Missouri is Sleepwalking into a Half-Billion Dollar Tax Cut for the Rich

This op-ed was originally published in the Missouri Independent

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Missouri lawmakers are debating a tax cut that will mostly benefit the wealthiest in the state, while relying on an unrealistic estimate of what it will cost.

The bill would eliminate all state taxes on capital gains, or profits from selling investments such as corporate stock, real estate, antiques and artwork. No state with an income tax fully exempts capital gains, in no small part because doing so would let wealthy people collect tax-free passive income while continuing to tax middle class workers and people whose savings are in retirement accounts.

Nearly two-thirds of capital gains that Missourians report on their federal tax forms flows to households with incomes over a half-million dollars per year.

There are ample grounds for debating this proposal but one that has come to the forefront is how much it will carve from the state’s budget. The state’s Department of Revenue estimated the cost at $111 million per year. Nobody doubts that the department has access to good data. But tax analysis is hard, and it’s not unusual for people working with good data to reach the wrong result. Every piece of publicly available data I’ve unearthed points to that being the case here.

While Missouri is less transparent than most states in how it publishes basic tax statistics, IRS data on Missourians’ federal tax filings, and the real-world experience of states with similar policies show that Missouri will confront a revenue hit many times larger than the department predicts.

First, consider the IRS data. In 2022, Missourians reported more than $13.3 billion in capital gains on their federal tax forms. If those gains were taxed at the state’s top rate of 4.7%, this would mean that a capital gains exemption would cost $600 million or more — a far cry from $111 million.

To be fair, this calculation is a simplification of reality, as department staff pointed out to The Independent when asked earlier this month.

Social Security income is fully exempt from Missouri tax, for example, and retirees who worked in the public sector can exclude their pensions as well. These policies may push some capital gains recipients into lower tax brackets and reduce the cost of a new exemption.

But the IRS data are clear that most gains flow to Missourians with exceptionally high incomes who are surely facing the state’s top marginal tax rate. Even if the average tax rate on capital gains was somehow half the top rate, the exemption would still cost almost three times the department’s estimate.

Tellingly, this simplified math works well in other states that have lowered taxes on capital gains. In Wisconsin, South Carolina, and Montana, official estimates for capital gains provisions all come within 30% of the estimate arrived at by applying the top rate to the IRS capital gains data. Only in Missouri does the Department of Revenue estimate so widely diverge from IRS data.

It is also possible to evaluate the department’s estimate another way. The department suggests that individual income tax revenue will decline by just 1.2% if capital gains are exempted.

But in Wisconsin, South Carolina and Montana, capital gains tax preferences that are about half as generous as the Missouri proposal are reducing income tax revenue by 3 to 4.9% per year. When we adjust the data from these states to reflect a Missouri-sized exemption, the result is a revenue loss between 5.2 and 8.5% of current revenues — four to seven times larger than the department predicts.

Although there are many possible explanations for the low estimate, public statements by the department offer two possible clues.

First, the department notes that some capital gains Missourians report on their federal forms may be taxed by other states. While true, this is not a compelling explanation because the effect cuts both ways. Missouri residents sometimes pay tax on capital gains to other states, and nonresidents sometimes pay tax on capital gains to Missouri. These two things typically come close to canceling out.

Some press reports suggest the department thinks nonresidents would be ineligible for the exemption. This is not apparent in the bill language and, even if it was, it would not matter because that design would be struck down in court as a violation of the U.S. Constitution’s interstate commerce clause.

If the department failed to consider the impact on nonresidents, that could lead to an understated revenue estimate. In Montana, for example, nonresidents receive one in every six dollars of that state’s capital gains tax preference.

Second, the department notes that many high-income people purchase tax credits that offset some or all of their tax liability. That is also true but it doesn’t explain why the estimate is so low and, in fact, it presents exactly the kind of wrinkle that could cause someone working with the right data to reach the wrong conclusion.

Imagine a high-income investor who purchases transferable credits to reduce or eliminate their Missouri tax liability. If capital gains become tax-exempt, they will have less tax liability and will purchase fewer credits. A recalculation of this person’s tax bill would show little change in state revenue because the taxpayer will simply switch from claiming one tax break (transferable credits) to claiming a different one instead (the new capital gains exemption).

But it’s essential to acknowledge that those credits will be transferred elsewhere. If the department did not hold transferable credits constant in its analysis, it would reach an incorrect answer.

While it’s not possible to pinpoint with certainty what may have gone wrong with the department’s analysis, every publicly available datapoint suggests that the true cost of this tax cut for high-income investors will be many times larger than estimated.

In other words, exempting capital gains would take an extra half-billion dollar bite out of the state budget, beyond what lawmakers have been told.

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