Public Assets Institute > Policy Areas > Vermont Budget > Putting away money for a rainy day

Putting away money for a rainy day

The Legislature has passed five budgets since the start of the Great Recession in fiscal 2008, and it didn’t use the pot of money set aside for just such a crisis: the state’s rainy day funds. The $50 million-$60 million in reserves in just the General Fund could have helped the state through difficult times, maintaining services when Vermonters needed them most. But that didn’t happen.

Now that the recession appears to be winding down—though slowly—the Legislature has created a new “rainy day fund[1]” in preparation for the next downturn. Ostensibly, the rules governing this new fund are less restrictive than for the old one. But if the Legislature is serious about creating—and using—this savings account for the next rainy day, it should beef up the revenue it sets aside.

One way to do this would be to eliminate the preferential tax treatment for capital gains, and dedicate the additional receipts to the rainy day fund.

In a recent interview with Bill Moyers, Sheila Bair—head of the Federal Deposit Insurance Corp. (FDIC) under President George W. Bush and chair of the newly formed Systemic Risk Council at the Pew Charitable Trusts— made the case for taxing capital gains the same as ordinary income. The focus of the interview was corruption in the banking system, but Bair also expressed her concern about the growing divide between rich and poor.

In the first place, preferential treatment of capital gains simply isn’t right. Why should someone who invests for a living have a lower tax rate than someone who works for a living? Secondly—and Bair said this so matter-of-factly: “There’s no credible economic literature that says that the lower capital gains tax produces jobs; it’s just not there.” What it does produce, she said, is “terrible income inequality. And it skews incentives.”

The Vermont legislature got it right a couple of years ago when it dramatically reduced the amount of capital gains that taxpayers could subtract from their taxable income. Gov. Jim Douglas made the argument against the preferential treatment and was dead on when he called it a “working tax penalty.” Unfortunately, the Legislature and the administration reversed themselves the following year and reinstated the penalty.

One problem with capital gains taxes is that they tend to be volatile. They roll in when the economy is doing well and decline when it goes south. That’s why capital gains are risky to use for regular operations, but are ideal as a revenue source for a rainy day fund. These receipts can be put aside when the economy is hot, and then the fund can be tapped to make up the shortfall when the economy cools and regular tax receipts from income and sales fall off.

Vermont needs to be better prepared for the next recession. It has to be ready to step in and help when Vermonters lose jobs through no fault of their own and families have trouble feeding their children and heating their homes. The state needs a sizeable rainy day fund that political leaders aren’t afraid to use.

[1] Act 162 of 2012, p. 113

Posted by Jack Hoffman on August 21, 2012 at 4:45 pm

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