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HB1660 risks driving down investment, entrepreneurship

The following testimony was submitted by the Grassroot Institute of Hawaii for consideration by the House Committee on Finance on Feb. 21, 2024.
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Feb. 21, 2024, 2 p.m.
Hawaii State Capitol
Conference Room 308 and Videoconference

To: House Committee on Finance
      Rep. Kyle T. Yamashita, Chair
      Rep. Lisa Kitagawa, Vice-Chair

From: Grassroot Institute of Hawaii
           Ted Kefalas, Director of Strategic Campaigns

RE: TESTIMONY OPPOSING HB1660 — RELATING TO CAPITAL GAINS

Aloha Chair Yamashita, Vice-Chair Kitagawa and Committee Members,

The Grassroot Institute of Hawaii would like to offer its comments opposing HB1660, which would eliminate the 7.25% tax rate for capital gains, replacing it with the rates applied to ordinary income.

There are a number of sound fiscal reasons for taxing capital gains at a lower rate than income. For one, it reflects the fact that capital gains are not indexed for inflation, thus the lower rate is intended to offset the fact that some portion of the gain represents inflation rather than real returns.

In addition, high capital gains taxes create a “lock-in” effect in which investors delay the sale of investments in order to avoid tax repercussions. This reduces economic growth by discouraging diversification and the movement of capital in the state.

Consider the example of Jeff Bezos, who halted his stock sales after Washington State passed a capital gains tax of 7% on sales of stocks and bonds over $250,000. Bezos has since moved to Florida and initiated a plan to sell 50 million shares over the next year. The move is estimated to save Bezos about $600 million in taxes.[1] Florida will now benefit from Bezos’ purchase of property and other economic activity, while Washington will lose out.

That is why higher tax rates on capital gains could have the unintended effect of driving down investment and entrepreneurship in Hawaii.

Curtis Dubay, chief economist at the U.S. Chamber of Commerce, wrote in 2021 that: “The economic models and past history all reach the same conclusion: When you significantly increase taxes on capital gains you get significantly less capital investment.”[2]

In other words, investors and entrepreneurs would be less likely to conduct business in Hawaii as an increase in the capital gains tax would contribute to Hawaii’s already poor business environment. In 2022, CNBC ranked Hawaii as the 46th worst state in which to start a business.[3]

A 2021 study by the Baker Institute noted that “two decades of relatively slow economic growth call for increased innovation and faster diffusion of new technology, but higher capital gains tax rates will reduce innovation and technology diffusion.”[4]

Hawaii residents, of course, need more innovation, not less, to prosper.

Additionally, higher capital gains taxes can discourage savings. The national Tax Foundation wrote in 2019 that: “When multiple layers of tax apply to the same dollar, as is the case with capital gains, it distorts the choice between immediate consumption and saving, skewing it towards immediate consumption because the multiple layers reduce after-tax return to saving.”[5]

In terms of generating tax revenues, a 2021 economic model from the University of Pennsylvania’s Wharton School found that a proposed hike in the federal capital gains tax rate would actually produce less revenue, since investors would be more likely to hold onto their investments so their heirs would inherit them at death, thus avoiding the increased capital gains tax.[6]

In fact, Hawaii legislators should be skeptical of optimistic tax revenue projections achieved via a capital gains tax hike. A study from the Congressional Budget Office on how taxes affect the decision to realize gains concluded that such decisions are very responsive to changes in taxation.

The study found a persistent elasticity of -0.79,[7] which means that a 10% cut in capital gains taxes would increase realizations by 7.9%. Thus, a cut in the capital gains tax would have minimal or even a positive effect on tax revenues.

In fact, in 2007 the IRS collected $122 billion at a 15% capital gains tax rate compared to only $26.7 billion in 2007 dollars at the 40% rate in 1977, [8] This was a significant increase even after adjusting for inflation and other relevant factors.

Conversely, an increase in the capital gains tax would net significantly less in tax revenues than what might be calculated from a static model.

Looking at the even broader picture, one must consider that tax increases in general are not a good idea for Hawaii’s economy, especially not now when it already has one of the highest tax burdens in the nation.[9]

Consider these points:

>> Hawaii’s population has been declining for the past six years.[10] Tens of thousands of Hawaii residents have moved to the mainland over the past six years — and mainly to states without income taxes, such as Washington, Nevada, Texas and Florida.[11] Their departure from the islands is not only emotionally distressing, but economically depressing as well.

