The capital gains tax “makes Arkansas less competitive in attracting capital as compared with states with lower or no capital gains tax rates.” Murphy Commission, Policy Foundation, 1998
(February 2011) Legislative branch action to freeze part of Gov. Mike Beebe’s proposed $109 million spending increase for FY 2012 creates the policy option of a capital gains tax cut to generate jobs creation in a weak labor market.
Capital Gains Tax: A Disincentive to Jobs Creation
The tax cut is needed because of the emergency in Arkansas’ labor market. Arkansas payroll employment, seven quarters into a national economic expansion is at 2004 levels, with only 5,300 jobs created since the recession’s end (June 2009). Texas, by contrast, does not tax capital gains, and has created 162,300 new jobs, a growth rate (1.6 percent) more than triple Arkansas’ (0.5%). Arkansas’ capital gains tax is a disincentive to jobs creation.
Cutting the state capital gains tax rate from 4.9 to 3.5 percent would make Arkansas more competitive in terms of jobs creation. Eliminating the tax on Arkansas-based gains held more than one year would have a similar effect.
“Dynamic Considerations”
A preliminary analysis of a proposal by state Rep. Ed Garner, R-Maumelle, to eliminate the tax on Arkansas-based gains held more than one year notes “dynamic considerations” including “higher investment and capital accumulation in Arkansas.” The analysis was conducted by Dr. Michael Pakko, chief economist and state economic forecaster at the Univ. of Arkansas-Little Rock Institute for Economic Advancement. He terms the magnitude of this effect “uncertain,” noting “it would serve to raise productivity and capital accumulation” in Arkansas. The proposal’s “revenue impact” is “particularly uncertain” but “economic growth would be enhanced” to “the extent that the Arkansas capital gains tax exemption facilitated more rapid capital accumulation.”
The Policy Foundation has long noted the dynamic effects of reducing or eliminating the Arkansas capital gains tax. (1) Dr. Keith Berry of Hendrix College explained in one report:
“Dynamic scoring of tax rate changes should be utilized in budgetary projections for the State of Arkansas. It is irresponsible to ignore the behavioral impacts of tax rate changes on consumers and suppliers of labor and capital. Dynamic scoring simply recognizes the fundamental economic principle that if you tax something more, you get less of it.”
Drs. Ronald John Hy and R. Lawson Veasey of the Univ. of Central Arkansas maintained in another Foundation report the use of “dynamic scoring” of tax policy changes should be important not only to academics, but to policymakers. The Policy Foundation noted a “static” model does not take into account any behavioral change on the part of an individual when policy is changed, but at times can serve as starting point for analysis.” A comprehensive analysis requires “dynamic scoring.”
The Arkansas Department of Finance and Administration has opposed the practice.
Conclusion
The emergency in the Arkansas labor market-payroll employment at 2004 levels seven quarters into a national economic expansion-should be addressed by a reduction in the state capital gains tax rate, a disincentive to jobs creation. There are two ways to achieve this goal: a reduction in the rate or eliminating the tax on Arkansas-based gains held more than one year. Policymakers should recognize the dynamic effects from both ideas. These include capital accumulation and the higher level of jobs creation in states that do not tax capital gains.
–Greg Kaza
(1) See Taxes and Savings In Arkansas and Improving Productivity By Reducing Taxes. The Policy Foundation published both reports in 1998.
