THREE WAYS TO CUT

THE ARKANSAS CAPITAL GAINS TAX

Tax policy recommendations extracted from a statewide conference on taxation and two Policy Foundation research papers include a proposal to repeal the state capital gains tax. (Arkansas Policy Foundation, 1998)

(October 2010) Arkansas Republicans are poised to increase their numbers at the state Capitol next month, which means capital gains taxes are likely to emerge as an issue when the 88^th General Assembly meets in January 2011.

Capital gains are taxed as income in Arkansas, with the state’s top income tax rate of 7 percent highest among the six states that border it, according to the Federation of State Tax Administrators. (1) Arkansas exempts 30 percent of net capital gains from income with the remaining 70 percent being treated as ordinary income, the state Department of Finance and Administration explains. Long-term gains are realized on the sale of a capital asset held more than 12 months. Short-term gains are realized on the sale of a capital asset held for one year or less and are 100% taxable as ordinary income. (2)

Republican-sponsored measures to cut the tax have passed the Democratic-controlled House in the last two legislative sessions (2007 and 2009). State Rep. Ed Garner, R-Maumelle, sponsored the measures, which later died in the state Senate. The Beebe administration opposed the tax cuts, arguing state government could not afford them.

There are three ways to cut the Arkansas capital gains tax, ranging from a narrow reduction to the broadest action: a multi-year phase-out of the tax.

Narrowest Tax Cut: Another 30 Percent Reduction

The 82^nd General Assembly, in 1999, approved a proposal (SB 23) by state Sen. Jim Hill, D-Nashville, to exempt thirty percent (30%) of a capital gain from the state income tax.’ The measure became law as PA 1005 of 1999. Another 30 percent reduction would provide narrow, but significant tax relief.

Compromise Tax Cut: Exempt Arkansas Investments

Rep. Garner’s 2009 proposal would have exempted from the state income tax the net capital gains from the sale of Arkansas property that was owned by the taxpayer on a long-term basis, i.e., more than one year prior to the sale. Short-term capital gains would still be 100% taxable as ordinary income.

This proposal could emerge as a compromise if a majority of legislators in the Democratic-controlled General Assembly conclude a total phase-out of capital gains taxes is not feasible.

Broadest Tax Cut: Phase-Out Capital Gains Taxes

Eliminating the taxation of long-term and short-term capital gains would provide the broadest tax cut. One way to implement this policy is by phasing-out the capital gains tax over a multi-year period, even a decade. The state sales tax on groceries is being phased-out in a similar manner.

Conclusion

“Economic theory, as well as historical experience,” a 1998 Policy Foundation research paper noted, tells us that “in the case of state and local taxes, residents and businesses vote with their feet [by moving to new locations] for or against prevailing levels of taxes and spending." These include states without income taxes, such as Texas, Florida and Wyoming; or lower rates, including the states that border Arkansas.

The issue should not be defined around the needs of state government. Rather, the issue should be defined in terms of taxpayers and the damage that state government policies have done to the Arkansas economy, which has recorded anemic employment and income growth over the long-term.

(1) Texas does not have a state income tax, and Tennessee only taxes dividends and interest. Other border states and their top rates are Mississippi (5%), Oklahoma (5.5%) Louisiana (6%), Missouri (6%). Arkansas’ top rate is 7%.

http://www/taxadmin.org/fta/rate/ind_inc.pdf

(2) Arkansas Department of Finance and Administration

http://www.dfa.arkansas.gov/offices/policyAndLegal/Documents/moving_2_arkansas.pdf