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Video: Economist Jared Bernstein Explains Capital Gains Taxes

Andy Nicholas — 2012-02-03T00:18:28Z

Looking for a quick explanation of national capital gains tax policy? The video below features Economist Jared Bernstein, former Chief Economist and Economic Adviser to Vice President Joe Biden, and Chye-Ching Huang of the Center on Budget and Policy Priorities. Bernstein and Huang explain how capital gains -- profits from the sale of corporate stocks, bonds, and real estate -- receive preferential tax treatment at the national level. They also debunk the myth that special tax treatment for capital gains has led to increased business investment and economic growth. (Spoiler alert: it hasn't.)

Here in Washington state, our proposal for a state excise tax on capital gains would help build a more adequate, equitable, and stable budget process in future years.

Updated data: Capital Gains Still More Concentrated Among Wealthiest Few

Andy Nicholas — 2012-01-31T16:33:53Z

The capital gains tax proposed in House Bill 2563 represents a bold path to a more stable and adequate revenue system in our state. The measure would create a new 5 percent excise tax on capital gains in excess of $10,000 each year in Washington state. As we’ve discussed previously (here and here), capital gains – profits on the sale of corporate stocks, bonds, and real estate assets – are highly concentrated among the richest households in our nation. However, new data from the nonpartisan Tax Policy Center (TPC) shows that capital gains have become significantly more concentrated among the richest few since the onset of the Great Recession.

As of 2010, the TPC’s data show that 96 percent of capital gains were going to a small minority of very wealthy households – those with incomes above $1 million per year (see graph below). Furthermore, on average, households earning less than $200,000 per year experienced net capital losses in 2010, meaning they lost money on sales of stock or other capital assets. (Capital losses would not be taxed under HB 2563. In fact, capital losses are deductible from federal income taxes.)

The extreme concentration of capital gains among the richest Washingtonians means that a tax on these resources would be paid almost exclusively by those at the top of the income scale. Even so, HB 2563 goes a step further by establishing an exemption on the first $10,000 of capital gains ($5,000 for single filers). The $10,000 exemption would limit the tax to only about three percent of Washingtonians.

Accordingly, the measure would tap into a highly concentrated economic resource in order to sustain our public investments in health care, education, and safe communities – all vital to long-term and broadly shared economic growth.

For more information check out our policy brief, “A Capital Reform: Using Capital Gains to Fuel Job Creation and Economic Prosperity in Washington State.”

Capital Gains Tax + Rainy Day Fund = Greater Economic Stability

Andy Nicholas — 2012-01-31T16:37:36Z

Last week legislation was introduced to create a new 5 percent excise tax on capital gains – profits on the sale of stocks, bonds, and other financial assets above $10,000 each year. The bill, based on our proposal, would provide badly-needed resources to help rebuild our ailing investments in health care, education, and other core public structures. It also offers our state an opportunity to stabilize financing for these and other important priorities in the long run. Both objectives can easily be accomplished by dedicating a portion of revenues from the proposed tax to the state’s constitutionally protected Budget Stabilization Account, more commonly known as the rainy day fund (RDF).

Dedicating a portion of capital gains excise tax revenues to the RDF would create a more stable system for financing our education and health infrastructure. Some have argued a capital gains excise tax would add volatility to our revenues system. Yet, with 35 percent of capital gains tax revenues dedicated to the constitutionally protected rainy day fund, Washington would have accumulated sufficient savings to maintain capital gains tax revenues at pre-recession levels throughout the course of the last two recessions (see graph below). Furthermore, even after repeatedly withdrawing funds to maintain pre-recession levels of resources during the current downturn, there still would have been about$500 million available in the RDF to help address shortfalls in the current fiscal year.

The thin green line in the graph above shows total capital gains tax collections, had the tax been in place between fiscal years 1996 and 2011. In the absence of a rainy day fund, it shows that capital gains revenues would have risen rapidly during good economic times while falling precipitously at the onset of recessions. The blue bars show the size of the RDF (cumulative balances) each year if 35 percent of capital gains tax revenues were dedicated to it during periods of economic growth. During recessions, savings from the RDF would have been withdrawn by the amount needed to maintain capital gains tax revenues at peak economic levels. Finally, the thick purple line shows capital gains tax revenues smoothed over time via deposits to and withdrawals from the RDF.

Let us be clear: combined with a more robust rainy day fund, a new excise tax on capital gains would create a more stable and adequate means of funding investments in good health, a high-quality education system, and safe communities – all of which are vital to our economic recovery.

Capital gains becoming even more concentrated among richest few

Andy Nicholas — 2012-01-19T19:20:16Z

As we noted earlier this week, the richest one percent of households claim more than 75 percent of all capital gains. While capital gains have always been highly concentrated among our nation’s richest few, they have become even more concentrated among wealthy families over the past two decades.

House Bill 2563, which would create a new 5 percent excise tax on high-end capital gains in Washington, would tap this highly concentrated economic resource in order to restore public investments in health care, education, and other public structures proven to foster job-creation and broadly-shared prosperity.

The graph below reveals that the share of capital gains flowing to the wealthiest Americans has grown over the past couple of decades.

The graph shows the changing value of the “concentration index” for capital gains from 1991 to 2007. The concentration index is a tool used by economists to measure how broadly or narrowly economic resources are shared among families of different income levels. The index ranges from a value of -1 to +1. The maximum value of +1 would mean that all capital gains flow to the single richest family in the country. A value of 0 would mean that the resource is equally shared across all income groups, and a value of -1 would mean that the poorest single family claims all of the resources.

Since 1991, capital gains grew steadily more concentrated among wealthy families, reaching a peak value of 0.955 in 2003. Though the concentration declined modestly after 2003, capital gains remained significantly more concentrated in 2007 than they were in 1979, according to the nonpartisan Congressional Budget Office.

The bottom line is that the vast majority of capital gains accrue to a small number of very wealthy households -- and their share has been growing over the past several decades. The modest capital gains tax proposed in HB 2563 would utilize a highly concentrated resource to spur broadly shared job creation and economic prosperity.

For more information read our policy brief "A Capital Reform: Using Capital Gains to Fuel Job Creation and Economic Prosperity in Washington state."

“Son of 1053” would continue to exacerbate budget woes

Michael Mitchell — 2012-01-17T16:55:18Z

Earlier this month Initiative 1185 (Son of 1053) was filed with the Secretary of State’s office. The initiative would extend the onerous supermajority voting requirement of I-1053 – a requirement that has repeatedly prevented the adoption of sensible policies needed to address our ongoing economic problems.

Due to the supermajority requirement, our public health, education, and other economic structures have been cut by at least $10 billion over the last three years, while unproductive tax breaks have remained completely intact. Like I-1053, I-1185 would extend the mandate that all tax increases be subject to either a public referendum vote or pass a supermajority (two-thirds) vote in both houses of the legislature.

For policymakers, the supermajority requirement works as a significant roadblock to finding responsible solutions to our severe budget shortfalls. The two-thirds mandate allows a small minority of lawmakers to block legislation needed to prevent economically damaging cuts to critical public services, at the expense of the well-being of state residents.

The imbalance caused by I-1053 has prevented the state from scrutinizing ineffective and costly tax breaks while directly leading to the enactment of over $10 billion dollars of cuts threatening our state's economic security, k-12 and higher education systems, and investments in health care.