>> Fewer people remaining means fewer people to work at our private businesses — or even staff our government agencies. It also means fewer people to help pay for Hawaii’s ever-increasing tax burden.

>> Higher taxes for the residents who still live here is more fuel for the exodus of talent and capital — our friends, neighbors and family — to places that are more affordable. It’s a downward spiral economically fostered by the relentless upward spiral of more and more taxes.

>> Hawaii taxes high-income earners at 11%, second only to California at 13.3%.[12] Hawaii’s top 1.5% of taxpayers already pay 34.9% of all income taxes in the state.[13]

>> Hawaii is suffering from a stagnant economy, and both the Economic Research Organization at the University of Hawai‘i[14]  and the state Department of Business, Economic Development and Tourism[15] have predicted continued slow economic growth in 2024. Tax hikes could exacerbate this slowdown, since entrepreneurs would be less likely to invest their capital — or “wealth assets,” as the case may be[16] — in Hawaii’s economy.

In short, Hawaii’s residents and businesses need a break from new taxes, tax increase, fees and surcharges. This is not the time to make Hawaii a more expensive place to live and do business.

Thank you for the opportunity to testify.

Ted Kefalas
Director of Strategic Campaigns
Grassroot Institute of Hawaii
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[1] Robert Frank, “Jeff Bezos will save over $600 million in taxes by moving to Miami,” CNBC, Feb. 12, 2024.
[2] Chris Dubay, “Raising the Capital Gains Tax: Who Does it Really Hurt?” U.S. Chamber of Commerce, May 13, 2021.
[3]America’s Top States for Business 2022: The full rankings,” CNBC, July 13, 2022.
[4] John Diamond, “The Economic Effects of Proposed Changes to the Tax Treatment of Capital Gains,” Baker Institute Center for Public Finance, Oct. 27, 2021.
[5] Erica York, “An Overview of Capital Gains Taxes,” Tax Foundation, April 26, 2019.
[6] John Ricco, “Revenue Effects of President Biden’s Capital Gains Tax Increase,” Penn Wharton Budget Model, April 23, 2021.
[7] Tim Dowd, et al., “New Evidence of the Tax Elasticity of Capital Gains,” Congressional Budget Office, June 2012, p.17.
[8] Daniel Block and William McBride, “Why Capital Gains are taxed at a Lower Rate,” Tax Foundation, June 27, 2012.
[9] Jared Walczak and Erica York, “State and Local Tax Burdens, Calendar Year 2022,” Tax Foundation, April 7, 2022.
[10] Maria Wood, “Where People from Hawaii Are Moving to the Most,” 24/7 Wall Street, Jan. 23, 2022.
[11] Katherine Loughead, “How Do Taxes Affect Interstate Migration?” Tax Foundation, Oct. 11, 2022.
[12] Timothy Vermeer, “State Individual Income Tax Rates and Brackets for 2023,” Tax Foundation, Feb. 21, 2023.
[13]Hawaii Individual Income Tax Statistics,” Hawaii Department of Taxation report for Tax Year 2021, August 2023, Table 12A.
[14] Carl Bonham, Byron Gagnes, Steven Bond-Smith, et al., “State Facing Headwinds as Maui Recovery Begins,” Economic Research Organization at the University of Hawai‘i, Dec. 15, 2023.
[15] Hawaii Department of Business, Economic Development, and Tourism, “Hawaii Economic Growth Remains Low for 2024 as Recovery Continues,” Dec. 11, 2023.
[16] Aaron Hedlund, “How Do Taxes Affect Entrepreneurship, Innovation, and Productivity?” Center for Growth and Opportunity at Utah State University, Dec. 23, 2019; Ergete Ferede, “The Effects on Entrepreneurship of Increasing Provincial Top Personal Income Tax Rates in Canada,” Fraser Institute, July 10, 2018; Robert Carroll, Douglas Holtz-Eakin, Mark Rider and Harvey S. Rosen, “Personal Income Taxes and the Growth of Small Firms,” National Bureau of Economic Research, October 2000.

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