Economists have tons of data and research on current incomes. However we have considerably less on wealth. In fact we have next to nothing at the regional or local level. Given the increased concentration of wealth in recent decades, and the aging of the large Baby Boomer generation, wealth is becoming a larger component of our community, economy, and potentially our tax revenues.
Now, the first thing I think of when it comes to wealth is housing, or home equity. This is particularly true in recent years given the housing market. Owner occupied home equity in Oregon, as a share of personal income, or as a share of GDP, is at an all-time high. Across the country, home equity in a primary residence is about half of the typical family’s net worth. But among families in the bottom 75% of the distribution, housing wealth is essentially all they have, if that.
However, while home equity is the major source of wealth for the vast majority of the population, that is not the case for the highest net worth families. In looking at the Federal Reserve’s triennial Survey of Consumer Finance over the years, the value of a family’s primary residence is about 15% of the total assets for those in the top 10% of net worth. Financial investments and equity in privately owned businesses account for the lion’s share of assets for such families.
These trends and factors come into play regarding Oregon’s estate tax. Such collections have greatly outstripped our office’s forecasts in recent years. Our revenue outlook is tied to asset values and demographics, but also dampened some by the expectation of estate tax planning based on feedback from our advisors. The total number of taxpayer subject to the estate tax hasn’t increased much in the past 15 years, but the value of these estates certainly has. One further, unpredictable factor here are deaths and when our friends and family pass away. We know not everyone passes perfectly in line with actuarial tables, helping to drive some of the volatility seen in tax collections.
While there is considerable fluctuations in estate taxes, capital gains are even more volatile. There are myriad factors at play including when a taxpayer chooses to realize gains based on their value, or the taxpayers need for income to pay the bills. That said, the hardest component here when it comes to capital gains is the fact we do not have good information on what the cost basis for these gains actually is. Is the gain based on an asset (a stock, or business, or house) that was purchased recently, or one that was bought decades ago and which there are considerable unrealized gains?
The answer to this question is a known unknown, it varies tremendously by taxpayer, and is something our office regularly discusses with our revenue advisors. Given we are now in the midst of the third major run-up in asset values and capital gain realizations in the past 20 years, our office is concerned about the outlook going forward. Not in the sense that asset values with crash — that is always a risk — but in a bigger sense about the stockpile of potential capital gains outstanding. With the dotcom crash and housing bubble, the economy has recently underwent two major purges of capital gains. It is possible that taxpayers are tapped out and we will not see the same type of revenue growth moving forward, or rather, tax collections will be even more closely tied to current asset prices with less alpha and more beta than the underlying economy.
Well, it turns out this may be less of a concern then we first thought. The average amount of unrealized capital gains for privately owned business and for financial assets (excluding retirement accounts) are back to all-time highs as of 2016. Potential real estate gains were not back to their bubble peaks just yet, but as seen at the top of the post, we are here in Oregon and the U.S. is closer with an additional two years of rising prices.
Now, with a bit of further numerical gymnastics, we can estimate the total stockpile of U.S. unrealized capital gains and then share that down to Oregon based on the growth in our high income households over the years. This is not a perfect look, but is as good as we can do given the lack of local data. And it turns out that if you match up these estimates of the unrealized capital gains with actual realized capital gains as reported on tax returns, they line up pretty well.
It is interesting to note that at the peak of the past two cycle, the trends in realized capital gains outstrip the trends in the underlying stockpile of unrealized gains. Does this represent profit taking at the top of the cycle? Or that taxpayers are no longer delaying their gains/gratitude as much? Or that there is considerably larger capital gains from current economic activity driving revenues, and not being as reliant upon long-held assets? Whatever the case, at least in 2016, this top of the cycle behavior was not yet happening. That said, given the increase in realized capital gains in 2017, expectations for strong 2018 tax filings, and now a stock market that is largely moving sideways or down in recent months, this gap may be happening today or in the near future. We will have to wait for more tax collection data and the 2019 SCF to know for sure.
Finally, in large part due to the volatility of estate taxes and capital gains, Oregon policymakers during the 2017 legislative session, passed Senate Bill 1566 which will direct some of these revenues — when they are above their 10 year growth trend — to help with the PERS unfunded liability.