Progressives have found precious little to like in the 2011-2013 budget Gov. Scott Walker will sign into law Sunday at a ceremony in Green Bay.
But perhaps the most regressive item is a new tax loophole — disguised as an economic development tool — that is projected to cost the state hundreds of millions in lost revenue over the next decade.
Walker’s budget creates two new provisions to provide income tax shelter for capital gains — or profits made from an investment like stocks, bonds, real estate or precious metals.
Right now, Wisconsin exempts 30 percent of capital gains on assets held at least one year and allows 100 percent exclusion for gains on the sale of business assets to a family member or sale of small business stock.
But the new budget makes all capital gains free from state income tax as long as the money is reinvested in a qualified Wisconsin business for at least five years. A separate provision allows taxpayers to defer any tax on capital gains if they reinvest the profits within 180 days to a Wisconsin business. Tax on the deferred gain would be paid when the new investment is sold.
At first blush, it sounds like a good way to encourage investment in state-based companies. Grow your own, so to speak.
In reality, however, it's a tax accountant's dream and a nice loophole for upper income residents, says Andrew Reschovsky, professor of public affairs and applied economics at UW-Madison.
“The benefits of this provision will almost certainly be concentrated among the wealthy,” he says.
That’s because the wealthy also book the big capital gains. According to this Legislative Fiscal Bureau report, taxpayers with incomes over $150,000 represented only 10 percent of 2009 state tax filers but claimed 52 percent of the capital gains exclusions.
For the vast majority of taxpayers, the only real capital gain in their lifetime comes from the sale of a house — and that gain is already exempt from state and federal taxes up to $250,000.
But an investor in Mequon, for example, with $100,000 in taxable gains from the sale of a bond or gold could avoid paying state tax by buying stock in any company that registers with the new Wisconsin Economic Development Corporation.
“Will my purchase of shares in, say, Harley Davidson, have any positive impact on job creation in Wisconsin?” asks Reschovsky. “In the case of publically-traded stocks, the answer is almost certainly no."
“I call my broker and ask to purchase 1,000 shares. Those shares are in effect purchased from someone else who is willing to sell 1,000 shares. This transaction and those like it will have no impact on the operation of Harley Davidson, and will certainly not lead Harley to increase job creation in Wisconsin,” he argues.
And the loophole isn’t without financial consequences.
The Legislative Fiscal Bureau estimates the new exemptions will reduce revenues by $16.1 million in 2011-12 and $20.2 million in 2012-13. Once fully phased in by 2016, tax collections would fall by over $100 million annually, the bureau estimates.
Others have expressed skepticism whether the elimination of taxes on capital gains will make investments in Wisconsin any more attractive. Moreover, the provision does nothing to attract outside moeny since non-Wisconsin residents don’t pay capital gains taxes here to begin with.
Legislative Fiscal Bureau analyst Rick Olin says the long-term impacts are unclear. “This thing is kind of like Jello,” he says. “You’re not sure what you have.”
What's also unclear is whether directors of a public corporation could use the new capital gains provision to purchase shares of their own firm or shelter other income. Leave that one up to the tax attorneys.
Still, Todd Berry, president of the Wisconsin Taxpayers Alliance, says the proposals just might make some economic sense.
"I don't think this issue is quite as black and white as some suggest,” he says. “Is there value in having more locally generated investment capital? Is there value in increasing the probability of retaining our ‘best and brightest?’ I understand the Harley example but might there even be value in having in-state investors increasing their say in in-state corporate decisions.”