James P. Angelini
David G. Tuerck
Howard R. Wright
Graduated Income Tax:
Who Wins, Who Loses?
Can Massachusetts reduce taxes for 92 percent of its residents without
reducing government services? Yes, say proponents of a graduated income
tax (GIT) that will go before Massachusetts voters in the November election.
This proposal would amend the state constitution to require the imposition
of a graduated (or "progressive") tax on personal income.
An accompanying measure would replace the flat tax imposed under present
law (5.95 percent, except for certain unearned income taxed at 12 percent)
with the rate structure shown in Table 1.
Tax Brackets by Indicated Tax Rate
for taxable income less than
for taxable income of
for taxable income greater than
measure contains a number of additional features, including relief for
MWRA ratepayers, an increase in the no-tax threshhold, a child care
tax credit and an increase from $1,000 to $2,000 in the deduction for
dependents. It also phases out the personal exemption ($4,400 for married
and $2,200 for single taxpayers) for taxpayers whose adjusted gross
income exceeds a certain threshold.
appear to be staking their appeal to the voters on the claim that winners
from the GIT would vastly outnumber the losers. Even if true, there
is good reason why a claim of this kind should not be so appealing.
is, for example, the inadvisability of removing the existing constitutional
barrier to tax progressivity. By doing so, Massachusetts voters would
dangle further temptation before an already tax-hungry state legislature.
There is also the questionable basis of the claim that the proposal
would not reduce revenues or, therefore, government services (which
is to say that the proposal is "revenue neutral").
now subject to the higher rates imposed by the grad tax pay about 35
percent of Massachusetts income taxes. The fraction paid by taxpayers
who would, in the years ahead, become subject to higher rates by increasing
their taxable income is, as we suggest below, substantially larger.
Because of the negative effect that the higher rates will exert on the
willingness of these taxpayers to generate additional taxable income,
the GIT would, in all likelihood, reduce tax revenues in the short run.
This means that, in the short run, the GIT would force the legislature
either to cut services or to raise taxes.
the long run, the GIT has just the opposite effect: It increases the
revenues collected from taxpayers and thus the amount of money the state
has available to spend. This is because of growth in the economy and
therefore of taxable incomes that automatically drives taxpayers into
higher brackets. This growth causes taxpayers to pay more in taxes,
even if the GIT is indexed against inflation and even if the legislature
never raises tax rates again.
effect of the GIT puts into perspective the claim that, under the GIT,
the winners vastly outnumber the losers. The authority for this claim
is a study by the Massachusetts Department of Revenue (DOR), which finds
that about 92 percent of the taxpayers affected by the grad tax would
gain while only 8 percent would lose in 1995. Those found to lose consist
almost entirely of high-income filers (in particular, married filers
making more than $100,000).
question is, however, "What about beyond 1995?" Can middle-income
filers expect to be better off under the GIT in future years? In particular,
can they expect to be better off over the rest of their working lives,
as their taxable incomes rise in response to career improvements and
other factors? Unfortunately, the DOR study provides no answer.
In an effort to fill this gap, we examined the effect on combined federal
and state tax liabilities of 180 hypothetical Massachusetts taxpayers
before and after adoption of the GIT. For each such taxpayer, we show
how much the taxpayer would win or lose as a result of adoption of the
we expect losers as well as winners? The answer is, "Yes."
Many middle-income taxpayers can expect to be worse, not better off,
over their working lives as a result of the GIT.
is that, measured in "real," inflation-adjusted dollars, taxpayers
normally experience growth in their taxable incomes over their working
lives. Not only do they receive salary increases, but, at different
points in their careers, they and their spouses expand their working
hours, enter or re-enter the labor force and earn income on their savings.
