In 2002, Vermont was losing jobs. When the year ended, .09 percent fewer Vermonters would be employed than when the year began.

To reverse the decline, Gov. Howard Dean and the Legislature passed a capital gains tax exclusion. On the first 40 percent of a capital gain – from selling stocks or a business – a taxpayer would pay no state tax. The hope was that this tax break would encourage investment, therefore the creation of new businesses (or the expansion of old ones), therefore more jobs.

In 2003, the year the exclusion went into effect, the state still lost jobs, if by one tenth of a percentage point less. But one year is not a fair test. Better to check the five years before and after the tax change.

From 2003 through 2007, the number of employed Vermonters rose from 298,600 to 307,800 a 3.1 percent increase. From 1998 through 2002, before the capital gains exclusion took effect, employment rose from 282,000 of 300,900, an increase of more than 6.5 percent,

Does this prove that cutting capital gains taxes depresses job growth?

No. It doesn’t conclusively prove anything. Despite the mini-recession of 2001-2002, employment in the rest of the country grew faster between 1998 and 2002, also. No state is an economic island, entire in itself, and no state’s tax change can save that state from the effects of a nationwide recession, or, for that matter, prevent it from enjoying the fruits of nationwide prosperity.

But along with several other examples, the relationship – or lack thereof – between Vermont’s capital gains exclusion and its job growth does come close to proving that cutting the capital gains tax does not necessarily create more jobs.

In fact, capital gains tax preferences, such as the one the Legislature and Jim Douglas just adopted, (bringing back part, though not all, of the 2002 exclusion) have only two certain outcomes:

(1)  People who pay capital gains taxes, mostly the very wealthy, will pay less in taxes.

(2)  The state government will have less money to spend on highways, schools, law enforcement, health care, protecting the environment, and the like.

This Fiscal Year (FY 2011, starting July 1), Vermont will have only $3 million less because of the capital gains cut, and state officials and lawmakers agree that they can save that much without actually cutting state programs or services. For FY 2012, though, the revenue loss will be closer to $11 million. Cuts will be required.

It is reasonable to assume that those who benefit from the lower rates will not be discomfited by the spending cuts.

It isn’t that there is no case to be made for a positive association between lower capital gains taxes and more employment. Most mainstream economists agree that, in theory, any tax reduction will eventually lead to more private economic activity, hence more jobs. And the assumption (or hope) that cutting the tax will boost employment crosses party lines. President Obama has recently proposed a cut in some capital gains taxes for small businesses.

But even in theory, the increase is very small, and the real world there seems to be no connection at all. In November, 1978, Congress cut the top capital gains federal tax rate from 39 to 28 percent. Economic stagnation followed.

The top rate was cut again, to 20 percent, in the summer of 1981, while economic was growth was  a healthy 3.5 percent. In the next 12 months, the economy declined, entering the early stages of the 1982 recession, the worst post-war downturn until now. In both cases, unemployment rose in the period immediately following the tax cuts.

Higher capital gains taxes don’t necessarily hurt job growth, either. They didn’t in 1976, when a capital gains tax hike was followed by faster increases in the Gross Domestic Product and lower unemployment.

Even the responsible pro-capital gains cut economists (as opposed to the shills for chambers of commerce and similar groups) do not project substantial job increases from cutting capital gains taxes.

Appearing before the Joint Economic Committee in June of 1997, Allen Sinai (one of Sen. John McCain’s economic advisors during the 2008 campaign) said he estimated that a 50 percent cut in federal capital gains taxes would lead to more jobs, but not many.

“The increases relative to what might have happened otherwise are definitely significant, but small to modest in magnitude,” Sinai said, presenting tables suggesting an increase of 353,000 more jobs nationwide over a seven-year period.

That’s such a tiny increase – about 50,000 jobs a year nationwide – that it’s hard to see how anyone could possibly figure out, after the seven years had ended, just how many of the newly created jobs might have been due to the tax change. Other academic studies project even tinier job creation from cutting the capital gains tax.

But there is no doubt that a state need not create capital gains preferences to inspire business investment. The biggest investment boom of recent decades – if not ever – was in the high-tech, “dot com” start-ups during the 1990s, concentrated in California.

California “taxes capital gains the same as ordinary income,” reported (by email) Jean Ross of the California Budget Project in Sacramento. “We provide an exclusion for cap gains on the sale of a principal residence – the same as in fed law – but that’s it.”

There are even circumstances under which a lower capital gains tax could lead to fewer jobs. The cut, after all, does not provide a direct incentive to invest in a business; it provides a direct incentive to sell a business. That’s when the investor realizes a capital gain.

John Canning of the Vermont Software Developers’ Alliance, representing an industry that has been growing in Vermont and expects to add 150 high-paying jobs during the rest of this year, said his organization decided not to press for a capital gains tax preference now because it might cost jobs in Vermont.

“Venture capitalists would like to see the capital gains tax go away completely,” Canning said. “What concerns our association is that when someone sells his company, he’s often going to sell it to a bigger company out of state, and we’re not sure that’s good for Vermont.”

Canning said his industry is thriving and growing in Vermont because “people who grew up here or visited fell in love with Vermont,” and wanted to live in the state.

Starting a software company, Canning said, “doesn’t require a huge amount of capital.” A software startup entrepreneur, he said, primarily needs “an idea.” And also “enough bright people in an area and they feed off one another.” Thanks to institutions such as the University of Vermont, Fletcher Allen Health Care, and IBM, Canning said, Vermont provides that advantage also.

All this suggests that to attract more jobs, Vermont might worry less about taxes and more about enhancing amenities and attracting the kind of businesses that respond to those amenities. Something like the “statewide office of Innovation and Intellectual Property” proposed by State Sen. (and Democratic candidate for governor) Susan Bartlett would seem to have at least some real potential for providing a path to more job creation.

The same cannot be said for the capital gains tax cut just adopted.

As some of the lawmakers who agreed to it seem to know. Democrats went along with the move because they had to compromise with Republican Gov. Jim Douglas, who wanted deeper cuts in the tax. But also because they wanted to placate the state’s business community.

“It was a reasonable compromise, targeting it to Vermont businesses,” said Rep. Janet Ancel, a Calais Democrat who is on the House Ways and Means Committee. “Perception is reality, and the perception (in part of the business community) is that Vermont has a poor business climate. This is an attempt to remedy that.”

In other words, for Douglas the Republicans, cutting the capital gains tax was an article of faith, against which mere evidence is powerless. For the Democrats, it was a matter of politics, signaling the “we feel your pain” message to the business community and trying to tone down the “poor business climate” rhetoric.

And is the evidence for Vermont’s “poor business climate” any stronger than the evidence that cutting capital gains taxes will create jobs?

Tune in Monday.

This entry was posted on Friday, May 21st, 2010 at 12:16 am and is filed under Business & Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.