A Capital Gains Tax Would Hurt Economic Opportunity in Washington State

Washington state has a competitive advantage when compared to neighboring states because the state does not currently levy a tax on wage income or capital gains. In fact, the state’s own Department of Commerce agrees, stating, “We offer business some competitive advantages found in a few other states. These include no taxes on capital gains or personal or corporate income.”

Recently, however, the Department of Commerce has removed the capital gains mention on their website. In fact, Governor Jay Inslee has proposed a seven percent tax on the capital gains from the sale of stocks and bonds more than $25,000 for individuals and more than $50,000 for joint filers to fund an education legacy trust account. Currently, the Washington legislature is in special session, and they are also considering multiple capital gains tax proposals. However, as our own research in Rich States, Poor States documents, a capital gains tax is an unstable source of revenue and harms economic growth. Furthermore, a study by economist Allan Sinai found that a decrease in the federal capital gains tax rate leads to higher growth in gross domestic product,  productivity, and employment.

While Governor Inslee estimates that the seven percent tax on capital gains could generate $798 million in fiscal year 2017, the data show that capital gains tax revenue is extremely volatile from year to year. The figure below demonstrates that sales tax revenue is the less affected by the boom and bust cycle, while personal and corporate income tax revenue is the most affected.

State Tax Revenue Volatility

Source: 2014 Rich States, Poor States ALEC-Laffer State Economic Competitiveness Index

In Washington state, capital gains volatility is well-documented. For example, in 2012, the last time that Washington state considered a capital gains tax, the state department of revenue warned about the extreme volatility of capital gains. Standard and Poor’s recently noted that Governor Inslee’s capital gains tax proposal could “cause the state’s revenues to be more volatile. We have observed that capital gains-related tax revenues are among the most cyclical and difficult to forecast revenues in numerous other states.” Furthermore, the Washington Research Council recently studied the annual percent change in Washington capital gains versus the annual percentage change in sales tax revenue. As the chart below shows, sales tax revenue remains more consistent over time, while capital gains experience large fluctuations.

Washington Capital Gains Graph

                  Source: Washington Research Council

Not only is the capital gains tax an unstable revenue source,  but the tax will put Washington at a significant economic disadvantage. Currently,  the federal top marginal rate on capital gains is one of the highest in the industrialized world at 23.8 percent. In fact, the federal capital gains rate alone is higher than the average of all 34 nations in the Organization for Economic Cooperation and Development (OECD).  A combined federal and state capital gains rate would make it increasingly difficult for Washington to compete for jobs, investments, and economic opportunities on an international scale.

Washington currently benefits from not having a capital gains taxes as opposed to its neighbors. For example, data from the Oregon Department of Revenue show that hundreds of taxpayers move annually from Oregon to just across the Columbia River into Clark County, Washington. Furthermore, the American Council for Capital Formation states that Oregon has lost $1.3 billion in net income to Washington between 1992 and 2006. Imposing a state tax on capital gains would negatively impact Washington’s ability to compete with other states for jobs, investments, and economic opportunities.

In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth