The Agenda

Maryland’s New Capital Income Tax?

Ben Giles of the Washington Examiner reports that Maryland’s state legislature is debating a new capital income tax:

 

The legislation, introduced by Democratic Del. Ana Sol Gutierrez and a host of lawmakers from Prince George’s County and Baltimore, would charge an additional 2 percent tax on capital gains — profits on the sale of stocks, bonds and real estate investments — filed as a part of residents’ taxable income.

For Maryland’s highest-earning residents currently paying a 5.5 percent income tax rate on capital gains as well as income taxes — part of the so-called “1 percent” Gutierrez said the bill targets — the increase to 7.5 percent would raise taxes on investments by roughly 36 percent.

Small businesses with net capital gains also would see an increase in their income tax liabilities, according to state officials.

Drawing on the work of Kirk Stark of UCLA Law School, we’ve discussed why state-level capital income taxes are unwise. Basically, capital income is very mobile and state and local governments, which at least theoretically operate under balanced budget constraints, have good reason to try to limit the volatility of their tax base, which is why property taxes and retail sales taxes are relatively flat income taxes are generally the best option. The federal government, in contrast, has more scope to draw on more mobile tax bases, as people are less inclined to move across international borders, and more volatile tax bases, e.g., relatively progressive income taxes, as it has a greater ability to smooth spending levels over the business cycle through the use of debt. This is part of why it makes sense for the federal tax system to tilt in a progressive direction while state and local tax systems tilt in a regressive direction. 

Yet there are structural reasons why politicians at the state and local level are inclined to advance ideological legislative initiatives, even if they don’t make sense in the larger economic and institutional context. Gutierrez might see an increase in state-level capital income taxation as an eye-catching proposal that will help propel her to higher office, for example. Party activists (“policy demanders,” to reference the political science book of the moment) use heuristics to give them a sense of who is and who is not “on the team,” and this heuristics tend to revolve around attitudes towards national rather than local policy questions. As David Schleicher has argued, this has led to a lack of constructive political competition at the local level. 

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