Increased Massachusetts Revenue: Where Is It Coming From?

Governor Deval Patrick has unveiled a budget and tax plan that delivers just under $2 billion in new revenue to state coffers to fund transportation and educational initiatives. The Governor’s proposal does not simply rely on a straight increase in one category of tax, but has mixed in income tax rate increases, decreases in the sales tax, tax code changes, corporate tax changes, and increasing the sales tax base in order to achieve the $1.9 billion in new revenues. Michael Widmer of the Massachusetts Taxpayers Foundation said that the proposal had more moving parts than any similar proposal he had ever seen, and I believe he is right.

Widmer and the Foundation have come out with an analysis of the revenue proposal, showing exactly how each component of the proposal impacts state revenues. The numbers are a bit surprising. Let us take a look.

When you net out the income tax increase with the sales tax decrease you raise $110 million, which is only 6% of the overall total. ($1.48 billion increase in income tax, $1.37 billion decrease in sales tax). The real money comes from changes in personal income tax deductions that would be allowed under the Governor’s proposal. The 44 deductions and exemptions that would no longer be allowed bring just under $1.1 billion in new revenue. Expanding the sales tax to include candy and soda would bring in $53 million, and increasing tobacco and cigarette taxes would bring in $166 million. That is where the real money is, and will bring scrutiny to the tax code changes, and how they impact taxpayers. Those three items make up 68% of the new revenue, which is possibly the biggest surprise.

On the corporate side the Governor proposes to extend the sales tax to sales of specialized software and data services ($265 million), proposes three different technical changes to the corporate tax code ($194 million)and would limit the film tax credit to $40 million (increase of $40 million in revenue).Those changes are worth $499 million, or 26% of the increased revenue.

What are some of the deductions and exemptions that are impacted? The deduction for employee Social Security and Public Pension plans is one that will certainly draw some scrutiny. That change will impact 3.5 million filers in Massachusetts, and is worth $357 million at the 6.25% rate. Next up would be the capital gain for the sale of a home. Current Massachusetts law allows for exempting the first $500,000 of gain from the sale of a primary residence, a benefit that has been extended to all taxpayers. The Governor’s proposal would eliminate the benefit for all, and would impact 55,000 filers. A third prominent change would be the elimination of the deduction for child dependents. The Governor proposes to eliminate the deduction for dependents under the age of 12. 510,000 filers would be impacted by this change, worth $162 million at 6.25%. That change is going to draw heavy scrutiny.

The Governor and others point to these changes and others as part of an effort to restrain “tax expenditures”, which are tax code items that provide a benefit to a certain category of taxpayers that is not available to other taxpayers.From the State House News Service:

Patrick’s multi-faceted approach to overhauling the tax code generally meshes with calls for broad tax law reforms called for in recent years by Rep. Jay Kaufman (D-Lexington), who chaired the Committee on Revenue last session. House Speaker Robert DeLeo has yet to announce this session’s Revenue chair.

The state’s tax expenditure budget identifies hundreds of specific tax breaks, which the Tax Expenditure Commission, chaired by former Administration and Finance Secretary Jay Gonzalez, recommended reducing in a report issued last April 30.

“A reduction in size of the Tax Expenditure Budget provides the opportunity to reduce tax rates paid by everyone, or to generate more revenue to support government programs and services,” the commission wrote.

I did a post on “tax expenditures” last year, and would have to say that my understanding of the term would not include the changes to the tax code mentioned above that impact individual filers. In looking at the proposals I believe that the best example of the elimination of “tax expenditures” would be the limiting of the film tax credit, and the other corporate tax changes. I realize the broader definition includes all tax deductions and exemptions, including personal ones, but the political discussions on it have frankly been centered on the corporate side.

The Governor, through these proposals, also seeks to use the tax changes to make the code more progressive.

Glen Shor, the governor’s secretary of administration and finance, did not take issue with Widmer’s math, but said he looks at the proposal through a different prism. “The governor’s revenue proposals should be taken as a whole. It raises $1.9 billion by creating a fairer and simpler tax system. Half of Massachusetts households will pay the same or less than what they do today.”

New Secretary of A&F Glen Shor points out that business will save about $470 million from the sales tax reduction, which was not included in the Widmer analysis. But as usual Widmer’s numbers are a good tool for taxpayers and legislators alike as they look at the scope of the Governor’s proposals, and what the specific impacts are. The Governor has not just produced a cookie cutter approach to revenues, but instead has laid out a proposal with many “moving parts.” The Legislature has some heavy lifting ahead.

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