Emerson Lynn On The Governor's Tax Plan

Closing A Loophole? 

In his state-of-the-state address, Governor Douglas proposed doing away with the capital gains exemption in order to reduce rates on ordinary income.  There is much to say about this proposal and some of the Governor's  strongest supporters are strongly opposed.  Emerson Lynn advances the "pro" side of the argument with his usual lucidity in the pages of the St. Albans Messenger.  We expect to the other side of the argument will be made here in the near future. 

Governor's Tax Plan Benefits 70,000 Working Vermonters

Vermont has long been a haven for those who make their livings clipping coupons. Why, is no mystery: they pay less in taxes than people who work for a living. The first 40 percent of their “unearned” income is tax-free. Gov. Jim Douglas Thursday said the free ride should end.
    In the governor’s state-of-the-state address he said it was a basic issue of equity. It was unfair to expect working Vermonters earning $50,000 a year to pay roughly 50 percent more tax than people who don’t work. He wants the loophole closed, noting that Vermont is one of the few states that allows such inequity.

It’s hard to imagine that the Democrats will object. The 5,000 or so affected is a privileged group and it’s inconceivable that the Democrats would mount a defense in their behalf.
    That’s not the issue. The issue is what is to be done with the $20 million that would be generated each year by closing the loophole.
    The loophole itself isn’t an unknown. It was put in place in 2001 to help balance the tax revenue effect incurred when the state decoupled its income tax rate from that of the federal government. The decoupling was supposed to be revenue neutral. It wasn’t. The 40 percent exemption was added to compensate.
     The exemption always been out there as part of any discussion involving the state’s tax system. What the governor is doing is preempting the Democrats on the issue, trying to remove the temptation to simply eliminate the loophole and pocket the money for other programs. This is akin to his preemptive effort to dedicate the unexpected windfall from the tobacco settlement toward his Vermont Scholarship program. He didn’t want the Democrats to use the money for programs that would ensure a higher rate of spending going forward.
    The same issue is in play this year. The governor wants the tax revenue to go back to Vermonters. About 70,000 of them.
    His proposal is straightforward. He wants to lower the income tax rate for middle income Vermonters, and he wants to lower the state’s top marginal tax rate, one of the highest in the nation.
    His timing is without flaw, and his intent is spot on.
    If we do slip into a recession, then putting money into the pockets of middle income Vermonters is prudent. They will need the cash, which also helps stimulate the economy. Think of it as a $20 million cash infusion. It may not turn the economy around, but it’s better than the alternative, which is to spend the money on government programs that don’t directly translate to the taxpayers in tough times.
    The proposal to lower the state’s top marginal tax rate will be more difficult to sell. This would benefit the highest income Vermonters, a group that rouses little sympathy, particularly in a highly Democratic Legislature.
    But that’s a perception that needs to be overcome. Vermont’s reputation as a high tax state needs correction, and it’s foolish to become embroiled in a debate as to whether our burden is the nation’s highest, as some claim, or in the top quintile. Being ranked 12th isn’t much better than being ranked first. High is high.
    Think about it. Is it preferable to allow those who don’t work for a living, those who don’t generate wealth, or jobs, to enjoy a huge tax break; or is it better to have them pay their fare share, but to lower [by a fraction] what the top income earners pay, those who take the risk, create the jobs [and the new businesses]? Those at the top would still have a marginal tax rate that would be among the nation’s highest, but it would be lowered a notch or two, which might be inviting to those who see Vermont’s employment potential. We might even be able to keep one or two from leaving.
    Although the tax proposal was not the governor’s sole priority in his Thursday speech, it is a pivotal part in dealing with Vermont’s biggest challenge, which is the need to make Vermont more competitive in a global economy. As our workforce shrinks in numbers, we will need to find other ways to compete. Being a highly taxed state with a declining workforce is not an appealing picture. The governor’s proposal is not only fair to those 70,000 working Vermonters, but it’s essential to making Vermont an easier place to do business.

by Emerson Lynn

Comments

[Philosopher]

If the Governor's plan was targeted just at trust-funders (by eliminating the capital gains exemption for securities only), it might have some logic (though even then, I would question it).

But why is he going after people selling businesses, or selling commercial property, or harvesting timber? He is targeting the very people needed to boost investment in the state's economy.

[Eric Davis]

The Democrats in the legislature might very well send the governor a bill that will only close the "loophole" but will not reduce the marginal rates. Douglas has said his proposal is a package, so he might well veto a bill that does not cut the marginal rates. If he can get a small number of House Democrats (e.g. some of the Franklin County delegation) to vote with him, the veto would be sustained.

There is one potential problem with the governor's proposal. In his speech last week, he said that the 40% exclusion would be continued for people over 65 and for the first $2500 in capital gains income. However, there are some people over 65 who have very substantial incomes from sources other than capital gains (salaries, pensions, IRA distributions, etc.) who could afford to pay higher taxes on the capital gains income, and other people under 65 for whom capital gains represent a substantial part of their incomes who would be hurt by the loss of the 40% exclusion, even if the marginal rates were slightly reduced.

