Tax rate cut would be best
David G. Tuerck and Kathleen M. Lang
Because of a surplus of state budget, Massachusetts
taxpayers stand to pay $146 million to $206 million less in 1996
taxes than expected (provided the legislature doesn't spend it first).
Good news? Sort of. Under the method prescribed by law, the money
will be returned through a one time reduction in taxpayers' personal
This, however, will do little to stimulate
the economy. A different method would, on the other hand, do much
to stimulate the economy. This method, readily available to the
legislature and employed before, would spur the creation of 19,900
to 27,800 new jobs, bring about $1.4 billion to $2.1 billion in
new capital spending, and increase annual wages of Massachusetts
workers by $667 million to $932 million per year.
By way of background, Gov. William F. Weld
recently announced a "fiscal dividend" for Massachusetts
taxpayers. Because FY 1996 collections will exceed projections by
$240 million to $300 million, taxpayers can look forward to a break
on their 1996 taxes. The first $94 million of this surplus will
go into the state's stabilization fund, leaving $146 million to
$206 million to be returned to taxpayers.
According to law, a one-time surplus of this
kind must be returned through a temporary increase in personal exemption.
In this instance, the personal exemption would increase from $4,400
to $5,720 for joint filers. The governor has urged the legislature
to return the money in this fashion "to its rightful owners"
and, in so doing, to resist the temptation to increase spending.
But there are two ways to cut taxes and refund
the surplus. One is by changing the tax base (taxable income). The
other is by changing the tax rate. Suppose that the tax base is
$100 billion and the tax rate is 5 percent, so that the government
collects $5 billion in taxes. Then the government can "refund"
by either (a) shrinking the tax base by $2 billion, or (b) cutting
the tax rate to 4.90 percent. While the two methods may look identical,
they are widely different with respect to their economic effects.
Temporarily raising the personal exemption
reduces the tax base, but leaves largely unchanged the cost of getting
workers to expand their hours. A permanent reduction in the tax
rate, on the other hand, reduces the cost of labor and thus significantly
expands employer demand for labor.
A one-time refund to Massachusetts taxpayers.
however well-intended, will therefore do little to encourage job
creation and stimulate state economic activity. In place of a one-time
personal exemption increase, the Beacon Hill Institute suggest returning
the money through a permanent reduction in the income tax rate.
Such a reduction would create and increase wages and capital spending
Current taxable personal income in Massachusetts
is $100.148 billion. Taxed at the current rate of 5.95 percent,
personal income tax revenue would be $5.959 billion in 1996. Lowering
the personal income tax rate between 5.74 and 5.80 percent would
enable the state to return $146 million to $206 million in surplus
revenues to taxpayers.
Returning this revenue by reducing the personal
income tax rate would generate the increased jobs, wages and capital
spending summarized below.
of new jobs
in annual wages
to $932 million
to $2.1 billion
to $206 million
to $54 million
to $152 million
It would even produce A fiscal dividend for
the state, insofar as the expansion in jobs and wages would increase
the tax base, bringing in new revenues to offset partially the initial
"refund." This "dynamic" tax-revenue gain, ranging
from $39 million to $54 million, would cause the net revenue loss
to be between $107 million and $152 million.
Some Massachusetts legislatures are arguing
that the state could not "afford" to give back any of
the surplus revenue, that it should instead "invest" the
money in new government projects. But these legislators have things
backwards. That the state has surplus revenue shows that the tax
rate has been too high, destroying jobs that would have been created
if the tax rate had been lower in the first place.
In practical terms, the state government
would never miss the $152 million that, at most, it would lose by
instituting a permanent rate reduction. Tax revenues have grown
at an average annual rate of almost 5 percent over the last four
years. A net revenue loss of $152 million would be less than 1 percent
of state spending.
George Will has said, "The only news
is economic news, and the economic news is bad." And so it
is with this supposed windfall to Massachusetts taxpayers. The budget
surplus and the tax cut it makes possible are signs that the tax
rate has been too high. Good economic news will come when the legislature
lowers the tax rate permanently and by enough to prevent future
David G. Tuerck is executive director
of the Beacon Hill Institute and chairman and professor of economics
at Suffolk University. Kathleen M. Lang is a BHI Research Associate.
This article first appeared in the July 27, 1996 issue of Mass
Format revised on 18