A capital gains hike would hit Detroit hard

Published in The Detroit News

It’s a sure bet that tax policy and the issue of “fairness” will be a centerpiece issue this election season. The “Buffett Rule,” a measure to raise income tax rates on individuals and capital gains of top-earning Americans, has become a rallying cry for President Obama and many others.

But if tax “fairness” is the goal, then the Buffett Rule is anything but.

The war on savings and investments will be felt strongly in pockets of the nation, particularly among investors and job creators in Detroit.

Investors already face high combined federal and state tax rates on capital gains. A new analysis released by the American Council for Capital Formation, based on a survey conducted by Ernst & Young, shows that investors face state-level capital gains taxes in 41 states with an average top individual capital gains tax rate on corporate equities of 5.2 percent in 2012. Combined with the federal rate, these taxes substantially increase the separation between what an investment yields and what an individual actually receives (known as the “tax wedge”).

The higher the tax wedge, the fewer investments that will be worth an investor’s time and risk, resulting ultimately in fewer investments being undertaken and longer holding periods as investors delay selling assets. Both of those outcomes will ultimately further pressure tax receipts.

In Detroit, the case is among the most severe. Detroit residents pay a top combined effective federal, state and local rate of 19.5 percent. That’s under the current tax scenario where the Bush-era tax cuts, including those on capital gains, were extended until the end of this year.

President Barack Obama and Congress are very unlikely to raise taxes in an election year. But even if they did extend lower rates, investors will be subject to a mandatory 3.8 percent Medicare surcharge on savings and investment as part of the new health care law, so the effective combined rate increases to 23.3 percent.

Then there’s the most sobering scenario — if Congress doesn’t act — and allows rates on capital gains taxes to return to their 1990s levels. Under that scheme, Detroit residents would see a dramatic jump to 29.1 percent combined rates.

What does this mean for Detroit’s economy? Plenty. Investment is a key factor in creating and growing jobs. And as the old saw goes, the more you tax of something, the less you get of it.

Economic evidence bears this out. In recent years, each $1 billion increase in investment is associated with an additional 15,000 jobs. Conversely, decreasing the amount individuals and firms will invest due to federal and state capital gains taxes form a direct impediment to entrepreneurship and economic growth.

The last thing cities like Detroit need is to punish the success and investment that is so critical to economic rebound.

Dr. Pinar Cebi Wilber is an economist for the American Council for Capital Formation.