Not all taxes are alike: some have little impact on the economy while others can be quite disruptive and hamper growth and investment. Capital gains taxes fall in the latter category.
This is doubly true at the state level. A higher capital gains tax rate at the federal level deters overall savings and investment, while at the state level it encourages the flight of capital (and investors) to other, more tax-friendly locales. In short, reducing or eliminating Ohio’s capital gains tax may be the most effective way to stimulate the state’s economy and create new jobs.
There is considerable empirical evidence demonstrating the potential effect that a reduction in the capital gains tax would have on job creation. To measure the impact that reducing the state’s capital gains tax would have on the economy, we constructed a dataset with 40 years of economic data on each of the 50 states, including statistics on income tax rates, capital gains tax rates, employment, wages, and other pertinent economic information. Over this period, seven states reduced their capital gains taxes to some degree while one increased its capital gains tax.
Using those changes, as well as the wide variation in tax rates across the states, we find that completely eliminating the capital gains tax in Ohio would create an additional 40,000 jobs in the state. Our results are statistically significant and robust, meaning that they remain true even when making myriad changes to the control variables included in the model.
The proposal currently before the Ohio Legislature reduces the taxes on capital income not by reducing capital gains taxes but by providing a 10 percent investment tax credit for Ohioans with less than $50 million in assets who invest in Ohio companies. While the range of possible investments that would benefit from the tax break is smaller than under the capital gains reduction that our study examined, the tax benefit is actually more generous for those investments that do qualify for the tax break.
The mechanism by which such a tax cut creates jobs is straightforward: the absence of a capital gains tax will induce investors to remain in the state and invest in Ohio businesses, which in turn will make them more productive, efficient, and competitive, leading them to expand and hire more than they would if the tax were still in place.
To be sure, reducing Ohio’s capital gains tax will not cause thousands of wealthy Hoosiers or Michiganders to flock to the Buckeye State. But it will slow the stream of Ohioan retirees to Florida and Texas, and those who stay are going to find that it is much more profitable to invest in Ohio than it is to invest elsewhere.
Like many other states, Ohio has struggled to balance its budget during the past few years, so it may seem like an odd time to reduce a tax that has brought in a significant amount of revenue. However, our research suggests that taxing capital gains is akin to cutting off the nose to spite the face. Its deleterious impact on investment and residency decisions means that the state collects much less revenue from the tax than official numbers suggest, and that it comes at a significant cost in the form of slower economic growth and fewer jobs.
Ike Brannon is Director of Economic Policy at the American Action Forum. William Melick is Professor of Economics at Kenyon College.