Rep. Sandell moves a bill to give Minnesota the second highest marginal rate of capital gains tax in the United States

This morning, I testified in front of the Minnesota House’s tax committee against HF 2756. This bill would hike Minnesota’s top marginal capital gains tax rate from 9.85% to 12.85%, the second highest in the country after California.

If someone buys, say, 100 shares for $1 each and their value rises to $2 each, this asset has doubled in value. But this ‘capital gain’ is only taxed when it is ‘realized’, ie, when the shares are sold for $2. The capital gain is $100 and it is this to which capital gains tax applies. This is a fairly sensible way of taxing capital gains.

Most states tax these capital gains at the same rate they apply to other income.* But problems arise when you have high income tax rates. By extension, this gives you high rates of capital gains tax.

As we wrote in our report, The State of Minnesota’s Economy: 2018, Minnesota is a high tax state. It is one of the 43 states to have its own income tax, but the top rate—9.85% on taxable incomes over $156,911—is higher than anywhere else apart from California, Hawaii, and Oregon. Equally significant, perhaps, is the fact that Minnesota’s lowest income tax rate of 5.35 percent is higher than the highest tax bracket in 23 states.

These rates also mean that Minnesota taxes capital gains heavily. This is not good for the state’s economy. As our population ages in coming decades, the share of Minnesota’s population working will shrink. This will mean fewer workers producing GDP to be divided among the population at large. All else being equal, per capita GDP – which is vital for determining standards of living – will fall.

To combat this, Minnesota will need its workers to become more productive. Our state’s workers currently lag the national average in labor productivity; we lag in GDP and Personal Income per worker and per hour worked. There is room for improvement.

This will require increased innovation and investment. We already lag the national average in terms of capital per worker, research and development spending as a share of GDP, venture capital per worker, and new and young businesses as a share of all business. So, again, there is room for improvement.

Given this, it makes no sense at all from an economic standpoint to lumber Minnesota with the second highest rate of capital gains taxation in the United States.

After the hearing, I had a conversation with a reporter who said that while Minnesota might have high taxes in some areas – personal and corporate income taxes, for example – it was only middling in others, such as the gas tax, where it currently ranks 28th nationally. I pointed out that Gov. Walz is trying to get us into the top five with his gas tax hike. Rep. Sandell wants us to be number two for capital gains tax rates. Minnesota’s Democrats currently seem to be animated by the spirit of The Wolf of Wall Street‘s Mark Hanna, bellowing “Gotta pump those numbers up. Those are rookie numbers in this racket”.

*Nine states — Arizona, Arkansas, Hawaii, Montana, New Mexico, North Dakota, South Carolina, Vermont, and Wisconsin — tax all long-term capital gains less than ordinary income.

John Phelan is an economist at the Center of the American Experiment.