Hampering policymakers from responsibly raising revenues directly jeopardizes our investments in safe neighborhoods, access to quality education, and supports for middle and low-income working families.

Extending the supermajority requirement will only work to prolong our state’s slow economic recovery, as thousands of working families lose access to child care, individuals with disabilities are cut off from critical financial supports and over 20,000 adults are left without job search and training assistance.

Limiting our state lawmakers with the supermajority requirement is irresponsible, and serves only to limit future opportunity for all Washington residents.

No denying it: At least $10 billion has been cut from the state budget

Kim Justice — 2011-12-19T00:35:55Z

by Kim Justice and Andy Nicholas

Introduction

State budget cuts have taken an enormous toll on Washington state’s core public health, education, and community safety structures. Basic public services have been cut by at least $10 billion since the start of the Great Recession. These budget cuts have taken a grizzly toll on the health and well-being of workers and families from Aberdeen to Spokane.

Yet, some have suggested that the impact of budget cuts has been greatly exaggerated. Nothing could be further from the truth. Here’s why:

The human toll of budget cuts is undeniable: Over 70,000 low-income working adults have lost health care coverage, over 20,000 children and families have lost assistance to get and keep a job, and the cost to attend college has almost doubled since 2007 at four-year institutions due to increases in tuition.
Claims about higher state revenues fall apart when placed in context: In real terms (after adjustment for inflation) state revenues are currently about $2 billion (12.6 percent) below pre-recession levels.
Resources are low, but the need for public services is high: In addition to normal cost pressures such as inflation and population growth, the impact of the Great Recession has led more families to seek assistance to meet their basic needs.
In reality, public structures have weathered more than $10 billion in budget cuts: Round after round of cuts from an ever-decreasing baseline has hidden the true magnitude of the cuts enacted since the start of the recession.

The human toll of budget cuts is undeniable

Those who argue that budget cuts have been exaggerated ignore the very real impact that these cuts have had on communities throughout our state:

The number of kids in K-12 increased by 12,135 between 2008 and 2010, but the number of teachers in classrooms shrunk by nearly 3,000.
Over 20,000 eligible students were unable to receive financial aid in 2010 due to insufficient state resources.
The average cost to attend college has risen 94 percent for students and families since 2007 at four-year institutions due to dramatic increases in tuition. The cost has risen 54 percent at community and technical colleges.
Over 70,000 low-income working adults have lost health care coverage since 2009, through the Basic Health Plan.
Over 20,000 adults and children have lost assistance needed for families to get and keep a job.
Approximately 7,000 low-income working parents have lost crucial child care support, which helps them remain in the workforce.
Over 50,000 low income seniors have lost support to help them afford their prescription drugs.
Roughly 20,000 individuals who cannot work due to a disability have seen their income support vanish.

For more detailed information on these cuts and others, view the Budget & Policy Center briefs, “Economic Security: Key to Recovery” and “Declining Support for Education Threatens Economic Growth.”(1)

Every area of state investment has been affected by cuts (Figure 1). The majority of cuts have fallen on our education and health care systems. Cuts to education have reduced the quality of our children’s education and the ability of workers to obtain the skills they need for the jobs of tomorrow. Health care cuts have left thousands of Washingtonians without medical care.

In reality, public structures have weathered more than $10 billion in budget cuts

Some have argued the budget cuts reported to date are mere accounting tricks – that actual service reductions have been much lower. In fact, the opposite is true. Budget cuts are significantly undercounted in our state budget process. That’s because every year that reductions are made, the current service baseline, or “maintenance level,” is reduced (see Box 1). The maintenance level has been diminished with multiple rounds of budget reductions. And, cutting from an ever-shrinking baseline masks the true magnitude of the cuts enacted so far. The bottom line, as shown in Figure 2, is that at least $10 billion in budget cuts have been enacted since the start of the recession.

Box 1: The maintenance budget

The maintenance level refers to the cost of maintaining the same level of services from one fiscal year to the next, accounting for factors such as general price inflation, increases in the population, and increases in the number of people qualifying for support.

The maintenance level is recalculated each year to account for changes in state law enacted the previous year and for increases or decreases in caseloads. Because it is recalculated annually, it is unknown how much it would cost to provide pre-recession levels of services in the current year.

Claims about higher state revenues fall apart when placed in context

State tax revenues are far below pre-recession levels. Before adjustment for inflation, Figure 3 shows that by 2010, the deepest part of the recession, state revenues had fallen to $1.9 billion (12.3 percent) below 2007 levels. Revenues are presently $820 million (5.3 percent) below the pre-recession mark, and aren’t projected to approach 2007 levels until 2013.

The decline in state revenues is even more dramatic once elements of inflation, such as rising energy prices – which make it more expensive for the state to fuel police cars and heat classrooms – are taken into account. In real terms (after adjustment for inflation) state revenues are currently about $2 billion (12.6 percent) below pre-recession levels, and aren’t projected to recover within the foreseeable future, based on estimates from the state’s Economic and Revenue Forecast Council.

Resources are low, but the need for public services is high

The cost of providing consistent levels of services rises each year due to inflation, demographic changes such as the aging of our state population, and other factors. In addition to these ordinary cost pressures, the Great Recession – and the mass layoffs that have come with it – has greatly increased the need for state-supported health care, educational opportunities, and other essential services among Washingtonians.

A good example is Washington’s Apple Health for Kids program, which has proven to be a crucial backstop for families throughout the recession. Figure 4 shows that while thousands of children in Washington have lost their parents’ employer-provided health coverage since the start of the recession, Apple Health and other public insurance programs have helped to fill the gap. As the graph shows, about 165,000 children in Washington lost employer-sponsored insurance from 2006-07 through 2009-10. During the same period, the number of children enrolled in state-supported health programs grew by about 208,000.(2) Accordingly, the costs of maintaining Apple Health have risen significantly in the last few years.

Conclusion

Over the next few months, state lawmakers will make pivotal decisions about the future of our state as they work to address a $2 billion shortfall. It is important for all of us to know where we’ve been before we can make decisions about where we’re going next.

In just three years, there have been more than $10 billion in cuts impacting working families, children, older adults, people with disabilities, and students. Another all cuts budget would be indefensible. Therefore, it is vital that new revenue be included as part of a balanced solution to our economic problems.

In the short run, we can raise additional resources to preserve our essential health and education structures by ending unjustified tax breaks and modestly increasing the sales tax.(3) An increase in the sales tax should be paired with the Working Families Tax Rebate to significantly reduce costs for lower-income working families with children.

In the long run, a small excise tax on some capital gains would go a long way toward improving the adequacy and equity of our flawed revenue system.(4)

There will be disagreements about the revenue package – where it should come from, how much it would raise, and who would pay. That is to be expected. But we should not diminish the magnitude of cuts to state investments enacted since the start of the recession. Thousands of Washingtonians have lost health care and opportunities to build a better future. Ignoring this fact clouds our ability to make sensible choices about public priorities going forward.

Acknowledgments

The Budget & Policy Center gratefully acknowledges the support of the Annie E. Casey Foundation, Bill & Melinda Gates Foundation, Paul G. Allen Family Foundation, Campion Foundation, Northwest Area Foundation, Stoneman Family Foundation, and The Seattle Foundation. The findings and conclusions presented in this report are those of the author alone, and do not necessarily reflect the opinions of these organizations.

