Taxing Capital Gains

by Tom Yamachika, President, Tax Foundation Hawaii

In our Legislature, crunch time has arrived.  Bills need to get out of their final committees and prepare for conference negotiations.  If they can’t clear their final committees, they are dead for this session, possibly to be revived next year.

There is a growing concern in our Legislature that the recent goings-on in Washington, D.C., including the slashing and burning by DOGE (which rhymes with “loge” as in loge seating at a concert, but which the Watch Doggie pronounces “doggie”), is making lawmakers think that we are going to need to make up for federal funding cuts with state revenue enhancement.  Which is a euphemism for new taxes.

House Bill 476, which appears to be on track to head for conference committee, concerns the taxation of capital gains.  Capital gains, or losses, arise when someone sells an asset that they have had for more than a year.  The asset could be a house, stocks and bonds, cryptocurrency, precious metals, or anything else other than cash.  What you receive from the sale is then compared your “basis,” which generally means what you paid for it.  If you made money overall, it’s a capital gain.  If you lost money, it’s a capital loss. (Warning: the actual law has more twists and turns, so if you are curious about details, please consult your friendly neighborhood tax professional.)

Capital gains are one of the few kinds of income that our General Excise Tax doesn’t hit.  But our income tax does.  However, in recognition that all of the income came in one year while the asset was held for several years, there is a limit on the rate at which capital gains are taxed.  Individuals, which are taxed at rates up to 11% in Hawaii (not counting federal tax), pay tax at no more than 7.25% on capital gains.  Corporations, which pay up to 6.4% on ordinary income, pay a maximum of 4% on capital gains.  Capital losses can be netted against capital gains, but any excess losses can’t be deducted against regular income, except that individuals can offset up to $3,000 a year.  The rest has to be used in a future year.

House Bill 476 changes the top capital gains tax rates.  But it doesn’t say what they will be changed to.  It raises (or lowers) the individual rate maximum to __% and raises (or lowers) the corporate rate maximum to __%.  Yes, this is yet another Blankety Blank bill.  We have complained about these in 2019 and 2022.

Many of the bill’s supporters think that even this doesn’t go far enough.  They think the maximum tax rate on capital gains should be scrapped altogether and the income should be taxed at our regular tax rates. They cite, among other reasons, several States that have done this already.  (Although most of these States do not tax income at 11% or anywhere close to that.)

At a recent hearing on this bill, proponents said the bill’s bite would fall most heavily on the most wealthy, and furthermore that the tax imposed on capital gains does not stifle investment (as seen in a graph of investment holding steady in this country while top capital gains rate wiggled and waggled over the years).  Some senators were concerned that the bill’s effects would not be limited to the wealthy.  If Auntie’s kids sell her house for a $500,000 gain to provide money for her to go to a nursing home, for example, the tax will fall on her the same as anyone who earns $500,000 in one year.

What will be the future of capital gains tax in the Aloha State?  We will see further developments in that story from our lawmakers soon.