Since California’s approach to taxing capital gains – the income earned when an asset, such as shares of stock or real estate, is sold for more than its purchase price – has been in the news recently, we thought that a review of some basic facts would be timely. Information from California’s Franchise Tax Board tells us that:
- California doesn’t have a “capital gains tax.” California has personal and corporate income taxes that treat capital gains as income.
- In 2008, the most recent year for which data are available, the 0.8 percent of Californians with adjusted gross incomes (AGI) in excess of $500,000 reported 82.5 percent of all capital gains reported by personal income taxpayers. The 84.5 percent of personal income taxpayers with AGI of $100,000 or less reported 4.1 percent of all capital gains.
- Capital gains accounted for 23.7 percent of the 2008 income reported by those with incomes over $500,000, but less than 1.0 percent of the income reported by taxpayers with AGI of less than $200,000.
- Capital gains account for a rising share of the income reported by wealthy Californians. In 1988, capital gains accounted for 16.7 percent of the AGI reported by the wealthiest 5 percent of California taxpayers. In 2007, capital gains accounted for 26.9 percent of the AGI of the top 5 percent. In contrast, capital gains accounted for 1.3 percent of the AGI reported by the bottom 95 percent of taxpayers in 1988 and just 2.0 percent in 2007.
Eliminating the tax on capital gains would significantly widen the state’s ongoing budget gap. The $4.5 billion in taxes paid on capital gains in 2008 approximately equals the state’s General Fund support for the University of California and California State University systems that year. Moreover, as discussed in a report on the state’s “dynamic revenue estimating” model, developed during the administration of former Governor Pete Wilson, there’s no such thing as a “free lunch.” Based on that model’s findings, a $4.5 billion tax cut would reduce state revenues by $4.455 billion after considering “dynamic feedback effects.”
The question of whether the state should tax income from investment at a higher, lower, or the same rate as that from work underlies the debate over taxation of capital gains. Historically, California has taxed income from work – wages and salaries – at the same rate as that from investment – dividends and capital gains. Eliminating the tax on capital gains would allow more than a quarter of the income of the wealthiest Californians to go untaxed while taxing nearly all – 98 percent – of the earnings of the bottom 95 percent whose income comes primarily from work.
— Jean Ross