State Individual Capital Gains Tax Rates

Capital gains tax rates have become part of the policy debate about how to get the U.S. economy growing again. Some policymakers advocate reducing the top individual capital gains tax rate (now 15 percent) with the view that lower rates will encourage stock purchases and add stability to the U.S. financial sector. Other policymakers advocate raising the top individual capital gains tax rate to 20 percent next year in order to pay for individual income tax cuts or other programs. In addition, the current top Federal rate is set to expire on December 31, 2010, after which the top rate increases to 20%.

As Americans face the possibility of a higher Federal top capital gains tax rate, it may be helpful to examine the ramifications of such a policy shift. Raising the top Federal rate would exacerbate the combined Federal and State tax burden on the sale of capital assets already faced by taxpayers in most states. To highlight the current total tax bite faced by individual investors, the American Council for Capital Formation commissioned the internationally recognized accounting firm, Ernst & Young LLP, to compare the tax treatment of capital gains in the 50 states.

As the new Ernst & Young report shows, investors face State-level individual capital gains taxes in forty-one States. According to the survey, the average top individual State capital gains tax rate on corporate equities was 5.8 percent in 2008. Combined with the federal capital gains tax rate, these State capital gains tax rates substantially increase the difference between what an investment yields and what an individual investor actually receives (known as the “tax wedge”). The higher the tax wedge, the fewer the number of investments that will meet the “hurdle rate” resulting in fewer investments being undertaken. State capital gains taxes, combined with the Federal tax, are therefore a direct impediment to entrepreneurship and consequently to economic growth.

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