On Wednesday, the Massachusetts legislature is scheduled to hold a constitutional convention on a so-called “millionaire’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. .” The “Fair Share Amendment” would levy a 4 percent surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on income above $1 million. This surtax would be in addition to the 5.1 percent state income tax, making the total income tax burden for high-income residents 9.1 percent.
The Massachusetts Department of Revenue (DOR) estimates that the surtax would bring in almost $2 billion in additional revenue annually, which the amendment would direct towards transportation and education funding. That revenue would be raised from taxing only 19,600 taxpayers, representing 0.5 percent of all filers. Of those taxpayers, the wealthiest 900 would pay 53 percent of the new tax revenues.
The tax also includes a marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. , as the $1 million threshold doesn’t change with respect to filing status; the DOR estimates that approximately 86 percent of the affected taxpayers would be married couples.
If legislators approve the amendment, it will be on the ballot for Massachusetts voters in 2018. Should the amendment be ratified, the legislature would have no ability to adjust the proposal due to Massachusetts’s constitutional requirements. The earliest the proposal could be modified would be 2023, illustrating the risk to policymaking via a state’s constitution.
The legality of the proposal is ambiguous, principally due to the appropriation of future revenue. The Massachusetts constitution prohibits ballot initiatives from appropriating funding. Since the Fair Share Amendment designates the new tax revenue for transportation and education, its constitutionality is debatable.
Legal questions aside, the amendment has serious economic implications. Notably, the bill does not specify any provisions for pass-through businesses. Such businesses report their income on an owner or shareholder’s tax filing, rather than on a separate corporate filing. Around 10,000 Massachusetts filers in 2013 listed income from partnerships or S corporations that was above $1 million, according to the latest available IRS data. These filers represented 5.9 percent of pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es, but accounted for 63 percent of net pass-through income.
The 9.1 percent top rate would expose Massachusetts pass-through businesses to the fifth highest rate in the nation. This diminishes the desirability of Massachusetts as a location for small businesses and start-ups, which are a core tenet of the state’s economic strength. Small businesses account for 97.8 percent of all employers in Massachusetts, and employ about half the state’s total workforce. Though small businesses do not have to be pass-through entities, the potential impact on those that are is worrisome.
In 2016, Illinois pondered a similar tax increase that would have levied an 11.25 percent top rate on pass-through businesses. Analysis from the Illinois Department of Revenue showed that imposition of the rate would cost the state 20,000 jobs and $1.9 billion in GDP over its first four years. Additionally, 43,000 individuals were projected to move out of Illinois as a result of the tax increase. The legislative session ended before action was taken on the measure.
Even if the Fair Share Amendment is better targeted to affect only wealthy individuals, there would still be economic repercussions for Massachusetts. The steep combined tax rate may cause high earners to migrate to other states.
If the amendment is ratified, neighboring states would offer significantly lower top rates to the wealthiest residents. Rhode Island charges a top rate of 5.99 percent, Connecticut charges 6.99 percent, and New Hampshire charges 8.97 percent. All are within two hours of Boston, where the majority of Massachusetts’s top earners reside.
Several studies have attempted to analyze the impacts of state income taxes on wealth migration. While many found that tax hikes did not prompt a significant departure of millionaires, the context of these studies is arguably quite different. The rate increases in these cases were not nearly as large as Massachusetts’s proposed 4 percent surtax, which represents a 78 percent rate increase for top earners.
In general, it is sound to assume that a rate increase will not spur an immediate exodus from Boston townhomes. Relocation is often costly, difficult, and frustrating. However, in the medium term, it becomes far more likely that the wealthy will relocate to lower-cost areas if the income tax proves burdensome.
A flight of the rich would have serious consequences for the state. The top 0.5 percent of Massachusetts earners accounted for 19 percent of total taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. in 2013. While the state might increase revenue in the short run, losing these earners would greatly diminish revenue stability. Just look to New Jersey: the departure of one high net-income individual caused severe revenue instability.
As the Massachusetts legislature considers the so-called “Fair Share Amendment” tomorrow, policymakers would be wise to heed the possible economic consequences of supporting such a large, concentrated tax increase.
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