An even-numbered year in U.S. politics means it is an election cycle. One of the aspects of the election cycle I enjoy most is the ballots on the state and local level. The variety of topics and the potential impact I find intriguing. This election cycle will bring ballots on abortion, as well as five states determining whether marijuana should be legal. While those are important topics, the ballot that I think is most consequential this election cycle is in the Commonwealth of Massachusetts.
This month, the citizens of Massachusetts will vote on a ballot called the Tax on Income Above $1 Million for Education and Transportation Amendment (also known as Question 1 or the "Massachusetts Millionaire Tax"). Question 1 asks whether the state government should amend the state constitution to create an additional 4 percent income tax on those making an income over $1 million. For millionaires, this would be an additional 4 percent on the already-existing 5 percent, thereby bringing the total to 9 percent. The Tax Foundation has a nice map of state income tax rates (see below). By New England standards, the Massachusetts state income tax is relatively low. That would change if Question 1 passes.
Fair Share MA, who are the main proponents of Question 1, argue that this will make the Commonwealth better for all, especially since the funds would be directed towards public education, roads, bridges, and public transportation. For public education in particular, this funding would help students in public schools to thrive. This, of course, ignores how the school closures disrupted learning in the pandemic in the first place. Leaving that aside, the premise of the argument is that this tax revenue would help the economy and help the Commonwealth recover from COVID-19.
I get skeptical when people talk about "fair share" with taxation because it such a subjective concept. I have analyzed multiple attempts at making taxation "fairer," whether that has been the wealth tax, the corporate tax, Illinois' failed attempt to pass a "fair" state income tax, or the marginal tax rate for federal income taxes. An attempt to make taxation "fairer" often leads to negative unintended consequences. I have to wonder whether the tax proposed in Question 1 will have similar, negative effects.
Tax Revenue
A report from Tufts University's Center for State Policy Analysis evaluates the Massachusetts Millionaires Tax. Tufts calculated that the tax would raise $1.3 billion of revenue in 2023, which is the equivalent of 0.3 percent of Massachusetts state income. A report from the think tank Beacon Hill Institute comes to similar findings with tax revenue (see below). The Tufts study finds that short-term economic impact would be negligible.
The Tufts study posits that the size of the tax is too small to have any major economic impact. At the same time, it recognizes that the tax revenue from this tax would be 35 percent higher if it were not for tax evasion and cross-border migration. Most of that tax loss in 2023 would be due to tax evasion ($670M), as opposed to cross-border migration ($100M). I appreciate the sense of nuance because I recognize that tax policy goes well beyond the over-simplified argument of "lower taxes = good; higher taxes = bad."
Negative Economic Impacts
The Tufts study comes up short because it only asks what the impacts on the tax revenue are. While it mentions other economic impacts, it does not attempt to quantify them. Tax evasion and cross-border migration have economic impacts both in the short-term and the long-term. The Tax Foundation makes this point abundantly clear in its analysis on the Massachusetts Millionaire Tax.
Declining GDP Output: The Tax Foundation cited a paper from economists Christina Romer and David Romer (Romer and Romer, 2010). Both are Keynesian economists and the former worked in the Obama administration. The Romers found that a tax increase equal to 1 percent of GDP results in a 3 percent decline of GDP in three years. Using that ratio and applying it to this Millionaires Tax, it would mean that the Commonwealth would lose an estimated $5.96 billion in GDP output by the end of 2025. The catch is that the Romer finding is based on federal income tax data. Since it is easier to avoid state-level taxes than it is federal-level taxes, it is likely that this $5.96 billion in lost GDP is a low-bound estimation.
Labor Fleeing the Commonwealth: Not only will the GDP decrease as a result, but so will the labor market. The Beacon Hill Institute report estimates that employment will drop by 9,329 individuals within the first year due to people leaving the Commonwealth (see below). This is not merely conjecture. A paper from the Journal of Economic Perspectives, which includes economists from Princeton and the London School of Economics, recognizes that high-income individuals sometimes move across borders in response to higher taxes (Kleven et al., 2020). Again, the Tufts study also recognizes there will be at least some outmigration.