For the period 1981-1991, the real, taxable income per Massachusetts
taxpayer grew at an average annual rate of about 2.5 percent.
typically report relatively low incomes early in their income-earning
years. A GIT benefits taxpayers during these years by subjecting them
to lower rates. As their real incomes grow, however, some taxpayers
automatically ratchet themselves into the higher tax brackets mandated
by the GIT. Any tax saving that these taxpayers enjoy while subject
to the lower brackets are thus offset at least in part by tax losses
incurred later on.
to determine how much a given taxpayer would win or lose, we computed
the effect of the GIT on both federal and state liability (this is because
state income taxes are deductible against federal taxes). In our analysis
a taxpayer wins by the amount that his combined state and federal tax
liability falls and loses by the amount his combined state and federal
tax liability rises.
taxpayers according to (1) filing status, (2) present age, (3) present
income, (4) expected growth of income (in real dollars), and (5) expected
retirement age. Taxpayers are assumed to have a present age of 25, 35
or 45 and to retire at age 65 or 70. Income is assumed to grow at 1,
2, 2.5, 3 or 4 percent. We detail our other assumptions on page 4, below.
hypothetical taxpayer, we computed the total, accumulated change in
federal and state tax liability that will take place over the taxpayer's
working life. We then added the change in both accumulated tax liabilities
and reported the result in Tables 2, 3 or 4 , as appropriate. Each number
indicates the amount by which the indicated filer's tax liability would
fall (negative number) or rise (positive number) under the GIT.
Our analysis shows that, while some middle-income taxpayers would gain
under the grad tax, many others would lose. In general, a taxpayer gains
more (loses less), the lower his starting income and the less his income
can be expected to grow over his working life. (Note that there are
several exceptions, however.)
we cannot, with this analysis alone, determine what fraction of middle-income
taxpayers would gain or lose, we can safely conclude that any characterization
of the grad tax as a "middle-class tax cut" is highly misleading.
Many thousands of middle-income taxpayers would surely lose.
Murphy Brown Tax
One reason why so many middle-income taxpayers would lose is because
of what amounts to a hidden fourth bracket that the GIT would impose.
This bracket results from the phase-out of the personal exemption that
would take place at incomes exceeding a certain threshold. Because taxpayers
lose 2 percent of their personal exemption for every $1,000 by which
their gross income exceeds this threshold, they are effectively taxed
at a higher rate.
married taxpayer making between $100,000 and $150,000 in taxable income,
for example, the statutory marginal rate is 8.8 percent. But, under
the GIT, taxpayers falling (roughly) into this range must give up 2
percent of their personal exemption for every $1,000 in additional income
that they earn.
Net Change in Tax Liabilities Under the GIT
Negative numbers indicate the amount by which the taxpayer's combined
state and federal tax liability would fall under the GIT over the rest
of the taxpayer's working life. Positive numbers indicate the amount
by which that liability would rise. Thus a married 35-year-old taxpayer
earning $50,000, who expects his income to grow by 2.5 percent and to
retire at age 65, would pay $5,553 less under the GIT. The same taxpayer
earning $70,000 would pay $4,897 more.
Taxpayers filing married and head of household have two children, one
born when the taxpayer is 25 and the other when he is 30. At age 50,
the filer loses one dependent deduction and age 55 the other. All filers
rent until they purchase their own homes. Married filers purchase a
home at age 30 and single and head-of-household filers at age 40. Home
buyers take out a 30-year mortgage of $120,000 at 8 percent interest.
State filers take a deduction of of $600 for children under twelve,
except when taking a deduction or credit for child care. Federal deductions
are phased out as income exceeds $108,450. At age 65, state filers receive
an additional $700 ($1,400 for married filers), and federal filers add
the same amount to their standard deduction.
are assumed to incur $4,800 in child care expenses for two children
over a period of four years. Under present law, filers deduct this amount;
under the GIT, they take a proposed tax credit of 12 percent of this
amount. Under the GIT, the personal exemption is reduced by two percentage
points for each $1,000 by which the filers gross income exceeds a certain
threshold, depending on filing status: married - $100,000; single -
$60,000; and head of household - $80,000.
are in real, inflation-adjusted dollars. Deductions and exemptions not
indexed for inflation are deflated at the rate of 5.63 percent per year.
This is equal to , where .017 and .0743 are, respectively, the estimated
real rate and the current rate on long-term governmment bonds. We assume
that all income is "5.95 percent" income, (mainly, wages,
business income or interest from Massachusetts banks).
P. Angelini is Associate Professor of Accounting and Taxation at Suffolk
University. David G. Tuerck is Executive Director of the Beacon Hill
Institute and Professor and Chairman of the Department of Economics
at Suffolk University. Howard R. Wright is Research Economist at the
Beacon Hill Institute.
19-Apr-2005 2:05 PM