What about structuring the end of the exclusion so that it phases out as one's taxable income from sources other than capital gains increases? Here's an example:

Less than $40,000 of taxable non-capital gains income: continue 40% exclusion

$40,000 - $70,000 of taxable non-capital gains income: 30% exclusion

$70,000 - $100,000 of taxable non-capital gains income: 20% exclusion

$100,000 - $150,000 of taxable non-capital gains income: 10% exclusion

$150,000 + of taxable non-capital gains income: no exclusion

This is just one example. The tax experts in Montpelier could play with the numbers to make the phase-out of the capital gains exclusion and the reduction of the marginal rates balance out in a revenue-neutral way.

[John Stewart]

I am very disappointed regarding the Governor's proposal to eliminate the capital gains exemption. Many of us have worked for years in Vermont paying Vermont's high taxes (both income and property)and planning for our retirement. Of course planning included allowing for the present tax regulations and rates. Now to change those basic assumptions is both unfair and unequitable.
You may say, "Well this change doesn't hurt you as you are over 65." And that is true for me, but many Vermonters who are making the same retirements plan that I did are not over 65. This proposal impacks their life savings and their retirement. While I, and many Vermonters like me, love Vermont and intended to live out our remaining years here - there comes a time when too much is too much. That time may be now!
This also sends the wrong message to our present Vermont businesses and those entrepreneurs who may be thinking of coming to Vermont. Sooner or later many of these businesses will be sold - why stay or come to Vermont if you have other opportunities where the tax burden is lower. Vermont all ready has high marignal tax rates, high property tax rates, high cost of permitting, estate taxes, probably high utility costs in the near future and the list goes on. Why put up another obstacle to staying or maybe coming to Vermont. This proposal is very short sighted. Plus, who wants to run the busness or personal risk of seeing their assets at risk due to changing tax law?
Lastly whatever happened to reducing spending? Most Vwermonters reduce their spending when their income is limited. Shouldn't we expect the same from state government (both the administration and the legislature)?
I think whoever gave the Governor advice on this proposal should be taken to the woodshed.
I am a long time contributor to the Republican party and candidates. I am so very disappointed!
John Stewart

I have no expertise in tax policy, so anyone can correct me, but isn't capital gains money that was already taxed at one point? Didn't somebody once pay an income tax on it? Or an inheritance tax, if it was a large sum of money?

[Cairn Cross]

As someone who is in business of primarily investing in Vermont companies (for an expected capital gain) this is perhaps the dumbest idea for taxation I have ever heard.

[Steve Webster]

The governor is to be commended for recognizing that Vermont's top income tax rates are too high, but I wish his proposal gave me confidence in his understanding of good tax policy. If he truly believes that working Vermonters need tax relief, then he should propose it and allow spending cuts to make it possible.

Tax relief should include repeal of the marriage penalty currently retained in Vermont's income tax code. By virtue of federal changes the standard deduction for married couples is now twice that of single persons, but Vermont's tax brackets for married persons filing jointly are not twice those of singles, although the federal ones are.

The governor's invitation to envy the investor and the "trustfunder" was disappointing. A great many of our public assets, such as libraries, meeting halls, hospitals, have been contributed by successful entrepreneurs and investors. Envy the trust beneficiary, if one will, but the lifetime beneficiary of a typical trust is entitled only to ordinary income. Capital gains generally are retained as principal of, and taxed to, the trust, and the tax on the capital gains is paid to the state where the trust was set up, quite possibly not Vermont. The trust's capital and its growth are not vested in the income beneficiary, and the beneficiary's dividend, interest, and rent income is already taxed by Vermont.

Those whom the governor's proposal would hit include farmers, landowners, innkeepers, newspaper publishers, entrepreneurs, and other persons who have grown a business or watched their asset values increase with inflation. It could include even some "working" Vermonters whose retirement savings are other than public or private pensions and employer-enhanced 401(k)'s and 403(b)'s. The gains from the sale of such assets would float to the top of a person's income and be taxed at the taxpayer's highest marginal rate or rates.

This legislature is not one on which to risk an income tax proposal, but a sensible change in the system would be to set a single low fixed rate at which net long-term capital gains would be taxed, say 4%, and a top marginal rate of 7% on ordinary income. Rates of that sort would "increase our competitive advantage when recruiting employers to start or expand businesses here," as the governor says he wants to do. People could then plan and not have their tax rate on capital gains depend on how great their gain turns out to be at the time of sale.

[David Usher]

Here we go again fiddling with and arguing over individual taxes when what's sorely needed is a thorough review of Vermont's overall tax policy. We need a strategy that is rational and abides the economic principles of taxation. We should sensibly tax ourselves to promote desirable outcomes insofar as possible.

This would require a mega-study perhaps over a couple of years, outside the legislative sessions. The way our leaders go about taxation and revenue raising now is helter-skelter to meet ever rising spending 'priorities.' That's a formula for more problems downstream.

Thoughtful Republicans and Democrats should be sponsoring a thorough examination of Vermont's tax policy.