Adjusted Gross Income: What should be more disconcerting is the net outmigration of adjusted gross income (AGI). As the Tax Foundation astutely points out, AGI is an important metric because income levels drive household spending. In terms of tax revenue, 57 percent of Massachusetts state tax comes from the individual income tax. Massachusetts has had net negative AGI since 1993 (see below).
In 2020, the biggest destinations for net migration Massachusetts AGI were New Hampshire and Florida, which are both states without income tax (see below). This trend largely held true between 2012 and 2020. If this ended up being the case before the Millionaires Tax, imagine how much more migration there will be if the tax is passed.
Will The Tax Revenue Be Spent on Education and Transportation?
Then there is the matter of how the tax dollars are actually spent. Tufts University believed that long-term economic impact would depend on whether the funds are actually used to increase education and transportation investments. This is because the tax revenue dollars remain fungible, which is to say that other tax dollars could be spent in a way that allows for the overall budgetary state of affairs for education and transportation to remain roughly the same. Plus, the text of the ballot measure clearly states that the revenues are "subject to appropriation," which means that the taxes can ultimately be spent on whatever the Commonwealth wishes.
Is This Additional Tax Revenue Necessary?
This also assumes that there needs to be increased expenditures. In general terms, Massachusetts tax revenue has been growing even in spite of the pandemic and lockdowns. You can see the Commonwealth's tax revenue data, as well as the data from the Federal Reserve Bank of St. Louis (see below). The graph below looks a bit volatile because the Fed collects and reports the data on a quarterly basis, with the fourth quarter being the largest quarter for tax collection purposes. Even so, the overall trend is still an upward one.
While increasing education spending has wide political appeal, Massachusetts already has the seventh highest per capita education spending. What about transportation? In its report on state highway performance rankings, the Reason Foundation ranked Massachusetts 47th in cost-effectiveness and condition. To quote Beacon Hill Institute report, "outside of general repairs and maintenance, the case for higher spending on transportation in Massachusetts is weak."
It Does Not Only Affect Millionaires
In spite of the title "Millionaire's Tax," it will not only affect the super-wealthy. This has the potential to hit middle-class workers who would be deemed "one-time millionaires." A small business owner (e.g., subchapter S-corporation, LLC, partnership) can sell their company, either at retirement or beforehand. This sale counts as "pass-thru income" on their individual tax forms, thereby making it taxable under the proposed constitutional amendment. This tax would diminish an owner's retirement savings. What about someone who decides to sell a home? If someone sells a modest vacation home that they bought 30 years ago, it could push them in this new income bracket that would raise their taxes by 80 percent. Such taxation can adversely impact the investments, including the nest eggs, of non-millionaires who are looking to retire. While this tax policy will not directly affect low-income households, this point serves to illustrate how imprecise tax policy can affect more than the millionaires that the amendment seeks to tax.
Postscript
Massachusetts has been faced with five previous attempts within the past century to soak the rich with taxes: 1962, 1968, 1972, 1976, and 1994. Each time, this relatively liberal state has been able to avoid such temptation. Given the increased political discourse around income inequality and "tax the rich" that has taken place since 1994, I have to wonder if the Commonwealth can resist such temptation.
The flat income tax is one of the only advantages of the Massachusetts tax system, according to the Tax Foundation's State Business Tax Climate Index. If passed, it would most likely be a repeat of what happened in Connecticut when it switched to a highly progressive tax system in 1996: lower GDP, higher unemployment, and higher migration to other states. The economy is not some abstraction or mere collection of numbers. Economic climate affects the overall wellbeing of everyone, not just millionaires.
Massachusetts has struggled with outmigration of economic activity for a number of years. This surtax on millionaires would only exacerbate economic trends in the Commonwealth. I hope that Bay Staters can resist the urge of populist economic policy and vote "No" on Question 1 this November.
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