Endnotes

For more information see “Economic Security: Key to Recovery,” located on-line at http://budgetandpolicy.org/reports/economic-security-key-to-recovery-and-properity and “Declining Support for Education Threatens Economic Growth,” located on-line at http://budgetandpolicy.org/reports/declining-support-for-education-threatens-economic-growth.
To improve statistical precision, the data were split in to two periods, each consisting of two years of data – i.e. 2006-07 and 2009-10.
For more details see the schumdget post “Five advantages of increasing the sales tax,” located on-line at http://budgetandpolicy.org/schmudget/five-advantages-of-raising-the-sales-tax.
For more information see “A Capital Reform: Using Capital Gains to Fuel Job Creation and Economic Prosperity in Washington state,” located on-line at http://budgetandpolicy.org/reports/a-capital-reform-using-capital-gains-to-fuel-job-creation-and-economic-prosperity-in-washington-state.

New national report identifies corporate tax avoiders

Andy Nicholas — 2011-12-08T21:53:01Z

A new report, released jointly by the Institute on Taxation and Economic Policy and Citizens for Tax Justice, identifies 265 highly profitable U.S. corporations that avoided paying state business taxes in recent years.

By taking advantage of state tax breaks and using complicated accounting to shelter profits in low-or no-tax jurisdictions, these businesses successfully avoided paying state taxes that could have been used to help fund health care, education, and other important public priorities. The report finds that 68 of these 265 corporations paid no state business taxes in at least one of the years between 2008 and 2010.

The amount of revenues lost for any particular state could not be identified due to data limitations. The report does show the extent to which businesses avoided paying state taxes in aggregate, however. And yes, there are some bad actors here in Washington state.

View the entire report for more information.

Five advantages of raising the sales tax

Andy Nicholas — 2011-11-29T18:11:07Z

As policymakers gather for a special session to address a $2 billion revenue shortfall it is crucial that they examine raising new revenues to protect essential public priorities. Policymakers should work to close wasteful tax breaks. But given the magnitude of the current shortfall, closing loopholes cannot solve all of our revenue problems. Accordingly, lawmakers should consider raising additional resources via Washington's primary revenue instrument: the state sales tax.

Key advantages of raising the sales tax include:

Generating new resources quickly: A modest sales tax increase could go into effect almost immediately. A one percentage point (one penny) increase in the sales tax would generate nearly $1 billion in the current budget cycle to help maintain core health and education structures.
Costs for lower-and moderate-income families can be offset: Pairing a sales tax increase with funding for the Working Families Tax Rebate (WFTR) would significantly reduce costs for lower-income working families with children. The WFTR is a Washington state version of the federal Earned Income Tax Credit (EITC) that was enacted in 2008, but never funded. Set at 10 percent of the EITC, the Washington state rebate would more than fully offset a one-penny sales tax increase among the poorest families in Washington. It's also important to note that up to one third of a sales tax increase would be offset among higher-income households due to larger federal income tax deductions for Washington state taxes.
Simple for taxpayers and negligible costs for the state: Policymakers have a 30-day legislative session to close a $2 billion shortfall. Any revenue solution must be simple to implement and administer. Raising the sales tax rate meets that criterion. It would be straightforward for the Department of Revenue to administer. Similarly, a sales tax increase would not entail burdensome compliance costs for businesses, which would only have to make small adjustments to current procedures to account for the new rate.
Minimal economic impact: According to mainstream economic theory, the worst thing policymakers could do for our state economy would be to enact further cuts to our core health, education, and public safety systems. A sales tax increase would provide the resources needed to prevent economically damaging cuts.
Could be temporary: An increase in the sales tax could be applied temporarily, phasing out after the economy has fully recovered. One option would be to include an expiration date in the authorizing legislation. Last week, Governor Gregoire proposed a temporary, 0.5 percentage point (half penny) sales tax increase that would automatically expire after three years. Another option would be to apply an "economic trigger" -- that is, to tie the increase to state economic conditions. For example, if the sales tax were increased by one percentage point to 7.5 percent from 6.5 percent, the increase could phase down to 7.0 percent when the state unemployment rate falls to seven percent (it currently stands at nine percent). It could be set to phase out completely when unemployment falls to six percent.

Washingtonians have a narrow window to secure our fiscal and economic future. Going forward, lawmakers should pursue a comprehensive revenue strategy. In the short run, policymakers must quickly generate additional resources to protect public priorities. The sales tax is an appropriate instrument for doing so.

In the long run, a new excise tax on some capital gains -- profits from the sale of stocks, bonds, futures contracts, and other high-end financial assets – would help address our structural revenue problems. While it could not be implemented quickly enough to help address the current budget shortfall, enacting such a tax now would foster a more robust and equitable revenue system in the coming years.

Access to higher education is shrinking due to cuts

Kim Justice — 2011-11-29T22:23:26Z

At a time when the state’s unemployment rate is the highest it has been since 1983 (9.1 percent), we need state investments in education. Educational attainment opens doors to better employability, higher wages, and economic stability for families. Yet, as our recent policy brief illustrates, the ability to access a higher education is shrinking as state investments have been severely slashed over the last three years.

Reduced state support for higher education has pushed the bulk of costs to students and families. Due to dramatic increases in tuition, the average cost to attend college has risen 94 percent for students and families at four-year institutions since 2007. The cost has risen 54 percent at community and technical colleges.

The state historically supported a commitment to learning by making sure students paid less than half the actual cost, but that flipped in 2011due to deep budget cuts, and now families are asked to pay the lion’s share at four-year institutions, and more than one-third (37 percent) of the costs at community and technical colleges (see figures below).

The Governor’s 2012 supplemental budget was rolled out yesterday, it relies on voter approval of a half cent increase (0.5 percentage points) in the sales tax to stave off further cuts to colleges and universities. Without additional revenue, higher education institutions face additional cuts ranging from 13 to 17 percent ($160 million).

Our economy cannot begin to recover until people get back to work. For many, this will require further educational development and enhanced job skills. Without increased revenue as part of the budget solution, access to a higher education will be impossible for many lower- to middle-income families.

Click here to read the full brief, Declining Support for Education Threatens Economic Growth.

Governor’s revenue proposal is a good start, more needed

Kim Justice — 2011-11-22T01:04:01Z

Earlier today, Governor Gregoire introduced her 2012 supplemental budget proposal, which would address the $2 billion gap between the amount needed to maintain our vital public health and education investments, and the resources available. While previous budget shortfalls have been addressed almost entirely via economically damaging cuts to community services, the Governor’s latest proposal offers a more balanced approach by including revenue as part of the solution. However, the suggested level of revenue falls short of what’s needed to maintain our investments in education, health care and thriving communities.

To prevent catastrophic cuts to Washington’s core economic structures, the Governor recommends that voters approve roughly $500 million in new revenues by temporarily increasing the state sales tax rate by 0.5 percentages points (half cent), to 7.0 percent from 6.5 percent.

While this is an important step in the right direction, more is needed. Given the magnitude of the shortfall and the depth at which our public structures have been cut in the last three years, additional revenue is needed. This could be accomplished by asking voters to increase the sales tax by a full penny to bring in $1 billion in revenue, and by closing targeted tax breaks.

If the recommended half cent increase in the sales tax were approved by voters, the Governor intends to protect some funding for education, public safety and health care. But the suggested level of revenue falls short of what’s needed to maintain our quality of life and rebuild our economy. Numerous programs in education, health and public safety would remain on the chopping block. Under the Governor’s proposal, even if the sales tax increase were approved by voters:

Fewer people will have access to a quality education:

7,600 students at public and private colleges and universities would lose financial assistance through the Work Study program.
Funding that ensures children enter school ready to learn would be eliminated.

