September 25, 2009

It Depends at What Period of Capital Flow One Looks

Justin Katz

What an improvement is the reemergence of sincere argumentation on RI Future. I may find its new owner, Brian Hull, to be wrong about the implications of taxation, but I trust that he's attempting to express his opinion to persuade rather than to mislead. Thus, not only may exchanges be fruitful, but the actual assumptions of each side may be addressed:

... any reduction in an individual's state tax liability does not necessarily lead to investment. The tax savings could be saved, or spent on luxury items (which may or may not be purchased in the state). Lastly, and most importantly, if an investment does actually occur, that investment can occur anywhere in the country or in the world. Wealth flows after opportunities to make money off that wealth, regardless of where the opportunities arise. A potential investor will seek the highest return on his investment, and not necessarily care about investing in his community or state. This shouldn't come as any surprise to you, so I'm wondering why you're so glib in correlating tax cuts to economic growth. ...

Do you honestly think that a $6,000 tax cut going to an individual making over $419,000 a year will generate job growth in Rhode Island? Do you think all those wealthy Rhode Islanders who got their $6,000 tax cut will join together and invest their tax savings in creating new businesses in the state? I suppose it's possible, just like it's possible that I’ll be struck by lightning, or win the lottery (you can't win if you don’t play), but we both know your claim is specious and the cost to the state necessitated its elimination.

That Brian is addressing capital gains taxes, specifically, is helpful, because it clarifies that the activity being taxed is in one way or another an investment in the state. If one treats a tax cut as no different than a direct handout from the government, like those rebate checks most of us received under misguided Bush policy, as Brian apparently does, then, no, $6,000 to each person in the limited group of really rich people won't generate much economic activity. But especially in the case of capital gains, that $6,000 is not the investment that the state is seeking with its low-tax policies — the investment that generated the revenue that was taxed at a savings of $6,000 is.

Brian's mistake is to treat revenue to the state as if it is the only, or at least most important, measure for the Rhode Island community. As a 2008 Poverty Institute fact sheet arguing for the elimination of the capital gains tax cut illustrates (PDF), the tax "savings" to the wealthy investor (in this case claimed to be $4,974) comes from an actual capital gain of $193,113, which itself is only a portion of the investment.

Although Brian is correct that the tax savings may be spent on anything, anywhere, for the tax to be levied in the first place, the investment must have been associated with Rhode Island in some way, whether by benefiting an actual Rhode Islander or by representing an investment in our state by a resident of some other state or nation. A low capital gains tax gives a state's businesses an advantage in their ability to offer stock options as remuneration as well as to attract investment from elsewhere. It also creates incentive to make money by investing, which one is often begin doing close to home — as with local real estate or nearby companies.

Of course, such cuts and business ventures are operating in a hostile tax and regulatory environment, but in isolation, the effects of a given policy are relative, meaning that it's better to have a lower tax even if it won't be a trump card.


Brian also presents a table purporting to illustrate that Rhode Island's tax burden isn't particularly heavy. His direct source isn't obvious, and I don't have the time, right now, to dig into the numbers for myself, but it appears to measure the actual dollar amount of different taxes — income, sales, property, corporate — as a percentage of actual personal income. The problem with this is that it lumps all Rhode Islanders together and doesn't really provide much useful information about tax policies effect on taxpayers.

The fact that Rhode Island's corporate income tax claims 0.4% of personal income (ranking us 26th highest in the country) could mean only that not a lot of Rhode Islanders operate businesses that make money. This possible interpretation is emphasized by the fact that New Hampshire ranks fourth, at 1.1%. Similarly, the fact that Rhode Island ranks 32nd in percent of personal income going to sales and gross receipts taxes could indicate that folks don't do as much shopping in our state.

Comments, although monitored, are not necessarily representative of the views Anchor Rising's contributors or approved by them. We reserve the right to delete or modify comments for any reason.

"What an improvement is the reemergence of sincere argumentation on RI Future. I may find its new owner, Brian Hull, to be wrong about the implications of taxation, but I trust that he's attempting to express his opinion to persuade rather than to mislead. Thus, not only may exchanges be fruitful, but the actual assumptions of each side may be addressed"

From what I have seen, Hull himself is very commendable and tries his best to facilitate rational and respectful discussion on the merits.

Unfortunately, I am starting to realize that most of the other commentators and contributors at RIFuture have no interest in actual debate, and simply resort to ridicule and personal attacks as a matter of course. They are apparently trying to establish their own echo chamber and simply drive out anyone who doesn't go along to get along with progressive policies by shouting them down. I have been labeled at least a dozen times as being a "right-winger" or "neo-con" so far, even though as anyone here could probably tell them, I am anything but.

I've also never seen so many strained-to-the-limit accusations of "racism" in my life. In a recent post they accused a picture of a dog circulated by a conservative organization as being supportive of 1950's segregationist policies. It borders on some kind of obsession or psychosis, I've never seen anything like it.

