The High Burden of State and Federal Capital Gains Tax Rates in the United States

Download PDF

Key Findings

• The average combined federal, state, and local top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on long-term capital gains in the United States is 28.6 percent – 6^th highest in the OECD.
• This is more than 10 percentage points higher than the simple average across industrialized nations of 18.4 percent, and 5 percentage points higher than the weighted average.
• Nine industrialized countries exempt long-term capital gains from taxation.
• California has the 3^rd highest top marginal capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. rate in the industrialized world at 33 percent.
• The taxation of capital gains places a double-taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on corporate income, increases the cost of capital, and reduces investment in the economy.
• The President’s FY 2016 budget would increase capital gains tax rates in the United States from 28.6 percent to 32.8, the 5th highest rate in the OECD.

Introduction

Saving is important to an economy. It leads to higher levels of investment, a larger capital stock, increased worker productivity and wages, and faster economic growth. However, the United States places a heavy tax burden on saving and investment. One way it does this is through a high top marginal tax rate on capital gains.

Currently, the United States’ top marginal tax rate on long-term capital gains income is 23.8 percent. In addition, taxpayers face state and local capital gains tax rates between zero and 13.3 percent. As a result, the average combined top marginal tax rate in the United States is 28.6 percent. This rate exceeds the average top capital gains tax rate of 23.2 percent faced by taxpayers throughout the industrialized world. Furthermore, taxpayers in some states face top tax rates of over 30 percent on capital gains, which is higher than the rates in most industrialized countries.

The recent tax plan released by President Obama would increase the average top marginal income tax rate on capital gains in the United States from 28.6 percent to 32.8, which would be the 5^th highest in the industrialized world.

Capital Gains Taxes in the United States

The current federal top marginal tax rate on long-term[1] capital gains in the United States is a total of 23.8 percent (20 percent plus a 3.8 percent tax to fund the Affordable Care Act) for taxpayers with adjusted gross incomes of $200,000 ($250,000 married filing jointly) or more. In addition, states and some localities levy taxes on capital gains income,[2] which range from zero percent in states with no individual income tax, such as Florida, Texas, South Dakota, and Wyoming, to 13.3 percent in California (See Table 1).[3]

An individual who has capital gains income is subject to both federal and state capital gains taxes. Taking into account the federal deductibility of state taxes and the phase-out of itemized deductions,[4] top marginal tax rates on capital gains range from 25 percent[5] in the nine states that do not levy a tax on personal income to 33 percent in California. The average across the United States is 28.6 percent.[6]

The U.S. Tax Rate on Capital Gains is 10 Percentage Points Higher than the OECD Average; California has the 3rd Highest Top Marginal Tax Rate on Capital Gains in the Industrialized World

The United States’ average top marginal tax rate on capital gains of 28.6 percent is the 6^th highest rate in the OECD and is more than 10 percentage points higher than the simple average of 18.4 percent across the 34 countries (Table 2).[7] The highest tax rate on capital gains is 42 percent in Denmark. Nine OECD countries do not tax capital gains.[8]

Taxpayers in many states face much higher marginal tax rates on capital gains than taxpayers in most OECD countries (Table 3). Comparing U.S. states with individual countries in the OECD, U.S. states have seven of the top ten capital gains tax rates in the OECD. California, with a top rate of 33 percent, has the third highest capital gains tax rate in the industrialized world. Even taxpayers in states without taxes on capital gains face top rates higher than the OECD average.

The Capital Gains Tax is One of Many Taxes on the Same Dollar

Capital gains taxes represent an additional tax on a dollar of income that has already been taxed multiple times. For example, take an individual who earns a wage and decides to save by purchasing stock. First, when he earns his wage, it is subject to income taxes at the state and federal levels. He then purchases stock and lets his investment grow. However, that growth is smaller than it otherwise would have been due to the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. on the profits of the corporation in which he invested.[9] After ten years, he decides to sell the stock and realize his capital gains. At this point, the gains (the difference between the value of the stock at purchase and the value at sale) are taxed once more by the capital gains tax. The effective capital gains tax rate could be even higher after accounting for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. ; a significant difference in the value of the stock may be from inflation, not real gains.[10]

A Tax Bias Against Saving

These multiple layers of taxation encourage present consumption over saving. Suppose someone makes $1,000, and it is first taxed at 20 percent through the income tax. This person now has a choice. He can either spend it all today or save it in stocks or bonds and spend it later. If he spends it today and buys a television, he would pay a state or local sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. . However, if he decides to save it, delaying consumption, he is subject to the multiple layers of taxation discussed previously plus the sales tax when he eventually purchases the television. This lowers the potential rate of return on an investment, which discourages saving. An individual can avoid the multiple layers of taxation on the same dollar if they spend the dollar now instead of later.