The health of people and the environment would deteriorate:

21,000 people who cannot work due to a disability would lose health care coverage.
Health care for 35,000 low-income working adults would be eliminated.
Child welfare programs that serve approximately 5,700 children a year would be eliminated, such as sex abuse recognition training, children’s advocacy centers, educational coordinators, adoption support recruitment, and support for street youth.
38,000 individuals with low incomes would lose access to routine dental care.
Funding for monitoring of water systems and surveillance of plague mosquito borne and tick-borne diseases would be cut.

Many would lose the support they need to get and keep a job:

Child care support that helps low-wage workers keep their jobs would be reduced, affecting 4,000 children and their parents.
Food assistance to an estimated 11,000 individuals each month would be eliminated.
2,000 families would lose supports that provide training, job search, child care, and financial assistance to help people find work.

We need immediate revenues to prevent the worst of the cuts that are under consideration. The Governor’s half-cent sales tax increase represents a significant step in the right direction, but more is needed. At the same time, policymakers should also work to address the long-term structural problems with our revenue system. Our recent proposal to create a new capital gains tax in Washington would do much to improve the adequacy and stability of our flawed tax structure.

For more information on what a balanced approach would entail for Washington state as well as information on potential revenues and investments that assist in economic recovery, read our “Framework for Prosperity.”

New Policy Brief: Declining support for education threatens economic growth

Tara Lee — 2011-11-16T21:02:10Z

Washington’s ability to create jobs and build a strong economy is closely linked to providing quality education and making it widely available. But progress is jeopardized by potential options that lawmakers will consider when they meet in special session later this month to respond to the ongoing revenue crisis.

Our newest policy brief by Kim Justice, highlights the need to maintain strong investments in education.

Some key highlights of the brief:

-The average cost to attend college has risen 94 percent since 2007 at four-year institutions and has risen 54 percent at community and technical colleges. Current proposals would cut an additional 15 percent of state support from higher education.

-Over 20,000 eligible students were unable to receive financial aid in 2010 due to insufficient state resources. Financial aid for 70,000 students is on the line in the next round of budget decisions.

-The number of kids in K-12 increased by 12,135 between 2008 and 2010, but the number of teachers in classrooms shrunk by nearly 3,000. Further budget cuts would increase class sizes in grades 4 through 12, making it harder for kids to get the attention and engagement they need to succeed.

-Access to quality early learning during the first five years of life for over 2,000 kids would be cut under budget proposals currently being considered. Opportunities for childhood educators to advance their skills have been eliminated, weakening the quality of education for children during the most important learning years of their life.

Read the full brief here

Declining Support for Education Threatens Economic Growth

Kim Justice — 2011-12-16T20:41:44Z

Introduction

The need to maintain strong investments in education is one reason why Washington needs a balanced approach that includes revenue rather than a cuts-only approach that backs away from the building blocks of a strong economy. Upholding a strong education system is crucial to our economic recovery and future prosperity. But decisions made in the wake of the Great Recession have taken our investments in a different direction, slicing approximately $5 billion out of our education system in the last three years (figure 1). Another $2 billion in cuts are being considered right now, many of which will come out of education, making it even harder for Washingtonians to access educational opportunities that are necessary for a better future. Some facts to help put this in perspective:(1)

The average cost to attend college has risen 94 percent for students and families since 2007 at four-year institutions due to dramatic increases in tuition. The cost has risen 54 percent at community and technical colleges.(2)Current proposals would cut an additional 15 percent of state support from higher education;
Over 20,000 eligible students were unable to receive financial aid in 2010 due to insufficient state resources. Financial aid for 70,000 students is on the line in the next round of budget decisions;
The number of kids in K-12 increased by 12,135 between 2008 and 2010, but the number of teachers in classrooms shrunk by nearly 3,000.(3) Further budget cuts would increase class sizes in grades 4 through 12, making it harder for kids to get the attention and engagement they need to succeed;
Access to quality early learning during the first five years of life for over 2,000 kids would be cut under budget proposals currently being considered. Opportunities for childhood educators to advance their skills have been eliminated, weakening the quality of education for children during the most important learning years of their life.

A high quality education system – one that spans early learning through higher education and prepares adults for the labor market– is essential to ignite our sluggish economy and prepare our workforce to be globally competitive. A strong education system guarantees high quality early learning opportunities for children, upholds a strong K-12 system to prepare students for college or a job, builds a workforce that can translate today’s breakthroughs into tomorrow’s cutting-edge industries, and ensures educational opportunities among low and moderate income students by providing financial aid.

In our Framework for Prosperity, we lay out a vision for the future prosperity of our state, which includes making investments in high quality, affordable education to put Washingtonians back to work. And we offer up solutions to boost our resources in order to make these essential investments.

Today’s job market requires more education and skills

At a time when the state’s unemployment rate sits at the highest it’s been since 1983 (9.1 percent), educational attainment has become even more essential to landing a job.(4) In fact, as of April 2010 nearly half of vacant jobs in Washington required an education beyond a high school diploma or GED, according to the University of Washington. Those with less educational attainment tend to fare worse in the job market — in 2010, nearly one in six people with less than a high school diploma were unemployed compared to one in 20 with a Bachelor’s degree or higher (figure 2).

Not only is higher education the key to employment, it also reaps significant benefits for individuals and society including higher lifetime earnings, better health, and more civic participation. According to a report by the Employment Security Department, a bachelor’s degree is worth $15.54 more per hour than a high school diploma.(5)

Our economy cannot begin to recover until people get back to work. For many, this will require further educational development and enhanced job skills. But there is a problem and policymakers need to prevent it from getting worse: just as the need to go back to school to train in a new career or advance educational skills is increasing, the ability to access education is shrinking.

HIGHER EDUCATION

Declining state support is making college unaffordable

The Great Recession, along with structural changes to our state and national economies, has greatly increased the need Washingtonians have for the opportunities provided by higher education. However, the prospect of obtaining an advanced education is diminishing for many as it becomes harder than ever to afford the cost of attending a college or university.

Since 2007, the average cost to attend college has risen 94 percent for students and families at four-year institutions, due to dramatic increases in tuition. The cost has risen 54 percent at community and technical colleges. The state historically supported society’s commitment to learning by making sure students paid less than half the actual cost, but that flipped in 2011 and now families are asked to pay the lion’s share at four-year institutions, and 37 percent of the costs at community and technical colleges (figures 3 and 4). At the University of Washington, tuition jumped by $3,528 between 2008 and 2011, and increased 30 percent at community and technical colleges over the same time period.

During the 2009-11 biennium, when the state faced enormous recession-induced declines in revenue, the Legislature authorized tuition increases of 14 percent at the six baccalaureate universities and seven percent at the 34 community and technical colleges.(6) In the 2011-13 biennium, the Legislature authorized further tuition increases and allowed four-year institutions to go beyond their authorized increases by granting them the authority to set their own tuition. The University of Washington exercised this authority and raised tuition four percent beyond what the legislature authorized, for a total of a 20 percent increase in 2011-12. As discussed in Box 1, the dramatic increases in tuition have significantly shifted the majority of the costs to families.

