The real cost of the capital gains deduction could be much more than $100 million, but we have good options for reform

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.

[pullquote]”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.”[/pullquote]

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.

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Gene Perry worked for OK Policy from 2011 to 2019. He is a native Oklahoman and a citizen of the Cherokee Nation. He graduated from the University of Oklahoma with a B.A. in history and an M.A. in journalism.

11 thoughts on “The real cost of the capital gains deduction could be much more than $100 million, but we have good options for reform

  1. I respectfully ask that the House bring SB 1086 to a vote. Please vote YES to eliminate this wasteful tax. Our kids are worth it! #thetimeisnow

  2. Our schools need their funding. Please refrain from protecting millionaires and give it to the other 3 million plus Oklahomans that need it to make Oklahoma a better educated state.

  3. Lawmakers I beg you to please reform capital gains. We must fix Oklahoma budget, not only for schools but for the jails, services including other state agencies.

  4. I done rely ask that you put SB 1086 up to be voted on. Capital gains makes no sense. 1% of the population, the wealthy benefit from the exemption while the state looses millions of dolllars it should be collecting from the wealthy. Then the legislature states there is no way to fund education without making the average person pay more tax. There is something very wrong with that thinking. The capitol gains tax is the way to fund schools and state employees. I thought members of the legislature are supposed to be smart and have common sense but I guess am wrong. There is clearly a way to fund education. Make the wealthy pay their tax instead of putting more on the working class stop making the rich richer and the poor poorer. THAT IS WRONG!

  5. What is wrong is that you think that other people’s money is yours to take away and do with as you please. You propose to take another’s earned income and redistribute into a 19th century education system that is broken and failing our children.

    This system has failed our kids, our teachers, and our state.

    You can throw all the money you want at Blockbuster Video and it will still fail.

    Where is the call for reform? Where is the call to build a school system that prepares our children from the 21st century?

    Do any of you care about an outcome or do you just want to win another useless political argument?

  6. This issue needs careful oversight and reform. We can’t let it hurt small farms and ranches like many of us grew up on. Cut the corporations profiting from the deduction but we have to keep support of the public for our rural schools.

  7. This is a very simplified explanation that is skewed toward making business owners look greedy and mean. It is a much more complicated situation that needs careful study. Capital gains taxes will affect all
    home and business owners at some point, not just the hated rich (I am a small business owner but I am far from rich.)
    [Editors’ Note: It’s not true that capital gains taxes will affect all home and business owners. In most cases, your home is already exempt from both state and federal taxes on capital gains. Only a small percentage of low- and middle-income Americans pay capital gains taxes.]

  8. Tax deductions (and exemptions) allow taxpayers to keep more of their own money. It is not money “given” to anyone by the state, and it does not “cost” the state anything, (unless you believe that all money is owned by the government, and we citizens are allowed to keep whatever the politicians decide).

    Now specifically for this study, the authors fully admit that “There was insufficient evidence to determine the level of direct new economic activity and job creation associated with the Capital Gains Deduction.” Therefore, their conclusion is entirely one-sided, only looking at the negative effects to government revenues. In reality, lower capital gains taxes have numerous economic benefits that a static scoring like this study to not discuss.

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