Slows Economic Growth

As more people prefer consumption today due to the tax bias against saving, there will be less capital available in the future. For investors, this represents less available capital for factories, machines, and other investment opportunities. Additionally, capital gains taxes create a lock-in effect that reduces the mobility of capital.[11] People are less willing to realize capital gains from one investment in order to move to another when they face a tax on their returns. Funds will be slower to move to better investments, further reducing economic growth.

President Obama’s Fiscal Year 2016 Budget Would Increase Capital Gains Taxes in the United States to over 30 percent

President Obama released his FY 2016 budget, which had a series of tax changes.[12] Among these changes was an increase in the federal top marginal capital gains tax rate from 23.8 percent to 28 percent.[13] Combined with state and local income taxes on capital gains, the average top marginal capital gains tax rate would increase to 32.8 percent. California’s top marginal tax rate would increase from 33 percent to 37.2 percent. Taxpayers in states with no income taxes would still face a top rate of 29.2 percent, a higher marginal rate than what taxpayers face in all OECD countries except for Denmark, France, Finland, Ireland, and Sweden.

Conclusion

The United States currently places a heavy tax burden on saving and investment with its capital gains tax. The U.S.’s top marginal tax rate on capital gains, combined with state rates, far exceeds the average rates faced throughout the industrialized world. Increasing taxes on capital income, as suggested in the president’s recent budget proposal, would further the bias against saving, leading to lower levels of investment and slower economic growth. Lowering taxes on capital gains would have the reverse effect, increasing investment and leading to greater economic growth.

Table 1. Top Marginal Tax Rate on Capital Gains, by U.S. States, 2015 and Under President Obama’s Proposal

Rank	State	State Rate	Combined Rate	Rate Under Obama Budget
Source: Tax Foundation, Commerce Clearing House, and Author’s Calculations.
* States either allow a taxpayer to deduct their federal taxes from your state taxable income, have local income taxes, or have special tax treatment of capital gains income.
1	California	13.3%	33.0%	37.2%
2	New York*	8.8%	31.5%	35.7%
3	Oregon	9.9%	31.0%	35.2%
4	Minnesota	9.9%	30.9%	35.1%
5	New Jersey	9.0%	30.4%	34.6%
6	Vermont	9.0%	30.4%	34.6%
7	Maryland*	5.8%	30.3%	34.5%
8	Maine	8.0%	29.8%	34.0%
9	Iowa*	9.0%	29.6%	33.6%
10	Idaho	7.4%	29.4%	33.6%
11	Hawaii*	7.3%	29.4%	33.6%
12	Nebraska	6.8%	29.1%	33.3%
13	Connecticut	6.7%	29.0%	33.2%
14	Delaware	6.6%	29.0%	33.2%
15	West Virginia	6.5%	28.9%	33.1%
16	Georgia	6.0%	28.6%	32.8%
16	Kentucky	6.0%	28.6%	32.8%
16	Missouri	6.0%	28.6%	32.8%
19	Rhode Island	6.0%	28.6%	32.8%
20	North Carolina	5.8%	28.5%	32.7%
20	Virginia	5.8%	28.5%	32.7%
22	Ohio*	5.3%	28.3%	32.5%
23	Wisconsin*	7.7%	28.2%	32.4%
24	Oklahoma	5.3%	28.2%	32.4%
25	Massachusetts	5.2%	28.1%	32.3%
26	Mississippi	5.0%	28.0%	32.2%
26	Utah	5.0%	28.0%	32.2%
28	Arkansas*	7.0%	27.9%	32.1%
28	Montana*	6.9%	27.9%	32.1%
30	Louisiana*	6.0%	27.9%	32.0%
31	Kansas	4.8%	27.9%	32.1%
32	Colorado	4.6%	27.8%	32.0%
33	Indiana*	3.3%	27.8%	32.0%
34	Michigan*	4.3%	27.7%	31.9%
35	Arizona	4.5%	27.7%	31.9%
36	Alabama*	5.0%	27.4%	31.5%
37	South Carolina*	7.0%	27.3%	31.5%
38	Illinois	3.8%	27.2%	31.4%
39	Pennsylvania	3.1%	26.8%	31.0%
40	New Mexico*	4.9%	26.5%	30.7%
41	North Dakota*	3.2%	26.3%	30.5%
42	Alaska	0.0%	25.0%	29.2%
42	Florida	0.0%	25.0%	29.2%
42	Nevada	0.0%	25.0%	29.2%
42	New Hampshire	0.0%	25.0%	29.2%
42	South Dakota	0.0%	25.0%	29.2%
42	Tennessee	0.0%	25.0%	29.2%
42	Texas	0.0%	25.0%	29.2%
42	Washington	0.0%	25.0%	29.2%
42	Wyoming	0.0%	25.0%	29.2%
	D.C.	9.0%	30.4%	34.6%
	U.S. Average	6.1%	28.6%	32.8%

