Here’s why state’s tax grab is a big loser

Connecticut state lawmakers embarked on the budgetary equivalent of a trip to Foxwoods when they voted to create a new, separate tax on capital gains — and the bets they’re making aren’t the wisest.

Capital gains are the profit people make when they sell a good for more than they paid for it. They stem from selling anything from stocks to antiques and collectibles to real estate. Connecticut has taxed capital gains in one form or another since the early 1970s, but since the state income tax was created in 1991, capital gains been taxed at the same rate as ordinary income, like salaries.

But recently, the General Assembly’s Finance, Bonding and Revenue Committee advanced a multipart proposal that would, among other things, tax capital gains at a higher rate in hopes of raising an extra $262 million annually. The modified tax, targeted at individuals making over $500,000 and couples making over $1 million, means residents would pay a marginal rate of 8.99 percent — the state’s highest-ever tax on capital gains. The proposal now awaits votes by the full Senate and House of Representatives.

That’s a big gamble, to say the least, because both the individual investors and the financial firms seemingly targeted by the bill are extremely mobile. Since the Great Recession, Connecticut has seen more of its high-earning taxpayers spending most of the year in other states, shielding a large portion of their income from state taxes.

Meanwhile, high-profile financial outfits have shifted their offices from the Northeast to places like South Florida — where there are no state income taxes. More tax increases in Connecticut will likely nudge others to make a move, especially after a yearlong education in how little location matters.

The financial incentives to leave Connecticut have swollen since the Great Recession because of a few rounds of income tax hikes and the 2017 federal tax changes that limited the deductibility of state taxes from federal bills — meaning state taxpayers are feeling a larger bite than ever from Connecticut’s higher rates.

At the same time, hitting capital gains with a surcharge would steer younger New York City finance professionals away from Connecticut and toward Long Island and Westchester County, where capital gains would, oddly enough, likely be taxed at a lower rate.

That would mark an ironic turn of events, considering Connecticut’s long history of serving as an economic safe space, one with lower taxes, than spendthrift New York.

And it would be risky in other ways. Capital gains are among the most volatile forms of income. Recent years have revealed their propensity to drop sharply and suddenly.

The capital gains realized by Connecticut residents, which are heavily influenced by Wall Street, fell by more than half between 2000 and 2002, and by more than 75 percent from 2007 to 2009. In fact, resident capital gains still hadn’t recovered to their 2007 levels in the most recent federal data through the end of 2018.

The costs of an added capital gains tax are more certain than the benefits. And while Hartford politicians are eager to spend more money when it comes in, they’re reluctant to curb that spending when it doesn’t.

Connecticut, in fact, is already heavily dependent on taxing capital gains. In recent years, it’s made up about 26 percent of the earnings for Connecticut residents making $1 million or more. And it’s a big part of why income tax receipts fell twice as quickly as sales tax collections during the Great Recession.

When markets underperformed — as markets routinely do — state lawmakers doubled down and hiked taxes further.

That damage has hardly been limited to the upper crust: Gov. Dannel P. Malloy’s 2011 tax hikes hit individuals making as little as $50,000 with higher rates and left every family permanently paying an extra 0.35 percent in sales tax.

So, when senators and representatives say they’re going to spend another dollar in capital gains taxes that were pried from the wealthy, be sure to ask them where they’ll get the other 50 or 75 cents when times aren’t so good.

As Gov. Malloy’s fiscal staff repeatedly admonished in large, bold print in annual budget reports: “CAPITAL GAINS ARE A VOLATILE REVENUE SOURCE.”

Gov. Lamont and the General Assembly would do well to heed that warning.