Financial aid has not kept pace with need

Along with the rising costs of tuition, Washington’s students are facing the challenge of having to pay for higher education with limited state financial aid. Even though the overall amount of state resources devoted to financial aid has increased since 2009, it has not kept up with growing needs. The State Need Grant (SNG), Washington’s largest and longest standing student aid initiative aimed at serving the state’s lowest-income students, has experienced unparalleled levels of need. Since 2005, the number of students eligible for these grants has increased by 18 percent. However, over the same time period the number of students receiving the SNG has declined by 8 percent. As shown in figure 5, the total number of students receiving a SNG in 2005 (65,328) was greater than the overall number of students receiving grants in 2010 (59,941). Furthermore, more than a quarter of all students eligible for state need grants in 2010 were unable to receive them due to insufficient state funding.

More cuts would close the door to opportunity for many

Reductions being considered for the 2012 supplemental budget would make access to a higher education impossible for many lower- to middle-income families.

Further increases in tuition would be inevitable under initial budget proposals that recommend a 15 percent deeper cut to state funding of colleges and universities.
Students who most need access to financial aid to withstand tuition increases could find that there is no support to turn to. Proposed reductions to the State Need Grant range from reduced eligibility to reduced grant amounts, to complete elimination which would impact 70,000 low-income students.

EARLY LEARNING

The first few years of learning are the most important

The first five years of a child’s life are the most critical time for learning. These years are a significant time for the development of a child’s brain and shape a child’s future health, happiness, and achievement in school. An effective early learning experience encompasses prenatal care for mothers, social-emotional development, child care and preschool, kindergarten through third grade, health and nutrition, education for parents, and professional development for educators.
Despite the importance of education during this time in a child’s life, funding for early learning makes up the smallest portion of state spending on education (figure 6).

Quality early learning depends upon quality teachers

One of the key components to a child’s successful learning during these first five years is having skilled, capable early childhood teachers. That was the driving force behind the creation of the Washington State Early Childhood Education Career and Wage Ladder. The program was first established as a pilot in 2000 to reduce staff turnover and improve the quality of early learning educators in licensed child care centers. It has been highly successful in providing opportunities for childcare staff to enhance their skills and the professionalism of their career by increasing wages based on level of education, years of relevant experience, and level of work responsibility.

In a final evaluation report of the pilot project, child care centers with the Career and Wage Ladder pilot were measured against a comparison sample of centers that were not part of the pilot. Compelling positive outcomes of the program were identified, such as quality of care was found to be significantly higher in the pilot than in comparison centers observed, educational attainment of employees at pilot sites was much greater, and the average wage for educators was higher in the pilot than the comparison centers.(9)

Despite its proven track record, funding for the Career and Wage Ladder was eliminated in the 2011-13 budget. The lack of opportunities for educators to further their educational attainment and increase earnings will likely have an impact on not only the sustainability of the profession, but also on the quality of care that children receive.

Looming cuts could close the door on early learning for many kids

As additional reductions are being explored, there is risk that many kids will no longer have access to early learning at all. Options being considered under further budget reductions include cutting enrollments in early learning programs to all 3-year olds and some 4-year olds.(10) This cut would leave up to 2,200 kids without critical early learning.

K-12 EDUCATION

Our public schools must prepare children to succeed

A top-notch education complete with highly qualified teachers, safe buildings, small class sizes, and updated textbooks and equipment is integral to the ability of kids to succeed in jobs, college, and in life. As our state’s population continues to grow, so do the number of kids enrolled in kindergarten through 12th grade. But our state’s investment in education — for good teachers, keeping class sizes small, and providing quality learning tools— have not kept pace with that growth. As shown in figure 7, Washington’s public schools have suffered steep cuts in the last three years. Consequently, kids are getting less support in the classroom. Between 2008 and 2010, enrollment in K-12 schools grew by 12,135 students, but the number of teachers in classrooms shrunk by nearly 3,000.

Student achievement threatened as class sizes grow

Research shows that smaller class sizes improve student learning and result in significant gains in student achievement. Small class sizes allow teachers to provide individualized attention to students. Initiative 728, passed by voters in 2000, established funding for quality improvements such as class size reduction. But in the last few years, our state has not maintained these investments. Funding for Initiative 728 was eliminated by the Legislature in 2010 and has been suspended ever since.

In addition, funding to reduce class sizes in fourth grade classrooms was reduced in the 2011 fiscal year, and in the current biennium, funding for class size reduction in kindergarten through fourth grade was eliminated altogether. Under the Governor’s preliminary 2012 Supplemental budget, class sizes would continue to increase in grades four through 12.

Conclusion

In the coming weeks, policymakers will convene during a special session to make decisions with serious implications for Washington’s commitment to invest in creating jobs and promoting economic recovery. Choices they make will go a long way toward determining whether the state stays with what has worked over the years to build economic growth or retreat from the established course and take stakes that hurt the ability to create jobs and compete around the world.

Washington’s path to economic recovery and future prosperity is dependent upon the choices that are made. Access to a high-quality, affordable education is necessary to the vitality of our overall economy, businesses, families, and the quality of life we all want to enjoy.

In our Framework for Prosperity, we lay out a vision for the future and solutions to get us there. We propose making investments that will put Washingtonians back to work by preserving opportunities to access high quality, affordable education. To do that, we need to build a revenue system that works. To continue to meet our immediate needs, we must raise revenue now, through options such as temporarily increasing and permanently modernizing the sales tax and eliminating unproductive tax breaks.

At the same time, we must also make long-term, structural changes to ensure our revenue system is sustainable into the future. This includes adding new revenue sources, strengthening our Rainy Day Fund, and increasing transparency and accountability of our tax system.

To read the full Framework for Prosperity, click here.

Acknowledgments

The Budget & Policy Center gratefully acknowledges the support of the Annie E. Casey Foundation, Bill & Melinda Gates Foundation, Paul G. Allen Family Foundation, Campion Foundation, Northwest Area Foundation, Stoneman Family Foundation, and The Seattle Foundation. The findings and conclusions presented in this report are those of the Budget &Policy Center, and do not necessarily reflect the opinions of these organizations.

Endnotes

1. The primary source throughout the report is the author’s analysis of budget data from the Legislative Evaluation and Accountability Program and the Office of Financial Management (see http://fiscal.wa.gov, http://leap.leg.wa.gov, and http://ofm.wa.gov).

2. Senate Committee Services, presentation to Senate Ways and Means Committee, Oct. 10, 2011.

3. Student enrollment data from LEAP, 350 students added to account for full-day kindergarten enrollment; data for teachers from the Office of Superintendent of Public Instruction, Personnel Summary Reports.

4. Data from the Bureau of Labor Statistics, Local Area Unemployment Statistics; Unemployment rate from 1976-2011, not seasonally adjusted.

5. Nora Keith, “WA State Spring 2010 Job Vacancy Report,” Employment Security Department, July 2010.

6. WA State’s six baccalaureate colleges: University of Washington, Washington State University, Central Washington University, Eastern Washington University, Western Washington University, and The Evergeen State College.

7. Data from the Higher Education Coordinating Board and US Census Bureau (ACS).

8. The Project on Student Debt, “Student debt and the class of 2010,” November 2011.

9. Boyd and Wandschneider, Career and Wage Ladder Final Executive Summary, March 2004. http://del.wa.gov/publications/research/docs/CareerWageLadder_2004.pdf.

10. Budget reductions identified by Governor for 2012 Supplemental budget; reflects 11 percent and 25 percent enrollment reductions. Reductions would impact all 3-year olds except where needed to maintain viable classrooms.

