Capital gains boost could affect many of us


By David G. Tuerck
Executive Director, BHI

The Internet is making the stock market more accessible for small investors. And stock ownership is an increasingly attractive form of employee compensation.



The Massachusetts legislature wants to raise the tax on capital gains. The new tax would yield about $131 million in new revenue. And there’s a worthy cause: The new revenue could be used to fund school construction.

Listening to talk about capital gains taxes is an eye-glazer for most people – the kind of thing that excites only the bean counters among us. More important, there is the impression that capital gains taxes are paid mostly by high-income taxpayers. The majority of us are thus not much affected by increases in capital gain tax rates.

If you believe that, please read on.

Under the budget approved by the Massachusetts House and Senate, state taxpayers making less than $20,000 per year will pay a new tax equal to .54% of their taxable income. Taxpayers making more than $200,000 per year will pay only .38%. This is a tax increase that hits lower-income taxpayers the hardest.

How can this be? The answer lies in the increasing democratization of the equity markets. With the boom in stocks, more and more individuals from across the economic spectrum own equities. In 1998, 43% of all U.S. household owned mutual funds. Among households with incomes less than $50,000, 27% owned mutual funds.

The Internet is making the stock market more accessible for small investors. And stock ownership is an increasingly attractive form of employee compensation. Massachusetts companies like Lotus, Raytheon, Office Max, EMC, Home Depot, Wal-Mart, and Polaroid routinely offer their employees company stock at a discount. Stock ownership is no longer the exclusive domain of the corporate executive.

Lower-income people are likely to sell stock to tide themselves over economic hardship, should it arrive. A household in which the principal breadwinner becomes unemployed could easily see its income drop to $20,000 a year or less. One way to weather the crisis is to sell stocks.

There are far more taxpayers at the lower end of the income spectrum than at the higher end. In 1997, for every Massachusetts taxpayer reporting capital gains or losses who had an income of $200,000 or more, there were three such taxpayers who had an income of $20,000 or less. Capital gains represented about half of the taxable income of taxpayers in the lower-income group who reported capital gains or losses.

There are other issues to be considered. Under current law, the capital gains tax goes to 1% on assets sold after five years and to zero on assets sold after six years. The proposed budget would change the law so that assets sold after five years were taxed at 2%.

Investors want to know what taxes, if any, they will have to pay on the sale of an asset. If the law says they won’t have to pay any tax by holding the asset for six years, then that’s a reason to buy and hold onto the asset. Turning around five years later and raising the tax to 2% is a double cross – the kind of thing that will make the same investors think twice before buying another asset.

Besides the negative consequences for individual investors, hiking the capital gains tax will have negative consequences for the Massachusetts economy. It will eliminate $921 million dollars in spending on capital equipment and structures, including factories, warehouses, office buildings, computers and delivery trucks. Local governments will lose $8.9 million in property taxes as a result of the reduced construction.

Finally, there’s the matter of trust in government. Five years ago, the legislature got a substantial and controversial pay raise. The political justification was that taxpayers got, in return, a reduction in capital gains taxes, part of which the legislature now wants to rescind.

Most policy issues involve tradeoffs. In the end, we hope there are more winners than losers. When it comes to this tax hike, there are no winners. It’s a loser for low-income households, for the state economy and for the taxpayers who were betrayed by the legislature.

No matter how worthy its motives, the legislature should find some other way to raise new revenue. The state, moreover, stands to run up another big surplus, from which it could easily squeeze out another $131 million in revenue. This triple loser should strike out.

David Tuerck is Executive Director of the Beacon Hill Institute at Suffolk University in Boston where he also serves as Chairman and Professor of Economics.

This article first appeared in Mass High Tech on July 12, 1999.

Format revised on 30-Jun-2005 3:53 PM