Posted by: Dan at September 25, 2009 11:03 AM

In response to your addendum, the final chart in the post you're referring to ( which relates to RI state and local taxes as a % of personal income is from a presentation by Jeff McLynch, Northeast Regional Director of the Institute on Taxation & Economic Policy (

I find the analysis useful in that it measures the total tax burden as a share of total income for the state. In many ways, untruthful claims are made regarding the overall tax burden in the state based on the "high tax rate" of either the sales tax, the corporate income tax, or the top marginal rate of the personal income tax.

I don't disagree that a 7% sales tax is high, but the tax is applied to such a narrow range of goods and services that could be taxed. Additionally, when the RI rate is compared to other states' sales taxes, there is an avoidance in addressing the many, many areas of the country which levy county taxes. This happen in most of the states west of the Mississippi, so any measure of percentage to percentage state rates can be specious without also calculating these other taxes, and the number of goods and services upon which sales taxes and these other taxes are applied. For instance, Providence adds a 1% meal tax which isn't considered a "sales tax" but works exactly the same way.

2nd, the corporate income tax is 9% in RI (OH MY GOD!!!....), but it only applies to about 7% of all businesses that operate in the state. To be sure, all the largest corporations are paying the 9% rate, but any other business (and a lot of them are VERY profitable), do not pay any corporate income tax because they are sole proprietorships registered with the cities rather than the state, or are S corps instead of C corps (S corps pay a $500 corporate fee and all profits flow to their income tax form - you guys know this). Rhode Island offers these different classifications, while New Hampshire and Massachusetts are much more restrictive. If I were to move my small business to NH for instance, my personal income tax would disappear (yay), but my corporate income tax would skyrocket (boo) and I'd end up paying more taxes in the tax-free haven of NH. Weird, huh? Looking at the 9% overall rate and making blanket assumptions about it can lead to inaccurate conclusions.

Lastly, the top marginal rate of 9.9% for the personal income tax rate is pretty high, right? Again, it depends on how you look at it. Forget for a moment that RI has the alternative flat tax (we'll pretend that 9.9% is what the wealthiest people will pay). Because Rhode Island allows many different exemptions and deductions that other states do not allow, as well as a whole slew of business deductions that sole proprietors and S corp businesses are allowed to capitalize on, the effective tax rate for the top income earners is reduced. Even when the flat tax didn't exist the top income earners in the state were not paying 9.9% of their income because of the deductions and exemptions, and because the top marginal rate only applies to the portion of their income over a certain amount. Everything else is taxed at a lower rate anyway.

For everyone over at Anchor Rising (great name, by the way), it's always good for people (me included) to question their assumptions and I honestly do appreciate thoughtful debate and critical analysis of what I write. I can assure you that my posts will always be well-reasoned and intellectually honest, and I look forward to furthering the debate!

Posted by: Brian Hull at September 25, 2009 12:43 PM

The real cost of capital gains taxes doesn't occur at the cashing out of a single profitable investment (where the tax liability is accrued), but in the discouragement of quick investment shifts. Capital gains taxes create rigidities in the investment market; investors will hold on to investments longer than would otherwise be ideal and potential investments will face a greater burden to prove their potential for profitability. This ultimately means that a significant number of otherwise worthy projects will never get a chance to get off the ground. Now Brian is right when he says that we have no way of knowing how much of those projects would have benefited this state directly, but I know that many Angel and Venture capitalists prefer to have good oversight of their investments (which implies a good bias toward local investments), and as a humanitarian I don't like it when anybody loses out, whether they live in my state or not.

If one of our goals in taxation is to minimize distortions in the allocation of resources (and I think that should be our main goal after sufficiency), we can do a lot better (I'm not sure we could do worse) than the capital gains tax.

Posted by: Mario at September 25, 2009 2:49 PM

Actually, I want to keep going as more things have occurred to me. First, I neglected to thank Brian for taking over at RIFuture. It's nice that it is once again being edited by someone who tries to add something of value to a conversation.

Second, capital gains. A major problem with raising the tax to the level of the personal income tax is that there is no logical reason to stop there. Like with the first increase, the vast majority of benefits (where the word benefits is construed in a very narrow way) of assessing the tax at the income level as opposed to twice that level would go to the very wealthiest among us (I'm not a fan of referring to the government not taking personal property as a benefit to the takee, but bear with me). What the push to tax investment amounts to is an argument against investment itself, which obviously can't be right.

There is no jurisdiction on earth (save for North Korea, possibly) that would find the majority of benefits of a low or nonexistent capital gains tax accruing to itself. What we have is a tragedy of the commons; since any individual locality sees the benefits of lowering the tax going elsewhere, no one sees the need to keep the tax low. Every potential increase in the tax appears to be essentially free to parochial authorities. In the end, we all lose, even though many governments, if not most, are aware that the optimal global level of the tax is far lower than they have it.

Posted by: Mario at September 25, 2009 3:35 PM
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