What’s Wrong with the Capital Gains Tax?

A Maine AP news story late this afternoon by state house reporter Fran Quinn reminds us that “On March 25, King signed a supplemental state budget designed to offset a General Fund revenue shortfall then pegged at nearly $160 million.” King signed it on live television and the deal was done… Or was it?

Famous Lost Words
Before the vote was taken in the Maine Senate on the supplemental budget, Senate President Richard Bennett proclaimed it ”A great compromise. One that will stand the test of time.”

The great compromise lasted five and a half weeks.

Now we’re told by the Governor that Maine has a $180 million deficit caused in large part by the stock markets poor performance as reflected in the capital gains portion of the personal income tax. The checks to the state coffers are down from last year they realized when they examined 100 tax returns in April sent in by the largest taxpayers in Maine (the ones who are still here and havent taken up residency in Florida or New Hampshire.)

As Maine Goes 
Americans for Tax Reform in Washington DC issued a statement this afternoon which says that capital gains gaps are bursting state budgets all over the country.

ATR calls for abolishing the capital gains tax at the state and national levels. One reason is its volatility. Its not a dependable tax, as were finding out.

“Bad Policy Equals Bad Politics” 
The ATR statement reads:

Maine governor announces that massive drop in cap gains tax revenues is hurting states budget. 
WASHINGTON Proving once again that capital gains tax revenue is an unstable revenue source that leads to budget deficits, Maine Governor Angus S. King Jr announced today state revenues may drop as much as $90 million by June 30th. And according to one of the governors aides, the revenue shortfall is a direct result of less than expected capital gains tax revenue.

This problem is not just new to Maine. States all across America continually relied upon capital gains revenue throughout the booming 1990s to fund permanent programs. And as the markets headed south, states are stuck with paying the bill for new spending with and no capital gains revenue to pay for it.

“The situation in Maine proves that capital gains taxes are not only bad tax policy, but extremely poor budgetary policy as well,” said taxpayer advocate Grover Norquist, who heads Americans for Tax Reform in Washington. “When the bubble bursts, all taxpayers have to pay.”

Revenue from capital gains taxes is highly volatile and unstable because it is closely associated with year-to-year fluctuations in the stock market. During the previous boom, stock prices increased significantly and capital gains revenue also increased. This revenue was often treated by state legislatures as a permanent increase in the tax base, and was used to fund permanent programs.

But when the economy slowed and stock prices fell, capital gains revenue declined significantly. As a result, the slowdown of volatile capital gains revenue is exacerbating the revenue shortfall in Maine and thus, places more pressure on lawmakers to increase taxes in other areas to pay for spending they previously committed themselves to. Capital gains tax revenue is also nearly impossible to forecast, as conventional techniques of revenue estimation are less applicable, because the acquisition of such income depends on decisions by the taxpayer, such as when to sell those shares of stock.

Thus, the reliance on capital gains revenue by the federal and state governments has significantly increased budget deficits. In California, for example, capital gains tax revenue declined by $10.5 billion in one year, which has led to Governor Gray Davis offering massive increases in taxes to offset the difference.

“Bad policy equals bad politics,” continued Norquist. “Capital gains taxes should be abolished on both the state and federal levels.”

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