Hawaiʻi’s capital gains loophole floats the rich as working families struggle to stay above water

In the interest of tax fairness, the State of Hawaiʻi should tax capital gains—income from selling assets such as stocks, bonds, art and real estate—at the same rates as income made from wages, salaries and other compensation for work. 

In Hawaiʻi, the tax rate for long-term capital gains is a flat 7.25 percent, while income tax rates are progressive, reaching a maximum income tax rate of 11 percent for the wealthiest residents. The potential impact of this preferential flat rate for capital gains is to give wealthy residents a tax break on the income they earn from capital gains. If a lower income person were to have capital gains, they would conversely pay a higher rate on their capital gains than on their regular income. 

However, at least in Hawaiʻi, lower-income residents do not tend to own capital assets or have any income from capital gains, which makes sense since these households lack the disposable income to invest in assets. In fact, 99.3 percent of all capital gains in Hawaiʻi are earned by people making at least $149,000 a year. Within that percentage, 96.9 percent of capital gains are earned by people making at least $282,000 and 85.4 percent are earned by people making at least $651,000 per year. 

This means that when Hawaiʻi taxes capital gains at a lower, preferential, flat tax rate, it is exclusively the rich that benefit. State legislators can close this loophole by passing HB1660 in 2024, which would tax capital gains at the same progressive income rates as regular work. That means the rich would pay the same fair rates on all their income, generating continuous new revenue for Hawaiʻi to reinvest in our schools, infrastructure, social programs and affordable housing.

How Capital Gains are Taxed in Hawaiʻi

Just how preferential is the flat 7.25 percent tax on capital gains enjoyed by the rich currently? That rate is on-par with the income tax rate for low-income individuals who earn $19,200 to $23,999 a year—barely above Hawaiʻi’s poverty line of $17,310 in 2024.

Consequently, any taxpayers earning over $200,000 a year—placing them in the top 11 percent of households income bracket—benefit from a huge tax break on their capital gains. Only nine states, including Hawaiʻi, still provide any kind of preferential treatment to long-term capital gains over regular income from employment.

Figure 1 shows the obvious difference in the amount of capital gains income between middle-income and high-income residents in Hawaiʻi. Even middle-income residents earning $75,000 to $150,000 drew an average of 2.3 percent of their income from capital gains, while lower-income residents earning $40,000 to $50,000 received just 0.7 percent of their income from capital gains. In that year, capital gains made up just 0.03 percent of the income for those in the $20,000 to $30,000 range.

In comparison, the wealthiest residents in the state (those with incomes over $400,000) received about a third of their income from capital gains, and non-resident taxpayers in this group earned an even higher 47.4 percent of their income from capital gains. 

Altogether, Hawaiʻi’s resident and non-resident taxpayers who earned more than $400,000 made $5.12 billion in profits from capital gains during 2021. This came at a time when thousands of working families were struggling with rampant unemployment and the rising cost of living, conditions that were accelerated by the COVID-19 pandemic.

Because the vast majority of capital gains are earned by the richest residents, the corresponding projected tax burden from HB1660’s capital gains tax increase (85.4 percent) would also fall on the wealthiest taxpayers in Hawaiʻi, as shown in Figure 2.

Capital gains bills in 2024

Given the legislature’s need for new revenue sources, closing the capital gains loophole is a common-sense way to raise taxes on those who can afford to pay them without impacting working families that are already burdened by regressive taxes such as the General Excise Tax (GET).

HB1660 was passed by the House Committee on Finance, and it will likely be heard by the Senate Committee on Ways and Means before the session closes. HB1660’s proposed changes to the capital gains tax would bring in an estimated $134.8 million in 2025, increasing to $166.9 million by 2030. 

With this money in hand, the legislature could have paid for several key policies that would help low-income Hawaiʻi residents, including the Child Tax Credit (HB1662) and Universal Free School Meals (HB1775), both of which died in the 2024 session due to a “lack of funding.”