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Capital Gains Tax + Rainy Day Fund = Greater Economic Stability

Posted by Andy Nicholas at Jan 23, 2012 04:30 PM |

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 During recessions, savings from the RDF would have been withdrawn by the amount needed to maintain capital gains tax revenues at peak economic levels.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.

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