Capital gains: A rapidly growing, untapped resource

Andy Nicholas — 2011-11-08T20:11:45Z

Our latest policy brief proposes a new tax on capital gains to help spur long-term job creation and economic growth in Washington state. While it could not be implemented quickly enough to address our current revenue shortfall, a capital gains tax would significantly improve Washington’s revenue system in the long run.

A key attribute of capital gains is that they grow rapidly over time. As shown in the graph below, capital gains rose by 21 percent on average each year over the last economic cycle, to $24 billion in 2007 from $7.4 billion in 2001. By contrast, taxable retail sales -- the largest component of our current revenue system -- grew by about five percent each year during the same period.

Our current revenue system, which doesn’t leverage the power of capital gains, fails keep pace with the costs of maintaining core investments in health care, education, and other important public priorities from one year to the next. Enacting a modest tax on fast-growing capital gains would begin to address this fundamental problem.

For more information, read our latest policy brief, A Capital Reform: Using capital gains to fuel job creation and economic prosperity in Washington state.

New policy brief proposes capital gains tax in Washington state

Andy Nicholas — 2011-11-03T19:05:16Z

Our latest policy brief, "A Capital Reform: Using capital gains to fuel job creation and economic prosperity in Washington state," was released today. The brief proposes a new tax on capital gains to help rebuild our core health, education, and other vital public structures.

Why did we propose a Capital Reform now? Because a new tax on capital gains would:

Generate up to $1 billion a year in new resources for job creation;
Benefit all Washingtonians, though few would pay;
Establish a sustainable, long-term stream of resources to promote economic growth;
Reduce the impact of future recessions by building a more robust “Rainy Day Fund;” and
Create an opportunity to lower taxes for the vast majority of Washingtonians.

Read the full brief to learn more.

A Capital Reform: Using Capital Gains to Fuel Job Creation and Economic Prosperity in Washington state

Michael Mitchell — 2012-01-10T23:41:58Z

By Andy Nicholas

Introduction

To create jobs, spur long-term economic growth, and foster prosperity, Washington state desperately needs to rebuild its eroding education, public health, and community safety infrastructure. Our state has a powerful, but untapped resource to accomplish this: capital gains. A modest tax on some capital gains would help fuel economic recovery and opportunity for future generations of Washingtonians.

Enacting a small tax on capital gains would:

Generate up to $1 billion a year in new resources for job creation: Once in place these resources would immediately be put to use building the high-quality, health, education, and community safety systems Washington will need to be a prosperous and competitive state in the coming years.
Benefit all, though few would pay: Setting a reasonable exemption – up to $10,000 for married couples – on capital gains subject to taxes would ensure that 97 percent of Washingtonians would not pay any additional taxes.
Establish a sustainable, long-term stream of resources for economic growth: Using fast-growing capital gains resources would allow our state to maintain the quality levels of health care, education, and other important priorities that in the long run are crucial to attracting jobs. Our current revenue structure can’t do that.
Reduce the impact of future recessions by building a more robust rainy day fund: With an amendment to the State Constitution, up to 50 percent of revenues from the Capital Reform proposal would be dedicated to our state Budget Stabilization Account or “Rainy Day Fund.” Saving more of our resources when times are good would help Washington better withstand future recessions, reducing the need to impose damaging service cuts when our public health and education systems are most needed.
Create an opportunity to lower taxes for the vast majority of Washingtonians: Some of the revenues from a capital gains tax could be used to lower the state sales tax rate and finance a rebate for working families with children. Doing so would result in a net tax cut for the vast majority of Washingtonians while leaving significant additional resources to help rebuild our state economy.

A capital gains tax is not a state income tax. The paychecks of Washingtonians would not be reduced by one penny.

The Capital Reform proposal is a reasonable approach for Washington state. It would create a new, long-term stream of resources needed to help put Washingtonians back to work, build first-rate health and education systems, and maintain safe and vibrant communities in our state. We face economic problems that threaten our future; now is the time to take sensible action to foster long-term growth and prosperity.

Capital gains: a powerful but untapped resource

A capital gain occurs when shares of stock or other financial assets are sold at a profit – that is, when the selling price exceeds the original purchase price. Common transactions that result in a capital gain include the sale of stocks, bonds, and vacation homes. Capital gains are an abundant and rapidly growing economic resource in Washington. In 2009, during the deepest part of the Great Recession, nearly $6 billion were generated from the sale of capital assets in our state.(1)

A resilient and rapidly growing resource

A key attribute of capital gains is that they grow quickly over time. As shown in Figure 1, capital gains grew much more rapidly during the last economic cycle compared to other types of activities. Here in Washington state, capital gains grew to $23.7 billion in 2007 from $7.4 billion in 2001– an average annual growth rate of 21 percent. By contrast, the largest component of our current revenue system, taxable retail sales, grew by about five percent each year. As discussed in more detail below, at this growth rate, our existing revenue system fails to keep pace with ongoing costs of educating our children, caring for the growing number of seniors, and maintaining other important public priorities.

Unlike other parts of the economy, capital gains are highly resilient following recessions. Table 1 compares the recovery rates of four national economic indicators since 2009 – the stock market, consumer purchases, employment, and wage and salary disbursements. The table shows that the stock market (as represented by the Dow Jones Industrial Average) has recovered far more quickly than the other parts of the economy since the recession bottomed out in the summer of 2009. The Dow Jones Industrial Average grew by 47 percent between 2009 and 2011. By contrast, consumer spending has grown by 9.1 percent since 2009, and employment by less than one percent. Income from wages and salaries has grown by approximately two percent following the deepest part of the recession.

Capital assets are concentrated among the wealthiest households

The vast majority of capital gains wealth flows to the richest households in Washington. In 2007, at the peak of the last economic cycle, only 21 percent of federal tax returns filed in Washington state reported any taxable capital gains.(2) And, as Table 2 shows, 81 percent of capital gains that were filed under federal income tax returns were held by the wealthiest three percent of households. Three out of every four filers with adjusted gross income over $200,000 reported some kind of capital gains. On average, capital gains accounted for about 30.4 percent of total annual earnings among this group.
By contrast, only 13 percent of residents making less than $75,000 per year reported any kind of capital gains at all. Only 5.7 percent of total capital gains in Washington came from these households. Furthermore, capital gains represented a negligible 1.9 percent of earnings among these families. As a matter of perspective, the median income in Washington state in 2010 was $55,631.(3)

Implementing a capital gains tax in Washington state

Washington’s revenue system does not leverage the power of capital gains. A small tax on capital gains would provide our state the resources we need to help create jobs and build first-rate education, health, and other public structures proven to foster long-term economic growth and prosperity. Because capital assets are concentrated among the wealthiest households, excluding even a modest amount of capital gains would exempt a large majority of Washingtonians from paying the tax. For example, excluding just the first $10,000 of capital gains for joint filers from taxation ($5,000 for singles) would mean that only 3.2 percent of Washington households would pay any additional taxes under the Capital Reform proposal.(4,5)

Simple and cost-effective to administer

A tax on capital gains would be easy for taxpayers to calculate and would entail low administration costs for the state Department of Revenue (DOR). The tax would use the same definition of capital gains as the Internal Revenue Service; information that taxpayers from Washington already enter in Schedule D of their federal income tax return would be used on the state form. Washingtonians would simply use total capital gains reported on their federal returns, subtract the amount excluded from taxation in Washington state, and apply the state rate to the remainder. Using federal capital gains definitions would also allow for a cost-effective state administration process in which DOR would make use of IRS data to verify the accuracy of state returns filed each year.

