BHI
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Massachusetts
Tax Cut Would Generate $21 Billion in New Capital, Create 105,000
New Jobs
According
to econometric analysis performed by the Beacon Hill Institute, a
ballot initiative for cutting the marginal tax rate on earned income
in Massachusetts to 5% would increase the state capital stock by $21
billion. It would create more than 105,000 new jobs, raising employment
by 3% above the level it would otherwise have achieved. Payroll would
rise by $4.93 billion. The tax rate cut would be phased in over a
threeyear period, falling from the current rate of 5.95% to 5.6%
in 1999, 5.3% in 2000 and 5.0% in 2001.
Economic
Effects of Tax Cut Initiative


Change
in Jobs

Change
in Capital Stock

“Static”
Tax Revenue Effect

“Dynamic”
Tax Revenue Effect

Net
Tax Revenue Effect

1999 
$1.543
billion 
36,689 
$6.5
billion 
$479
million 
$86
million 
$393
million 
2000 
$1.566
billion 
33,369 
$6.7
billion 
$482
million 
$78
million 
$404
million 
2001 
$1.821
billion 
35,223 
$7.8
billion 
$556
million 
$82
million 
$474
million 
Total 
$4.930
billion 
105,281 
$21.0
billion 
$1.517
billion 
$246
million 
$1.271
billion 
The
tax cut would produce a net revenue loss of about $1.271 billion.
This is the net result of two effects: (1) the “static”
revenue loss of $1.517 billion (the loss computed on the assumption
that the tax cut would have no effect on the Massachusetts economy)
and (2) the “dynamic” revenue gain of $246 million (the
revenue gained as a result of the increased production and personal
income that the tax cut would bring about).
Proponents
of the ballot initiative, which was certified by Massachusetts Attorney
General Scott Harshbarger on September 3, 1997, must gather the signatures
of 64,928 registered voters by December 3, 1997 in order for the proposal
to be sent to the Legislature.
______________________________________________________________________________
Methodology
Two
steps are needed in order to measure the effect of the proposed tax
cut on the variables of interest – the number of jobs (L), the
wage rate (w), the capital stock (K) and state tax revenue (TR). First
we must establish baseline values for the variables, projecting them
out through the year 2001 on the assumption that the tax rate does
not change. Then we use the Beacon Hill Institute's State Tax Analysis
Modeling Program (STAMP) to estimate and project employment, wages
and the capital stock in the presence of the tax cut. These projections
may then be compared with the baseline values in order to isolate
the effects of the tax cut.
A.
Baseline Projections of Wages, Jobs and Capital
The
baseline projections are shown in the table below, and were constructed
as follows. Information on employment is available for 1996,
and we suppose that the growth rate in jobs observed for the first
half of 1997 persists for the rest of the year. We assume that employment
continues to grow thereafter at 2.33% annually through 2001; this
is the growth rate which was observed from 19951997.
The
value of the total payroll is known for 1996, and we assume
that it will continue to grow (in nominal dollars) at the same speed
as it did during 19951997, which is by 7.97% per year. We also assume
that the capital stock grows at the same speed as total payroll,
which amounts to assuming that the capital/labor ratio does not change
over time. Information on the capital stock in Massachusetts is available
for 1994, and so we use the historical growth rates of total payroll
to arrive at a value for 1997, and project continued growth thereafter
(in nominal dollars) of 7.97% annually. The average wage is simply
the total value of payroll divided by the number of jobs.
B.
Applying the Tax Analysis Model
A
fuller description of the tax analysis model is given in An Application
of the BHI Tax Analysis Model to the Massachusetts Mutual Fund Industry
(Beacon Hill Institute, October 1996). The model is designed to allow
the analyst to trace the effects of changes in state tax rates on
employment, wages and the stock of capital. It begins with a series
of structural equations which aim to capture the behavior of firms
and households, and then rearranges these equations to arrive at
a set of reduced form equations which are both theoretically consistent
and may be estimated econometrically. The equations are estimated
using data from 19701993. In simplified form, the two which are relevant
here are the labor equation and the capital equation.
The
labor equation shows how changes in state tax rates (and other
variables) affect the number of jobs in Massachusetts. The estimated
equation is of the form
(1)
ln(L) = 0.032 t + other variables
where
ln(L) is the natural log of the number of jobs, and t is the state
tax rate on earned income. The coefficient
0.032
is statistically significant, and measures the effect of a change
in the tax rate (t) on ln(L); in other words ln(L)/t = 0.032.
The
capital equation is similar, except that the dependent variable
is capital rather than labor. Specifically the estimated equation
is of the form
(2)
ln(K) = 0.053 t + other variables
where
ln(K) is the change in the natural log of the value of the capital
stock from one year to the next. The coefficient 0.053 is statistically
significant.
C1.
Projecting the Effects of the Tax Cut: Employment
In
1999 the tax cut would reduce t from 5.95% to 5.60%, or by 0.35%,
so t = 0.35. Thus from equation (1) we have
(DELTA)ln(L)
= (0.032)(DELTA)t = (0.032)(0.35) = 0.0112.
The
baseline value of ln(L) [=14.9965 = ln(3,257,459)] now rises by 0.0112
to 15.0077; taking the antilog gives the number of jobs with the tax
cut, which is 3,294,148, or an increase of 36,689 over the baseline
case.
An
essentially similar procedure is applied for 2000. We take the new
employment number for 1999 and raise it by 2.33% to project employment
in 2000 for the situation in which there is no further tax cut. Then
we apply the further tax cut, which is from 5.60% to 5.30%, using
the coefficient from equation (1) to determine how many additional
jobs are created in this next round. The approach is repeated for
the third phase of the tax cut which is scheduled for 2001, from 5.3%
to 5.0%. The results are shown in the table below, and indicate that
by the year 2001 an estimated 105,281 jobs will have been created
which would not have existed in the absence of the cuts in the state
tax on earned income.
C2.
Projecting the Effects of the Tax Cut: Capital
The
effects of the tax cut on the stock of capital are estimated in the
same manner as for employment. Thus from equation (2) we have for
1999
(DELTA)ln(K)
= (0.053)(DELTA)t = (0.053)(0.35) = 0.0186.
The
baseline value of ln(K) [=26.5782 = ln($348.95 billion)] now rises
by 0.0186 to 26.5968; taking the antilog gives a new capital stock,
after the tax cut, of $355.49 billion, or an increase of $6.53 billion
over the baseline case. For the subsequent two years the capital stock
is first adjusted upwards to reflect the assumed annual nominal growth
rate of 7.97% and then adjusted for the tax cuts in the same manner
as was done for employment.
C3.
Projecting the Effects of the Tax Cut: Wages
The
estimated reduced form equations of the tax analysis model show that
the state tax rate on unearned income does not have a statistically
significant effect on the wage rate in Massachusetts. Wages are thus
assumed to follow the baseline projections both with, and without,
the tax cut. The total value of the payroll, in the presence of the
tax cuts, is calculated by multiplying these average wage rates by
the number of people employed.
C4.
Projecting the Effects of the Tax Cut: Tax Revenue
What
effect will the cut in the tax rate have on state tax revenue? First
there is a “static” revenue loss, which is measured as the
reduction in the tax rate (i.e. 0.35% in 1999, 0.3% in 2000 and 2001)
times the tax base, which we take to be the baseline payroll. For
instance, the static revenue loss in 1999 would be $479 million
(=
0.35% of the payroll of $136.98 billion). But this overstates the
true revenue loss, because there is also a “dynamic” revenue
effect: the tax cut leads to an increase in the number of jobs and
hence the total payroll, and therefore to some offsetting increase
in revenue. For instance in 1999 the dynamic revenue gain would be
$86 million (= 5.6% of the $1.543 billion increase in payroll induced
by the tax cut).

