A tax break that benefits a small number of wealthy taxpayers and costs the state of Oklahoma around $100 million per year cannot “be credibly shown to have significant economic impact or a positive return on investment for the State,” according to a study presented to Oklahoma’s Incentive Evaluation Commission by a national consulting firm. Lawmakers should heed the advice of the experts and act quickly to repeal this expensive and inefficient tax break.
The study found that over the past five years, Oklahoma’s capital gains deduction has reduced state tax revenues by $474 million while creating just $9 million in additional tax revenue. “This results in a net cost to the State of $465 million,” writes PFM Group Consulting, a firm with extensive experience in evaluating tax incentives that is working under contract with the state’s Incentive Evaluation Commission. The study also found that “over the life of the program, an average of 85.5 percent of the total deduction amount was made by individuals with income equal to or more than $200,000.” By comparison, just 3 percent of all Oklahoma taxpayers make over $200,000, according to 2015 IRS data.
The Oklahoma 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 the full amount of 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 three years before the sale.
According to the study for the Incentives Evaluation Commission, foregone tax revenue has fluctuated from a low of $45 million in 2009 to a high of $166 million in 2007. Over the ten-year period from 2005 to 2014, taxpayers claimed an average of $100 million per year in capital gains deductions. Using an economic impact model, the study determined that the deduction has had minimal impact in boosting economic activity, totaling less than $2 million per year between 2010-2014. The study concluded:
Based on the economic and fiscal impact analysis, it appears that the annual incentives offered under this program exceed the tax revenue generated. The return on investment for this program is negative.
Based on this conclusion, the study recommends repealing the capital gains deduction. Alternately, the consultants suggest that Oklahoma could follow other states by targeting the incentive to a specific industry or by requiring that proceeds from capital gains transactions be re-invested in Oklahoma.
In defending the capital gains tax break, the Oklahoma State Chamber of Commerce argues that, “Taxing capital gains can discourage investment in the state at a time when additional job creation and innovation are so badly needed.” However, the study finds that the empirical research on the economic impact of lower capital gains is indecisive. As we have previously pointed out, there is 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 a significant incentive for investment.
The Incentive Evaluation Commission, created by a 2015 law authored by late Rep. David Dank, has the mandate to study every tax incentive program to assess its economic and fiscal impact and to determine whether it is achieving its goal. Last year, the Commission evaluated 11 incentives; its critical evaluation of the zero emission tax credit contributed to the credit’s termination this past session. This fall, along with calling for an end to the capital gains deduction, the consultants also called for repeal of the coal tax credit and the ethanol fuel retainer tax credit, while recommending that several other credits, including the various Quality Jobs programs, be retained but modified.
Ending the capital gains tax break would also be politically popular. Fifty-five percent of Oklahomans favor ending the capital gains tax break, compared to 35 who would oppose ending it, according to a recent poll by Global Strategy Group for OK Policy that looked at various revenue ideas for the state budget.
The Legislature has wisely put in place a fair and rigorous process for evaluating tax incentives, and they should follow through with these recommendations. Oklahoma simply cannot afford to continue handing out tax breaks that have been shown to cost hundreds of millions without paying off in economic impact while we are slashing budgets, losing teachers and state workers, and putting basic health care and human services at risk. Whether during the current special session or when they return to work next year, lawmakers should put repeal of the capital gains deduction at the top of their agenda.