Capital gains taxes need more than a tweak
The revenue bill passed by the Vermont House late last month will generate more money—about $5 million annually—by increasing the amount of investment income that is subject to the state’s capital gains tax. The additional revenue is welcome, and the change is a step in the right direction. But rather than simply tweaking the capital gains tax, the Legislature should be asking why it gives away $15 million every year by excluding certain investment income from taxes.
A January report by the Joint Fiscal Office and the Vermont Department of Taxes raises questions about the underlying justification for treating capital gains differently than the income earned by most working stiffs.
One of the statutory purposes of this tax break is “to increase savings and investments.” As the report points out, this is really vague. It doesn’t say, for example, whether the intent is to increase savings and investments in Vermont, or just anywhere.
And even if the purpose were defined more clearly, it’s not clear this tax break is big enough to provide an incentive to save and invest. At most, according to the report, the tax reduction amounts to 0.5 percent of income for the wealthiest Vermonters who take advantage of this break. By comparison, the federal tax break on capital gains amounts to almost 3 percent of income. If there is an incentive—and report says the link between lower capital gains taxes and savings is “tenuous”—it’s going to come from the federal break, not from the little bit of icing that Vermont is putting on the cake.
Another stated purpose of the policy is to give a break to people who have a big, one-time capital gain—for example, businesses owners who sell their companies to pay for retirement. Vermont has a progressive income tax, which means the tax rates increase as incomes increase. A business owner may have a moderate annual income, but in the year she sells her business, she might jump into the highest income bracket, in which case some of the capital gain would be taxed at the highest rate. One reason for the exclusion is to soften the effect of such one-time events.
Fair enough, but that’s not how this tax break is working in practice. According to figures from the Tax Department, between 2012 and 2017, 42 percent of filers who took the biggest exclusions did so more than once. And these filers who made claims in more than one year accounted for 70 percent of the most generous exclusions during the period.
In 2016, the Legislature decided to make a systematic review of all of the state’s so-called tax expenditures—the exclusions, exemptions, deductions, and other tax breaks they had approved over the years. This year’s in-depth analysis of the capital gains tax was part of that continuing review. Reclaiming some of the money lost to the capital gains exclusion is a good first step. But the Legislature also needs to ask what it hopes to accomplish with this tax break, whether it’s actually achieving that purpose, and if the money could be put to better use.
