If the Commonwealth refuses to cut services and can’t or won’t find a way to deliver existing services more efficiently, it will have to choose from a menu of tax-hike options, as sampled here. Whatever it chooses from this menu, there will be negative consequences for taxpayers and for the state economy as a whole. It is only sensible to know what is being served up before we order.

by David Tuerck

June 5, 2003

“Find the revenues.” That’s what the ads tell us to do in order to avoid devastating state budget cuts. Otherwise, we’ll have to end nursing home coverage for thousands of seniors, lay off teachers, police officers and firefighters, and close courts and prisons, turning criminals loose on the streets.

Governor Romney has argued that we can avoid Draconian measures such as these by adopting governmental reforms. But the Governor’s reform efforts are losing steam, and such reforms as are implemented may prove ineffective at reducing costs. Suppose then that the state turns to higher taxes as a way of closing the budget gap. What are the options and consequences associated with that course of action?

A widely-accepted estimate holds that, in order to sustain current services, the state needs an additional $3 billion in revenue for fiscal year 2004. Given that the state has already “found” $360 million in revenues in the form of higher fees and tax-loophole closings (tax hikes in disguise, some might say), that leaves a $2.64 billion shortfall.

There are different ways to close this shortfall through tax hikes, each with its own effects on individual tax burdens and on the greater economy. One problem that arises in assembling a menu of alternative tax hikes is accounting for the inevitable shrinkage in economic activity, and thus in the tax base, that any tax hike will bring about. Generally, the higher the rate at which something is taxed, the lower the base on which that tax can be assessed. Thus the amount of revenue ultimately raised depends in part on how much less there is to tax, once a tax rate is increased.

The Beacon Hill Institute (BHI) has developed its State Tax Analysis Modeling Program (STAMP) for the purpose of sorting out these conflicting effects. BHI used STAMP to develop a menu of tax-hike options, each of which would yield the needed $2.64 billion:

· Option 1: Raise the personal income tax from 5.3% to 6.3%; expand the sales tax to apply to groceries and alcohol; raise the sales tax rate from 5% to 6%; eliminate the “singles-sales-factor” tax break for certain corporations; eliminate the investment tax credit and raise the motor fuels tax from 21 to 22 cents.

· Option 2: Raise the personal income tax to 6.3%; raise local property tax revenues by 7% (overturning Proposition 2 1/2, as necessary); double the corporate income tax rate.

· Option 3: Raise the personal income tax by two percentage points to 7.3%; reduce personal exemptions by about 50%.

Consider individual taxpayers and how their tax burdens would rise. Under Option 1, the average Massachusetts taxpayer, filing jointly, would pay $1,004 more a year in income, sales and motor fuels taxes. Option 2 would put more of the burden on corporations, leaving this same taxpayer to pay $596 more a year in income taxes plus additional property taxes. Option 3 would put the entire burden on individual income earners. The average taxpayer would pay $1,277 more a year in income taxes.

Because taxes discourage the activities (work and investment) on which they are imposed, they cause reductions in these activities. Thus, in addition to imposing higher burdens on individual taxpayers, corporations or property owners, each option would inflict collateral damage on the broader economy in the form of lost jobs, wages and investment.

Using STAMP, we determined these collateral effects for each option. Table 1 illustrates.

The state could go with Option 1 and sacrifice 47,937 jobs, putting about 1.4% of people currently employed out of work. As a result of the loss in jobs, wages would fall by almost $2 billion or by 1.0%. Investment would fall by 1.7%.
Alternatively, it could go with Option 2, shrinking the loss in jobs but expanding the loss in investment. Or it could go with Option 3, putting most of the burden on workers. Those are some of the choices.

If the Commonwealth refuses to cut services and can’t or won’t find a way to deliver existing services more efficiently, it will have to choose from a menu of tax-hike options, as sampled here. Whatever it chooses from this menu, there will be negative consequences for taxpayers and for the state economy as a whole. It is only sensible to know what is being served up before we order.

David G. Tuerck, PhD, is chairman and professor of Economics at Suffolk University where he also serves as Executive Director of the Beacon Hill Institute for Public Policy Research.

This article appeared in the June 5, 2003 edition of the Boston Globe.

Format revised on 18 August, 2004