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Investors’ bad year produces ripple effects for government budgets, too

Last year’s disastrous stock market left many investors feeling blue, and now at tax time, it’s state and federal officials’ turn, too.

Taken together, all those accumulated losses on stocks, the reluctance of many citizens to even jump into the market and the squeeze on the sales of homes are creating even more problems for hard-hit government budgets, which already have been battered by the weak economy.

State and national budget forecasts anticipate steep drops in taxpayers’ capital gains taxes they can claim now and in future years.

That decline is one factor in Minnesota’s recent projection of a $4.8 billion budget deficit for the new biennium — a figure that’s expected to grow to $6 billion to $7 billion today, when the updated forecast is released.

That financial hit comes on top of all of Minnesota’s bleak projections for substantial drops in revenue for income, sales and corporate taxes and the like.   

Minnesota’s State Economist Tom Stinson is projecting a loss of $260 million in capital gains tax receipts for the current fiscal year, a 30 percent drop from last fiscal year. The slide in capital gains for tax year 2008, he says, accounts for more than half of the total decline in expected income tax receipts for this fiscal year.

State Economist Tom Stinson
State Economist Tom Stinson

“This change in capital gains assumption was a major contributor to our [budget] shortfall not only in fiscal 2009 but also in 2010 and 2011 [projections],” says Stinson.

Capital gains forecasting can be tricky, volatile
Stinson says the volatile nature of capital gains forecasting means once the real tax figures come in, the state’s losses could be even greater than the current projection of 30 percent.

“A 30 percent decline sounds like a lot,” says Stinson. “But if you look at what happened in 2001 — we had more than a 50 percent decline [after projecting a 30 percent decline] in capital gains revenue. So this can go down a lot. It’s not just something that moves around the edges — it’s capable of moving huge amounts.”

Stinson explains that the drop in statewide capital gains income comes about in two ways.

First, during a recession, many investors make less profit (or lose money) trading in the stock market than they would in a typical year. Others stop trading entirely, staying out of the market.

Ergo, fewer taxable capital gains and less income tax revenue for the state.

Similar patterns affect the feds, who are losing out on capital gains revenue, too.

The Congressional Budget Office is projecting a federal decline in 2008 capital gains tax receipts of about $55 billion, a decline of more than 40 percent over 2007.

The decline in the housing market also will affect capital gains revenue nationally, particularly in California, which is facing a 50 percent decline in capital gains revenue.

In Minnesota, home sellers don’t have to pay gains taxes on the sale of their home unless they earned more than $500,000 in profit (if filing jointly), so real estate capital gains are a bit of a non-issue for most Minnesotans, given the state’s housing stock and current market conditions.

Capital gains carry long-term implications

And while things look bad now for capital gains, the coming years aren’t looking much better.

At the end of 2010, the Bush administration’s tax cuts are scheduled to expire. If they do, the federal capital gains rate, currently at 15 percent, will increase to 20 percent. If the Bush cuts expire, that means many people will probably opt to sell their stock before the rates go up.

While in the short term, the activity in the market should increase overall capital gains revenue for the government, Stinson says, “The question is, how much gets accelerated on top of what it would normally be?”

That is, how much of that activity will take away from capital gains revenue in 2011 and 2012?

Stinson says state budget forecasting is very uncertain, particularly for capital gains income. The state won’t know how much money it’s going to get for the current fiscal year until sometime early in May, leaving just a couple of months before the end of the biennium to resolve any additional shortfall caused by an April 15 surprise.

“We could end up a couple hundred million dollars short because we could have a 60 percent decline by then,” says Stinson. “So that’s why we’re so concerned about the state having adequate reserves of a couple hundred million dollars, so they can cover that shock, that loss, that shortfall, if we find out in May that we’re wrong [in projecting a 30 percent decline].”

Marisa Helms writes about politics and other topics. She can be reached at mhelms [at] minnpost [dot] com.

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Comments (1)

  1. Submitted by Bernice Vetsch on 03/03/2009 - 02:08 pm.

    How much simpler our lives would be if Governor Pawlenty said, “You know, this anti-tax thing really DOESN”T work, does it?” and immediately cancelled the 1999 and 2000 tax cuts for the wealthy that have cost us a billion dollars a year in revenue.

    Problem solved.

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