of the District’s $4.9 billion local tax revenue last year, Lee said.
The proportion of Maryland, Virginia and District residents claiming capital gains has dropped significantly since 1997, mirroring a national trend that economists say may not turn around until 2014.
In 1997, 85 percent of District, Maryland and Virginia residents with adjusted incomes of $200,000 or more claimed capital gains. By 2009, the most recent year for which the IRS provides data, that number was down to 58 percent, according to a Capital Business analysis.
“One of the reasons state and local budgets were so flush with cash in the middle part of the last decade is largely a story of capital gains,” Basu said.
In Virginia, where all forms of income, whether from wages or investments, are taxed equally, officials say they do not track trends in capital gains, according to Joel Davison, public relations manager for the state department of taxation.
According to IRS data, 16 percent of Virginia residents reported capital gains in 2009, compared with 14 percent of Americans. Last year, the state created a capital gains exemption for certain small technology companies.