The quest for a firmer foundation

Oklahoma has options to reform costly capital gains deduction

Oklahoma’s capital gains deduction is one of the most expensive tax incentives in the state—more than $100 million each year. Two-thirds of the tax break is taken by just over 800 households with annual incomes above $1 million. The average tax break for these households was nearly $80,000 each. Meanwhile, only 6 percent of the deduction went to the large majority of households making less than $100,000.

Despite this massive cost, economic development consultants working with the state’s Incentive Evaluation Commission found little to no evidence that the incentive is working to boost the economy.

All of that is true, and yet it may substantially understate the cost of the capital gains deduction. The Tax Commission does not report the cost of capital gains deductions taken by corporations. This means the total lost revenues from this tax break could be significantly higher than we know.

Oklahoma is giving out hundreds of millions through this tax break, with little oversight of who gets the money, how recipients use the money, or whether the tax break is creating any benefit for the majority of Oklahomans. If lawmakers genuinely want to reduce waste in Oklahoma’s budget, they must acknowledge that the capital gains deduction is the single most expensive, wasteful policy anyone has found.

Only ten other states have any kind of tax preference for capital gains, and all those states have more safeguards or limitations on their deduction than Oklahoma. It doesn’t have to be this way. Lawmakers have good options to reform the deduction, cap its costs, and make sure that it works to boost economic growth.

For example, some have argued in defense of the capital gains deduction for the sale of cattle or farm property. Oklahoma could design a tax incentive to favor those groups by following the model of Iowa, where income from the sale of livestock that has been held for at least two years can be deducted, as well as real property that has been used in a farm business for at least 10 years. Both deductions also require that the person benefiting gets most of their income from farming and ranching.

Another option would be to allow a capital gains deduction only for investment in a small business or in a specific sector we want to develop. In Virginia, the capital gains deduction is allowed only for investments in small technology businesses (annual gross revenues of no more than $3 million).

Requirements can be added after taxpayers receive the deduction, too. In Utah, at least 70 percent of the benefit received from the capital gains deduction must be reinvested in small business in the state within 12 months.

To limit the overall cost of the capital gains deduction and prevent individuals from taking a massive windfall, Oklahoma could cap the deduction—Colorado limits their capital gains deduction to no more than $100,000.

Considering that most of the current deduction is going to those with incomes of more than $1 million, Oklahoma could reduce the cost substantially with this cap while protecting any middle-income taxpayers who benefit from the deduction.

By reforming the capital gains deduction, lawmakers can protect farmers, middle-income Oklahomans, and other groups while still eliminating most of the cost of this expensive tax break. Capital gains reform would put the whole state budget on a much firmer foundation going forward.

Gene Perry is Director of Strategy and Communications with Oklahoma Policy Institute (okpolicy.org).