Taxpayers React to Higher Taxes in 2013

Chart Showing Capital Gains Realizations

Amazingly, there are some people that continue to deny that changes in taxes impact taxpayer behavior. Put simply, if you increase taxes on something you can expect to have less of it. This is straight from the LAW of supply and demand which is always at work akin to the LAW of gravity.

In particular, the recent tax hikes that went into effect in 2013 predictably caused taxpayers to shift income into 2012. To see the full list of new taxes, please see my recent blog “Happy New Year, Now Pay Your (Higher) Taxes.”

Of course, you don’t need to take my word for it. As shown in the chart above, the Congressional Budget Office (CBO) has accounted for this tax shift of income into 2012, especially capital gains. CBO estimates a whopping 58 percent increase in capital gains realizations–to $606 billion in 2012 from $384 billion in 2011. Correspondingly, capital gains realizations are forecasted to plummet in 2013 by 38 percent.

Here is what the CBO has to say about this tax shift (pdf):

In addition, shifting of income—such as capital gains realizations from stock and other asset sales, wages and salaries, and dividends—mainly from calendar year 2013 into late 2012 in anticipation of those rate changes (and in anticipation of possible rate changes that did not ultimately occur) is expected to increase revenues in fiscal year 2013 and reduce them in 2014, when some of the taxes on that income would have been paid.

According to the most recent 2010 data from the IRS (xls), 38 percent of all capital gains realizations were made by taxpayers earning more than $100,000 in adjusted gross income. As a result, capital gains are taxed at the highest marginal income tax rates which have a large impact on year-to-year swings in total income tax revenue.

Additionally, it’s not just capital gains income that reacts to changes in taxes. The Bureau of Economic Analysis (BEA) recently reported that the acceleration of dividend and salary bonus income into the 4th quarter of 2012 significantly accelerated personal income in many states. Here is what BEA said:

Special or accelerated dividend payments to persons in anticipation of changes in federal individual income tax rates boosted personal dividend income in the fourth quarter. The gain was largest in Washington D.C. where dividend income rose 26 percent and smallest in South Dakota where it grew 12 percent.

Fourth-quarter earnings in the finance industry were also boosted by accelerated bonus payments or other irregular pay in anticipation of tax rate changes. Finance earnings grew 10.5 percent in New York, 7.9 percent in Connecticut, and 6.4 percent in New Jersey, states where the finance industry is particularly prominent. Finance earnings grew 2.7 percent in the other states.

Of course, Maine is not immune to these impacts. Dr. Michael Allen, the Associate Commissioner to Tax Policy at Maine Revenue Services, recently reported to the Maine Consensus Economic Forecasting Commission (Disclosure: I am a member of the CEFC) that he expects Maine’s capital gains realizations to jump 40 to 60 percent in 2012.

Overall, the recent news about Uncle Sam’s shrinking budget deficit should be taken with a grain of salt. This shifting of income into 2012 will continue to create a short-term boost in federal revenue as we approach the April 15th filing deadline (even beyond because high-income taxpayers often use filing extensions).

However, once the tax shift plays out revenue growth will slow. Unless spending is brought under control–especially entitlement spending as I have discussed previously–then Uncle Sam’s budget deficit will begin to grow again.

As for those people that deny taxes impact behavior, you should really go shopping in New Hampshire this weekend and remind all the Mainers shopping with you that “taxes don’t matter.”