Massachusetts to Have Second Highest Cigarette Tax, Rare Tax on Computer Services, Higher Gas Tax

Massachusetts legislators on Wednesday overrode Gov. Deval Patrick’s (D) veto of the transportation funding bill by votes of 123-33 in the House and 35-5 in the Senate to.

Effective August 1, several higher taxes go into effect. The 21 cents per gallon gasoline tax goes up to 24 cents per gallon (+$95 million/yr). The cigarette tax goes from $2.51 per pack to $3.51 per pack (+$144 million/yr), making the Massachusetts cigarette tax the second highest rate in the country after New York. Computer services will be subject to the 6.25 percent sales tax (+$150 million/yr). (That tax is retroactive to July 1, which is strange.)

Considering the discussion was about how to get more money for transportation, I’m not sure why the cigarette tax and computer services tax are in there. Cigarette taxes are a declining revenue source while transportation expenses grow each year, and states with very high cigarette tax rates face serious interdiction and black market sales problems.

The Massachusetts cigarette tax rate has been raised very aggressively, from 51 cents per pack in 1993, to 76 cents in 1996, to $1.51 in 2002, to $2.51 in 2008, and now to $3.51 per pack. Although the rate has increased fivefold from the early 1990s to today, the revenue has increased only by about three-and-a-half-fold, suggesting diminishing returns from higher rates. A 2010 joint report by the Campaign for Tobacco Free Kids, the American Lung Association, American Heart Association, American Cancer Society, and Robert Wood Johnson Foundation—while supportive of raising cigarette taxes—estimated that a $1 tax increase in Massachusetts would raise $76 million a year, far below the $144 million that the state is now projecting from the increase.

The computer services tax makes Massachusetts one of only four states with such a tax (the others are Hawaii, New Mexico, and South Dakota). While a well-designed sales tax taxes services as well as goods, Massachusetts’s change is not well-designed. Computer services are the only service thrown in, and because business-to-business services are not exempted, it will lead to a lot of unintended “pyramiding”—taxes on taxes, rather than just on final sales. The bill’s definition of computer and software services is quite broad, perhaps overly so.

Patrick had vetoed the bill because he considered the projected revenue inadequate due to the expiration of tolls on the Massachusetts Turnpike in 2017. The tax increases amount to about $500 million this year; Patrick had sought an additional $1.9 billion a year, primarily by increasing the state income tax.

Proving that sales tax holidays are gimmicks designed to allow tax-raising legislators to pretend to be for lower taxes, Massachusetts looks ready to approve a two-day sales tax holiday for August. House Speaker Robert DeLeo “will provide relief to consumers [while] supporting local businesses and keeping jobs in Massachusetts.” That expected $20 million in consumer tax savings isn’t much compared to the $500 million tax increase, in a state whose residents already bear the 8th highest tax burden in the country.

UPDATE: An alert reader writes in to note that Massachusetts DOR has issued an interpretation, deciding to enforce the computer services tax as of July 31, rather than retroactively.