One of Oklahoma’s largest tax breaks got no attention from legislators last year, despite its questionable legality, its questionable benefit for the economy, and a $1.3 billion budget shortfall that inspired legislators to go after many other tax breaks and programs.
The “Oklahoma Source Capital Gains Deduction” was enacted in 2004 as part of State Question 713, which also increased Oklahoma’s tobacco tax. The deduction allows taxpayers to exempt from their taxable income any gains from the sale of property located in Oklahoma or stock of a company headquartered in Oklahoma. To qualify for this exemption, the seller must have owned the property for at least five years or the stock for at least two years before the sale.
The benefit of this tax break goes almost entirely to wealthy business executives and investors. The Tax Policy Center estimates that nearly three-quarters of the benefit from lower tax rates on capital gains goes to taxpayers making over $1 million annually. The only major asset that a middle-class household is likely to sell for more than they bought it — their home — is already largely exempt from capital gains tax under federal rules that carry over to the Oklahoma tax code. So Oklahoma’s extra capital gains tax break does nothing for these families.
This tax break for a few wealthy households comes at no small cost. In FY 2014, the capital gains deduction cost Oklahoma $157 million. It cost more than four times as much as the Earned Income Tax Credit (EITC) for low-income working families, which was slashed in the latest budget deal. The capital gains tax break cost far more than the EITC even though it went to just over 18,000 households, compared to more than 330,000 households receiving the state EITC.
The only argument left for keeping this tax break is that it might boost the economy by incentivizing investment in Oklahoma companies and real estate. What the real impact on the economy is for capital gains tax breaks is a complex question, but at the federal level, the maximum capital gains tax rate has fluctuated significantly without any clear relationship to economic growth, as this chart from the Tax Policy Center shows.
We’ve seen no significant correlation between economic growth and capital gains tax rates at the federal level, where the top rate has fluctuated from a high of 40 percent to a low of 15 percent. With Oklahoma’s top income tax rate now at just 5 percent, the state tax break is even less likely to be incentivizing growth.
Former State Treasurer Scott Meacham was instrumental in securing passage of the capital gains tax break while serving as Finance Secretary for Governor Brad Henry. Today, Meacham leads a firm specializing in Oklahoma startup business investment. But he no longer believes Oklahoma’s capital gains tax break is worth the cost. He told Oklahoma Watch that since Oklahoma’s numerous income tax cuts have reduced the tax break’s effectiveness as an investment lure, “it doesn’t make a lot of sense to do both.”
“With Oklahoma making dramatic cuts to higher education, on top of the largest cuts in the nation to our K-12 funding formula, it’s hard to make the case that the need for this tax break is greater than the need for reinvesting in core services.”
It’s also important to remember that the burden of proof for this tax break is not just whether it benefits the economy, but whether that $157 million tax break helps the economy more than would comparable investments in core public services. With Oklahoma making dramatic cuts to higher education, on top of the largest cuts in the nation to our K-12 funding formula, it’s hard to make the case that the need for this tax break is greater than the need for reinvesting in core services.
Meanwhile, there’s some evidence that that tax break could be violating the Commerce Clause of the U.S. Constitution by discriminating against out-of-state companies. Oklahoma avoided that issue being brought before the U.S. Supreme Court only by settling with a Florida company that challenged it in court.
For all of these reasons, Oklahoma should do away with the costly capital gains tax break. This tax break is the largest single incentive being examined by Oklahoma’s new Incentive Evaluation Commission. The Commission members should bring a skeptical eye to the idea that exempting a few very wealthy households from much of their state income taxes is the best way to create an economy that works for all Oklahoma families.