Not a tax on paychecks or the most common investment activities

A capital gains tax is not a state income tax. Under the proposal paycheck income from Washingtonians’ salaries and wages would not be reduced in any way. Furthermore, the use of federal IRS definitions would ensure that other common investment activities, such as selling a residence or saving for retirement, would also be excluded from the tax.

In addition to paycheck income, other common investment activities that would not be taxed under the Capital Reform proposal include:

Ordinary home sales: Using the federal capital gains definition would ensure that the vast majority of home sales would not be covered under a capital gains tax. Under federal tax law, for a married couple the first $500,000 ($250,000 for single residents) in profit from the sale of primary residences is completely exempt from taxation. Because of this high exemption, only 2.8 percent of homes sold in the United State in 2007 were subject to any federal capital gains taxes.(6) The median price of homes sold in Seattle, Tacoma, and Bellevue in 2010 was $295,700 – far below the amount that would trigger a taxable capital gain under the proposal.(7)
Retirement savings and income: Coupling to federal capital gains definitions means that Washingtonians’ retirement savings through 401k and pension plans would not be taxed under the proposal. Retirement income would also remain untaxed in Washington because distributions from retirement plans are not taxed as capital gains under federal law.
Inherited investments: At the federal level, a capital asset held until death does not face the capital gains tax. Anyone who inherits a capital asset is merely responsible for paying taxes on gains occurring after taking ownership of the asset.

Few would pay

Very few Washingtonians would owe any capital gains tax under the Capital Reform proposal. Even if all capital gains were subject to the tax – that is, if no exemption or threshold were applied – only 11.9 percent of residents would owe any additional taxes, according to estimates from the Institute on Taxation and Economic Policy (ITEP). If a couple’s first $10,000 of capital gains were excluded from taxation, only about 3.2 percent of residents would pay any tax in Washington. Under a tax rate of 5 percent and a $10,000 exemption, the wealthiest one percent of families in Washington – those whose income averages more than $1.4 million a year – would see their taxes rise by only about nine-tenths of one percent of their annual incomes.

Table 3 compares how a capital gains tax structured in this way would affect two hypothetical taxpayers in Washington state.

Taxpayer A – who receives $79,500 in paycheck income, and $7,000 in capital gains each year – would pay nothing additional under the proposal. Taxpayer B – with $330,600 in paycheck income and $130,000 in capital gains – would pay $6,000. This comes to only 1.3 percent of Taxpayer B’s adjusted gross income. And, because the $6,000 in capital gains taxes paid to Washington state would be deductible from federal income, Taxpayer’s B’s federal income tax would be reduced by $2,100. In essence then, when the federal deduction is taken into account, Taxpayer B would see their taxes rise by about $3,900 in 2011 under the proposal.(8)

Options and revenue potential

In a single year, a tax on capital gains would generate hundreds of millions of dollars in new resources.

Exactly how much the state could raise would be determined by two factors: the level of capital gains to be excluded from any tax, and the rate levied on gains that are taxed. Information on the amount of revenue that could be generated at different tax rates and exemption levels appears in Tables 4 and 5.

A capital gains tax with a modest five percent rate and a $10,000 exemption ($5,000 for singles), would generate over $500 million in state revenue in the coming year. (As Box 1 explains, a five percent rate on capital gains would be quite low relative to rates applied by other states.) As a matter of perspective, if a capital gains tax had been in place between fiscal years 1996 and 2012, our state would have generated more than $9 billion in additional state revenues.(9) All of these resources could have been used to develop high-quality health, education, and other public systems that are crucial to long-term economic growth and prosperity.

Box 1: Majority of states tax capital gains at a higher rate than the Capital Reform proposal

As the map below shows, a modest five percent rate applied to capital gains is considerably lower than the top rates applied in most other states. In 31states, capital gains are taxed at a rate higher than five percent. Another 11 apply a rate at five percent or lower, and Washington is one of only eight states that do not tax capital gains at all. Notably, five percent is much lower than the 11 percent rate applied in Oregon and the 7.8 percent rate in Idaho.

New Hampshire and Tennessee

Most of states that tax capital gains do so through their state income tax systems. Like Washington, New Hampshire and Tennessee do not tax paycheck income. Unlike Washington, these states do tax high-end dividend and interest payments. In New Hampshire, the five percent tax on these investment activities has been in place since 1923. Between 2007 and 2009 the tax generated more than $100 million each year in resources for public priorities such as health care and education. Only nine percent of tax filers in New Hampshire actually owe the tax, and the average amount owed was $147.(a)

Tennessee levies a six percent tax on some capital gains, dividends, and interest payments, which has been in place since 1929. The tax generates about $287 million in state revenues each year and impacts about four percent of the state’s population that is over 20 years of age.(b,c)

a. An overview of New Hampshire’s tax system, New Hampshire Fiscal Policy Institute December 2010.
b. Tennesse Department of Revenue, Fiscal Year 2008 revenue statistics.
c. Budget & Policy Center calculations; data from TN Department of Revenue and U.S. Census Bureau.

Fixing our revenue system to foster long-term prosperity

Washington’s revenue system does not adequately or equitably support education, public health, and other structures essential to making the state favorable for job creation and long-term prosperity. Even in normal economic times our revenue structure does not support consistent levels of these important investments. As shown in Figure 2 below, in four of the last six bienna (9 of the last 12 fiscal years), state tax revenues have fallen short of the amount spent on health care, education, and other important priorities.

This ongoing gap between Washington’s investments and the resources available to pay for those investments is commonly referred to as our “structural deficit.” Due to a number of factors that are beyond the state’s control, the cost of maintaining our public systems rises each year. Rising energy prices continually make it more expensive to heat class rooms and to fuel police cars, ambulances, and school buses. The rapidly growing price of health care services (in addition to growing demand for these services) has made it more expensive for our state to provide adequate medical care for seniors, children, and laid-off workers.

The major cause behind the structural deficit is Washington’s slow-growing revenue system, which fails to keep pace with these costs. By introducing a rapidly growing revenue source, the Capital Reform proposal would represent a dramatic step toward creating a more robust and adequate revenue system in Washington state.

Figure 2 also shows that had a modest five percent capital gains tax (with a $10,000 exemption) been in place, in five out of the last six biennia (9 of the last 12 fiscal years) state revenues would have met or exceeded spending on health care, education, and other core public structures. The result would have been a more balanced and sustainable system of financing these and other important public priorities.

A five percent capital gains tax with a $10,000 exemption would have many positive impacts on our shared economic investments and would greatly improve our flawed revenue system. These benefits are described in the following sections.