Appendix
Table: Effect of Massachusetts Tax Cut on Employment, Capital
Stock and Tax Revenue








1997

1998

1999

2000

2001


Baselines






A

Employment

3,111,007

3,183,391

3,257,459

3,333,251

3,410,807

B

Payroll
($ billion)

117.50

126.87

136.98

147.91

159.70

C

Average
wage ($ p.a.) (=B/A)

37,770

39,854

42,053

44,373

46,821

D

Capital
Stock ($ billion)

299.32

323.19

348.95

376.77

406.81


Effects
with Tax Cut






E

Proposed
earned income tax rate

5.95%

5.95%

5.60%

5.30%

5.00%

F

New
Employment

3,111,007

3,111,007

3,294,148

3,403,309

3,516,087

G

Cumulative
job increase due to tax cut (=FA)



36,689

70,058

105,281

H

Annual
job increase due to tax cut



36,689

33,369

35,223

I

New
Capital Stock ($ billion)

299.32

299.32

355.49

389.98

427.82

J

Cumulative
extra capital due to tax cut ($ billion) (=ID)



6.53

13.21

21.01

K

Annual
capital increment due to tax cut ($ billion)



6.53

6.67

7.80

L

New
Payroll ($ billion) (=C*F)

117.50

126.87

138.53

151.01

164.63

M

Cumulative
extra payroll due to tax cut ($ billion) (=LB)



1.543

3.109

4.929

N

Annual
payroll increment due to tax cut ($ billion)



1.543

1.566

1.821

O

"Static"
tax revenue effect: cumulative ($ billion)



0.479

0.961

1.517

P

"Static"
tax revenue effect: annual ($ billion)



0.479

0.482

0.556

Q

"Dynamic"
tax revenue effect: cumulative ($ billion)



086

0.165

0.246

R

"Dynamic"
tax revenue effect: annual ($ billion)



0.086

0.078

0.082

S

Net
tax revenue effect: cumulative ($ billion) (=O+Q)



0.393

0.797

1.271

T

Net
tax revenue effect: annual ($ billion) (=P+R)



0.393

0.404

0.474

D.
The Total Effect
According
to BHI estimations, by the time the tax cut is fully implemented in
the year 2001, the number of new jobs created will be 105,281, raising
employment by 3% above the level it would otherwise have achieved.
The capital stock will be $21 billion (almost 5%) higher than it would
otherwise have been. Annual state tax revenue will be $1.27 billion
lower than it would otherwise have been; this total consists of a
static revenue loss of $1.52 billion, offset by higher revenue of
$0.25 billion generated by taxes on the additional payroll resulting
from the tax cut.