Opinion: Lower capital gains tax rates spur investment, keep successful Minnesotans here

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In the 21 years since I was recruited to Minnesota, I have watched successful entrepreneurs leave the state and take with them their capital, knowledge and, relationships. During that time, capital has become more difficult to get as venture capital has shifted to the coasts, and angel capital has become more risk adverse.

We still revel in the success of the founding of Minnesota’s well-known technology companies: Control Data (1957), Cray Research (1972), Honeywell (1927), Medtronic (1949), St. Jude Medical (1976). 3M (1902). Like the frog which doesn’t know to jump out of the gradually warming water before it’s boiled; Minnesotans think things are still pretty good. The reality is we’re living very much on past laurels.

Minnesota’s tax policy heads the list of issues that have made Minnesota an island in the upper Midwest… the highest-taxed state in the region (and among the highest in the nation).

This is specifically damaging for entrepreneurs. It makes it difficult for us to retain the most talented job creators and threatens the mid & long-term viability of our state.

Many of us who love Minnesota hate to see this decline. Others seem content to ignore it. I have written previously about several of the factors which have contributed to this exodus but will concentrate in this piece on a factor that has the primary effect of chasing both the most successful Minnesotans and their capital to other climes.

The old adage is that you get less of what you tax.

What Minnesota needs more of is investment capital and experienced senior business leaders. Working against both of these is Minnesota’s treatment of long-term capital gains which are taxed as ordinary income.

First, the basics. Long-term capital gains are the profits made on a long term investment.

The investment made by an investor or entrepreneur most often comes out of savings (as well as from sweat equity) which has already been fully taxed at the rate applied to ordinary income. Here in Minnesota, capital gains are taxed again at the same rate as ordinary income. There is no discount, exclusion, or lower rate for capital gains.

At the federal tax level, long-term capital gains are taxed at less than half the highest ordinary income tax rate. (15% versus the high marginal ordinary income tax rate of 35%] While rates may go up next year to 20% for capital gains and 39.5% for ordinary income, the approximately one-half the relative rate still applies.

According to an Ernst and Young (E&Y) 2012 study:

“The average top individual State capital gains tax rate was 5.2 percent in 2012. Combined with the Federal capital gains tax rate, these State capital gains tax rates substantially increase the difference between what an investment yields and what an individual investor actually receives (known as the “tax wedge”). The higher the tax wedge, the fewer the number of investments that will meet the “hurdle rate;” resulting in fewer investments being undertaken. High capital gains tax rates can also increase investors holding periods. Investment is a key factor in U.S. job growth, in recent years, each $1 billion increase in investment is associated with an additional 15,000 jobs. State capital gains taxes, combined with the Federal tax, are a direct impediment to entrepreneurship and consequently to economic growth.”

Minnesota has the 9th highest rate:

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However, 9 states have no capital gains tax, including our neighbor to the west - South Dakota:

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These states represent some of the states with the most vibrant economies:

Texas for instance, for several years now has created more private sector jobs than all the other states combined. In 2008, Texas represented 71% of all private sector jobs for that year. Or said another way, the private sector jobs created in all other states combined had to more than double to equal just Texas.

Florida attracts many successful Minnesotans and not just because of the weather but as a haven once they achieve a level of success. I have known more than a few successful Minnesotan medical technology executives who moved to Naples (Florida) far enough in advance of exiting their companies to meet residency requirements. With the money they did not pay in taxes to Minnesota, they were able to buy a house in Florida. We are driving the talented and successful away.

Six other states – including our neighbors to the east & west – have discounted the capital gains tax rates below the ordinary income tax rates:

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So, far worse than losing the capital, that these successful people earned, Minnesota is also losing these successful job creators. We lose their presence on a day-to-day basis. We lose their experience, their advice, their connections, their philanthropy, and their involvement in our state’s future. By definition, these successful people have created enormous value and just as their knowledge, experience and relationships hit their peak, Minnesota’s tax policy incents them to leave.

It has been proven with each moving van, that extracting every last tax dollar possible out of those most-successful Minnesotans has the side-effect of chasing them to low tax states.

As the Governor looks to his new power with democrats controlling both the Minnesota House and Senate, I urge him to consider investing in our future by, at least, lowering the capital gains rate. I would suggest an approximate 50% discount to the ordinary income rate bringing the capital gains rate to 4.0%. The resulting incentive should not only keep these talented individual here but encourage some who have left to return and further motivate companies to relocate to the North Star State.

John J. Alexander

John J. Alexander is President of Business Development Advisors, Founder and Chair of the Twin Cities Angels Funds, and business author of the Angel Investment Tax Credit.

Email him at: John@BusDevAdvisors.com

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