Speedier economic recoveries

While capital gains can decline rapidly at the onset of a recession – something that is appropriately addressed with a robust rainy day fund (see below) – they also recover much more quickly following recessions compared to other parts of the economy. Taxable retail sales, the largest component of Washington state’s present revenue structure, fell by 4.2 percent between July of 2009 and July of 2011. By contrast, the Dow Jones Industrial Average increased by over 47 percent during the same period.(10)

A capital gains tax would have significantly hastened the pace of Washington’s recovery from the Great Recession. State tax revenues are currently projected to grow by 1.4 percent in the current fiscal year. Had a capital gains tax been in place state tax resources would be growing by about 2.2 percent this year and would be poised to grow rapidly in the coming years.(11)

Other states that tax capital gains have benefited from the stock market’s rapid growth over the past two years. A recent report from the Center on Budget and Policy Priorities found that of the 28 states that recently experienced faster than expected revenue growth, the accelerated growth in 23 was due to high-end corporate and individual earnings – including capital gains.(12)

Stabilizing funding for economic investments

The Capital Reform proposal would stabilize funding for Washington’s core public health and education investments. Upon enacting the capital gains tax, policymakers and voters should amend the State Constitution to dedicate up to 50 percent of the new revenues to the state Budget Stabilization Account, commonly referred to as the “rainy day fund” or RDF.(13) Wisely saving more of our resources during good economic times would reduce the need for tax increases or severe cuts to essential public structures in future recessions.

Figure 3 shows that billions of dollars in economically-damaging cuts to our health and education infrastructure could have been avoided, had the proposal been in place since fiscal year 1996.

Figure 3 shows the amount of savings that would have accumulated between fiscal years 1995 and 2009 under three scenarios: 1) annual deposits to the RDF under current law; 2) current law deposits plus 25 percent of capital gains tax revenues; 3) and current law deposits plus 50 percent of capital gains tax revenues. (It’s important to note that Washington’s Rainy Day Fund was first enacted in 2007.) As the graph shows, under current law, which mandates that one percent of general fund tax revenues be deposited into the RDF each year, the fund would have achieved a balance of $677 million prior to the “dot com” bust recession of the early 2000s. It would have reached a balance of only $261 million before the Great Recession.

By contrast, with 25 percent of capital gains tax revenues devoted to it, the RDF would have achieved a balance of about $1.5 billion prior to the “dot com” bust recession and $823 million before the Great Recession. Had 50 percent of capital gains tax revenues been devoted to the RDF, savings would have reached $2.2 billion in the early 2000s and $1.4 billion by 2009. To put this in perspective, since the start of the Great Recession, Washington state has enacted about $10 billion in economically-damaging cuts to our public health, education, and community safety systems.(14) Under the Capital Reform proposal all of these savings could have been used to avert the worst of the service reductions imposed on Washingtonians throughout the recession.

Path to a better balanced, more equitable tax system

The Capital Reform proposal offers Washingtonians the opportunity to rebalance our system of financing public investments by lowering taxes for lower-and middle-income families while increasing them only modestly for the wealthiest households. We all have a responsibility to help maintain the public systems and structures that build a competitive economy and help make sure that prosperity is widely shared. However, our current revenue structure is upside-down: Washington state and local taxes take a larger share of the income of the lowest income households than from the highest.

For example, families in Washington with average earnings of about $11,000 per year pay 17.3 of their income in state and local taxes. Families whose incomes average $59,900 each year pay 10.8 percent. And those with annual incomes averaging $1.8 million – Washington’s richest 1 percent – pay just 2.6 percent of earnings.(15)

Our excessive reliance on the state sales tax is the major culprit behind Washington’s inequitable tax system. That’s because lower-and moderate-income families spend a large portion of their incomes on household necessities like soap, toothpaste, and toilet paper – all of which are included in the sales tax.

Some or all of the revenues generated by a capital gains tax could be used to lower the state sales tax rate and fund a Working Families Tax Rebate (WFTR). Used this way, the Capital Reform proposal would significantly lower taxes for the vast majority of Washingtonians, while leaving significant additional resources to reinvest in education, health care, and other job-creating public structures. The impact would be most pronounced among working families with children. Figure 4, shows how the proposal would benefit families in Washington state if all of the revenues were used to lower existing state taxes.

As the graph shows, families with children in Washington making less than $13,000 would see their state taxes reduced on average by two percent of their annual incomes, or $294 per year. Middle-income families with children – those with earnings between $38,000 and $61,000 per year – would also experience a reduction, averaging three-tenths of one percent of annual incomes, or $162 each year. Even households with earnings just under $192,000 would experience a net tax cut, due to the reduction in the state sales tax rate. On average, households with incomes in excess of $486,000 per year would see their state taxes increase by an average of only nine-tenths of one percent of their incomes, or $12,610 a year.

Conclusion

It’s time for Washington state to create new jobs through smart investments in our shared health, education, community safety, and other public systems that foster long-term economic growth and prosperity.

For too long we have been losing ground. The Capital Reform proposal would generate the resources to help rebuild our economy through a modest tax on capital gains – a powerful but untapped economic resource. Depending on the structure, a tax on capital gains could generate up to $1 billion each year in much needed resources. The tax would improve our entire revenue structure, making it a more robust and sustainable system of financing important public priorities.

Wisely devoting up to 50 percent of the resources created under the proposal to our state Rainy Day Fund would lessen the severity of future recessions by maintaining vital public health and family support systems when they are most needed.

Finally, resources from a capital gains tax could be used to lower taxes for the majority of Washingtonians – especially lower-and middle income families. Through sensible actions we can rebuild our economic prosperity. A Capital Reform should be the first step.

Acknowledgments

The Budget & Policy Center gratefully acknowledges the support of the Annie E. Casey Foundation, Bill & Melinda Gates Foundation, Paul G. Allen Family Foundation, Campion Foundation, Northwest Area Foundation, Stoneman Family Foundation, and The Seattle Foundation. Matt Gardner and Kelly Davis from the Institute for Taxation and Economic Policy provided data and analysis. The findings and conclusions presented in this report are those of the author alone, and do not necessarily reflect the opinions of these organizations.

Endnotes

1. Internal Revenue Service, Statistics of Income for Washington state Tax Year 2009.

2. Internal Revenue Service, Statistics of Income for Washington state Tax Year 2007.

3. U.S. Census Bureau, 2010 American Community Survey.

4. Institute on Taxation and Economic Policy (ITEP), Custom estimates for FY2012.

5. For more information on ITEPs methodology visit http://itepnet.org/about/ITEP_tax_model_full.php

6. Budget & Policy Center calculations; Data from IRS and the National Association of Realtors.

7. National Association of Realtors, http://www.census.gov/compendia/statab/2012/tables/12s0977.pdf

8. The federal Alternative Minimum Tax (AMT) would limit the amount of the deduction for some taxpayers.

9. ITEP, Custom estimates for Washington state. Tax years 1995-2011

10. Budget & Policy Center calculations; Data from the Economic and Revenue Forecast Council (ERFC), September 2011 revenue forecast and Dow Jones Industrial Average

11. Budget & Policy Center calculations; Data from ERFC and ITEP

12. Elizabeth McNichol, Michael Leachman and Dylan Grundman, “Better-Than-Expected State Tax Collections Highlight Importance of Income Taxes,” Center on Budget and Policy Priorities. July 11, 2011. http://www.cbpp.org/cms/index.cfm?fa=view&id=3530

13. Revenues from the proposed capital gains tax could also be dedicated to the RDF by statute. However, a Constitutional amendment can only be enacted via a supermajority vote of the legislature plus a vote of the people. As such, an amendment would be a more effective long-term mechanism for building a robust RDF.

14. Budget & Policy Center calculations; Data from Legislative Evaluation and Accountability Program (LEAP) Committee

15. The Institute on Taxation and Economic Policy, “Who Pays? A Distributional Analysis of the Tax Systems in all 50 States,” 3rd ed. November 2009. http://www.itepnet.org/state_reports/whopays.php