Oklahoma’s capital gains deduction is the most expensive tax incentive in the state, according to reports from the Oklahoma Tax Commission. In 2015-2016, this deduction cost $105 million, and it led to an estimated $474 million in forgone tax revenues from 2010 to 2014. Despite this massive cost, economic development consultants working with the state’s Incentive Evaluation Commission (IEC) found that Oklahoma has little to no evidence that the incentive is working to boost the economy. IEC member and University of Oklahoma economist Cynthia Rogers found that two-thirds of the tax break is taken by just over 800 households with annual incomes above $1 million.
All of that is true, and yet it actually may substantially understate both the cost of the capital gains deduction and its skewed distributional impact. The statute on Oklahoma’s capital gains deduction does allow it to be taken on corporate income. But a footnote in the Oklahoma Tax Commission’s report on tax expenditures explains that, “While some of these deductions and exemptions are available for both corporate and individual income tax filers, aggregate data for corporate filers is not available. The tax expenditure estimates in this report, for deductions and exemptions that are available for both corporate and individual filers, reflect only individual income tax due to the data limitation.”
In other words, corporations can claim the capital gains deduction, but we have no idea how much that part of the tax break is costing the state. Considering how much capital gains income from the sale of Oklahoma stock or real estate may be going to corporations, the total cost of this tax break could be dramatically understated in all of the information that’s available to the public.
This is more evidence that Oklahoma is giving out hundreds of millions in tax breaks with very little oversight of who gets the money, how recipients use the money, or whether the tax break is creating any benefit for the state as a whole. The capital gains deduction is poorly designed and almost completely unmonitored. If lawmakers genuinely want to reduce waste in Oklahoma’s budget, the capital gains deduction is the single most expensive, wasteful policy anyone has found.
We have good options for reforming the capital gains deduction
Only ten other states have any kind of tax preference for capital gains, and all of those states have more safeguards and limitations on their deduction than Oklahoma. It doesn’t have to be this way. Even if lawmakers decide to keep the capital gains deduction in some form, that can be done without handing out unknown amounts of money to unknown entities. We can limit the deduction to cap its costs and to make sure that it actually incentivizes economic growth in a way that helps the state as a whole.
“Oklahoma is giving out hundreds of millions in tax breaks with very little oversight into who the money is going to, how they are using it, or whether it is of any benefit to the state as a whole.”
For example, some lawmakers and lobbyists for the agriculture industry have argued in defense of the capital gains deduction for the sale of cattle or property when a rancher retires. Oklahoma could design a tax incentive to favor those groups by following the model of Iowa, where income from the sale of cattle, horses, and breeding livestock that have been held for at least two years can be deducted, as well as real property that has been used in a farm business for at least 10 years. Both deductions also require that the person benefiting gets most of their income from farming and ranching. In this way the tax break could be targeted to a particular activity that lawmakers want to support, rather than giving away millions of dollars to protect a small benefit for agriculture.
Another option would be to allow a capital gains deduction only for investment in a small business operating within the state, or for businesses in a specific sector that we want to develop. In Virginia, the capital gains deduction is designed to encourage investment in small technology businesses (annual gross revenues of no more than $3 million) that are operating in the state. Arizona offers that deduction and defines a small business as one that has at least two full-time equivalent employees who are state residents and total assets not exceeding ten million dollars.
Requirements can be added after taxpayers receive the deduction, too. In Utah, at least 70 percent of the benefit received from their capital gains deduction must be reinvested in a Utah small business within 12 months.
To limit the overall cost of the capital gains deduction and prevent a single taxpayer from taking a massive windfall, Oklahoma could cap the deduction. For example, Colorado limits their capital gains deduction to no more than $100,000. Assuming that the income falls under Oklahoma’s current 5 percent top rate, that means each taxpayer would receive no more than a $5,000 tax reduction. Considering that most of the current deduction is going to those with incomes of more than $1 million, we would likely reduce the cost substantially with this cap, and we would protect the vast majority of middle income taxpayers who may receive some benefit from the deduction.
The path to resolving Oklahoma’s teacher walkout is clear
By reforming the capital gains deduction, lawmakers can protect farmers, middle-income Oklahomans, or other favored groups while still eliminating most of the cost of this large tax break. When combined with the revenue measures already approved or moving through the Legislature, capital gains reform would bring more than enough new revenues to meet the needs identified by teachers, state employees, parents, and students. It would put the whole state budget on a much firmer foundation going forward.
The path is clear, if lawmakers are willing to take it.