Table 2. Top Marginal Tax Rate on Capital Gains, by OECD Country, 2015

Rank	Country	Rate
Source: Ernst and Young and Deloitte Tax Foundation Calculations.
1	Denmark	42.0%
2	France	34.4%
3	Finland	33.0%
3	Ireland	33.0%
5	Sweden	30.0%
6	United States	28.6%
7	Portugal	28.0%
7	United Kingdom	28.0%
9	Norway	27.0%
9	Spain	27.0%
11	Italy	26.0%
12	Austria	25.0%
12	Germany	25.0%
12	Israel	25.0%
12	Slovak Republic	25.0%
16	Australia	24.5%
18	Canada	22.6%
19	Japan	20.3%
20	Estonia	20.0%
20	Chile	20.0%
20	Iceland	20.0%
23	Poland	19.0%
25	Hungary	16.0%
26	Greece	15.0%
27	Mexico	10.0%
28	Belgium	0.0%
28	Czech Republic	0.0%
28	Korea	0.0%
28	Luxembourg	0.0%
28	Netherlands	0.0%
28	New Zealand	0.0%
28	Slovenia	0.0%
28	Switzerland	0.0%
28	Turkey	0.0%
	OECD Simple Average	18.4%
	OECD Weighted Average	23.2%

Table 3. Top Marginal Tax Rate on Capital Gains, by OECD Nation and U.S. State, 2014

Rank	State/Country	Rate
Source: Ernst and Young, Deloitte, Tax Foundation, and Author’s Calculations.
1	Denmark	42.0%
2	France	34.4%
3	California	33.0%
4	Finland	33.0%
4	Ireland	33.0%
6	New York	31.5%
7	Oregon	31.0%
8	Minnesota	30.9%
9	New Jersey	30.4%
10	Vermont	30.4%
10	D.C.	30.4%
12	Maryland	30.3%
13	Sweden	30.0%
14	Maine	29.8%
15	Iowa*	29.6%
16	Idaho	29.4%
17	Hawaii	29.4%
18	Nebraska	29.1%
19	Connecticut	29.0%
20	Delaware	29.0%
21	West Virginia	28.9%
22	United States	28.6%
23	Georgia	28.6%
23	Kentucky	28.6%
23	Missouri	28.6%
26	Rhode Island	28.6%
27	North Carolina	28.5%
27	Virginia	28.5%
29	Ohio*	28.3%
30	Wisconsin*	28.2%
31	Oklahoma	28.2%
32	Massachusetts	28.1%
33	Portugal	28.0%
33	United Kingdom	28.0%
35	Mississippi	28.0%
35	Utah	28.0%
37	Arkansas	27.9%
37	Montana	27.9%
39	Louisiana	27.9%
40	Kansas	27.9%
41	Colorado	27.8%
42	Indiana	27.8%
43	Michigan	27.7%
44	Arizona	27.7%
45	Alabama	27.4%
46	South Carolina	27.3%
47	Illinois	27.2%
48	Norway	27.0%
48	Spain	27.0%
50	Pennsylvania	26.8%
51	New Mexico	26.5%
52	North Dakota	26.3%
53	Italy	26.0%
54	Austria	25.0%
54	Germany	25.0%
54	Israel	25.0%
54	Slovak Republic	25.0%
58	Alaska	25.0%
58	Florida	25.0%
58	Nevada	25.0%
58	New Hampshire	25.0%
58	South Dakota	25.0%
58	Tennessee	25.0%
58	Texas	25.0%
58	Washington	25.0%
58	Wyoming	25.0%
67	Australia	24.5%
68	Canada	22.6%
69	Japan	20.3%
70	Estonia	20.0%
70	Chile	20.0%
70	Iceland	20.0%
73	Poland	19.0%
74	Hungary	16.0%
75	Greece	15.0%
76	Mexico	10.0%
77	Belgium	0.0%
77	Czech Republic	0.0%
77	Korea	0.0%
77	Luxembourg	0.0%
77	Netherlands	0.0%
77	New Zealand	0.0%
77	Slovenia	0.0%
77	Switzerland	0.0%
77	Turkey	0.0%
	OECD Simple Average	18.4%

Share