Policy Study Executive Summary
Economic Model of Massachusetts Tax Policy
graduated income tax (GIT) for Massachusetts would cause a loss, in
1995, of 78,000 jobs, of $1.231 billion in labor income, and of $87.448
million in state tax revenue. This would happen as a result of the way
in which the GIT reduces the economic reward for taking jobs and for
creating job opportunities in Massachusetts.
would reduce the take-home pay that a Massachusetts worker gets to keep,
on average, by taking an extra or temporary job, by working extra hours,
by becoming a family's second-income earner, or by working and living
in Massachusetts rather than some other state. By thus reducing work
incentives, the GIT would increase the cost of labor to Massachusetts
employers. The result is the above-estimated reduction in Massachusetts
jobs, labor income and tax revenue.
1994 election ballot will contain two measures that relate to the proposed
GIT. The first of these, Question 6, would amend the state constitution
to require the adoption of a graduated income tax. The second, Question
7, would implement Question 6 with a law that scraps the existing "flat
tax" of 5.95 percent on earned income and of 12 percent on certain unearned
income. The new law applies a single rate to all income, rising from
5.5 percent to 9.8 percent, depending on tax bracket and filing status.
report, published in October 1993 by the Massachusetts Department of
Revenue, contains a thorough and persuasive discussion of the importance
in tax analysis of accounting for the behavioral effects of tax-law
changes. Economic models that account for such effects (so-called "dynamic"
models) make it possible (1) to determine how a tax-law change would
affect economic indicators like jobs and earnings and (2) to determine
how the tax-law change would affect tax revenues in light of its effects
on these indicators.
are sometimes forced by data limitations and other problems to ignore
behavioral effects in analyzing tax-law changes. When doing so, they
might offer a judgment of what change, if any, will take place in tax
revenue under a new tax law, given the admittedly unrealistic assumption
that the new law has no effect on taxpayer behavior.
models based on an assumption of this kind (so-called "static" models)
are necessarily limited in value. While they can be reliable for very
limited changes in tax law, where the behavioral effects are likely
to be small, they are not reliable for sweeping tax-law changes like
the GIT, where the behavioral effects are likely to be large. Because
they assume away behavioral effects, models of this kind are unable
to determine what effects the new law would have on economic indicators
like jobs and labor income.
of Revenue Report was required, as it happens, to rely on a static model
in performing its analysis. Using this model, it concluded that the
GIT would cause tax revenue to rise by only $44 million, less than .5
percent of state tax revenue. It further concluded that "the economic
impact due to the aggregate increase in tax liability of this magnitude
is expected to be quite modest." Proponents of the GIT have interpreted
these conclusions to mean that the GIT is revenue "neutral" and economically
however, one can safely accept such an interpretation, it is worth taking
another look at the GIT and the possibility of estimating its behavioral
effects. In economics, where one attempt to estimate such effects might
fail, another might succeed. And, anyway, there are dozens of highly-regarded
studies showing that state tax increases have negative effects on employment.
Why not look a little more closely at this issue before automatically
accepting the reassurances of grad tax proponents?
what we set out to do in this study. In taking up this challenge, we
assembled historical data on key Massachusetts economic indicators such
as employment, capital, labor and capital income, and federal and state
tax rates. We then developed a dynamic econometric tax model for the
purpose of determining the effects of the GIT on Massachusetts employment,
labor income and tax revenue.
findings emerge from our analysis: (1) Massachusetts employment is significantly
and negatively related to the state "average marginal tax rate" (AMTR)
on labor income (the average state tax that Massachusetts workers pay
on an additional dollar of labor income) and (2) the GIT raises the
AMTR. Our predictions concerning job and tax-revenue losses are
based on a statistical determination of how changes in the AMTR
affect jobs and how the GIT would change the AMTR. It turns out,
as we would expect, that, when examined in the context of a dynamic
model, the GIT has significant negative effects on economic activity.
of this study can be purchased by e-mailing the institute at BHI
or by calling (617) 573-8750.