Dec 5, 2008 6:59 am US/Eastern
Dwindling Capital Gains Taxes Add To Mass. Woes
BOSTON (AP) ―
Capital gains taxes may be the ultimate fiscal narcotic, producing soaring revenue highs in flush times, followed by crashing budget lows when the economy tanks.
A new report finds that states that boosted their spending in part by relying on spikes in capital gains taxes -- taxes on the profits from sales of assets like stocks and bonds -- are now dealing with budget hangovers after years of pulling in big revenues.
Massachusetts is a prime example.
From 2002 to 2006, revenues from capital gains accounted for 54 percent of the state's growth in revenues, putting Massachusetts third in the nation in its overall reliance on capital gains taxes, as measured by the nonprofit
Massachusetts Institute for a New Commonwealth.
It wasn't alone. Clustered at the top of the list are other states which share some of the traits that made Massachusetts vulnerable to sudden drops in capital gains -- a wealthier population, a strong fiscal services sector and a heavy reliance on income taxes.
Topping the list is Oregon, followed by Connecticut, Massachusetts, California, New York, Colorado and Virginia.
"Massachusetts is now going through a crisis that's brought on by a precipitous drop in revenue that is largely due to the loss of capital gains," said Cameron Huff, who authored the report.
Massachusetts' current state budget anticipates about $1.5 billion in spending based on revenues from the volatile taxes -- much of which is now in jeopardy.
In October, as the state's fiscal outlook grew cloudier, Gov. Deval Patrick announced more than $1 billion in cuts and spending controls, and the elimination of 1,000 state jobs. He also urged the state's rainy day fund be tapped for $200 million, a move later approved by lawmakers.
The state has been here before.
Six years ago, after Massachusetts enjoyed several flush years, capital gains revenues suddenly plunged by more than $1 billion. And in the early 1990s, after another boom, capital gains receipts dropped by about $900 million.
Huff acknowledged that lawmakers learned a lesson from the first plunge and, during the late 1990s built up a sizable "rainy day" fund.
But he said they've come up short in recent years, even as they've increased their reliance on capital gains. If lawmakers had to use the rainy day fund to replace the entire potential drop in capital gains it could wipe out the fund in a year.
"Much of the harm from the current decline in capital gains might have been avoided," the report concludes. "This reality only underscores the need for serious action to fend off future damages to programs and services from difficult-to-predict capital gains."
Part of the reason capital gains taxes are difficult to predict is because they are only collected when an individual decides to sell an asset.
Massachusetts House Ways and Means chairman Robert DeLeo, whose committee writes the House version of the budget during the state's annual budget debate, said lawmakers know capital gains revenues are "inherently volatile" -- but have to weigh that against a myriad of needs.
"In the end, however, it is impractical to think that we could simply ignore or segregate as much as $1.5 billion from the budget when there are very real needs in areas such as education, the environment, public safety and health care," DeLeo said.
Michael Widmer of the business-backed Massachusetts Taxpayers Foundation said one step the state could take would be to automatically deposit a portion of the annual growth in capital gains taxes into the rainy day fund to reduce the temptation of using it to build the annual operating budget.
"When you're basing spending on a revenue source that you know will disappear, it's a major problem," Widmer said.
Other states have struggled as their capital gains revenues stumbled.
In California, the top 1 percent of earners paid 48 percent of the state's income taxes, much of that in the form of capital gains, which have dropped precipitously as stock prices plummeted.
Connecticut, which ranks second on the report's list, is struggling in part because it is tied more closely to Wall Street than other states. Gov. M. Jodi Rell's budget director last month predicted "Connecticut will take a bigger hit" than other states from the loss of capital gains tax revenues.
And in New York, the financial sector -- a key contributor to the ups and downs of capital gains tax revenues -- accounted for about 6 percent of employment and 41 percent of all New York wage growth since 2003.
The report uses two factors to calculate the relative importance of capital gains to a state.
The first measures the share of a state's total revenues that come from income and capital gains taxes, while the second measures share of the total income in a state that comes from capital gains -- a measure of people's willingness to spend the money they received from the sale of capital gains.
Based on the measure, Massachusetts is 47 percent above the national average in its reliance on capital gains revenues.
(© 2009 The Associated Press. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.)
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