BHI Faxsheet 5-20-98: BHI Tax Cut Plan Offers Strongest Immediate Benefit to the Massachusetts Economy

BHI Tax Cut Plan Offers Strongest Immediate Benefit to the Massachusetts Economy

The Beacon Hill Institute proposes a cut in the Massachusetts tax rate on earned and unearned income to 5% over a three-year period beginning in 1998 and ending in 2000. This plan would provide the strongest immediate benefit to the Massachusetts economy of any of the announced tax cut proposals.

The BHI plan would lower tax rates on both earned income (presently 5.95%) and unearned income ^[1] (presently 12%) to 5.6% in 1998, to 5.3% in 1999 and to 5% in 2000. When fully implemented, the cut in the tax on earned income would, by itself, have created 98,210 new jobs and $17.0 billion in new business capital (factory space and equipment, business computers, delivery trucks and so forth). See Table 1. The change in the tax on unearned income would provide additional benefits to the economy. ^[2]

Calendar Year	Cumulative Change in Payroll	Cumulative Change in Jobs	Cumulative Change in Capital Stock	Cumulative “Static” Tax Revenue Effect	Cumulative “Dynamic” Tax Revenue Effect	Cumulative Net Tax Revenue Effect
1998	$1.3 billion	34,812	$5.4 billion	-$691 million	$70 million	-$621 million
1999	$2.5 billion	66,245	$10.8 billion	-$1.13 billion	$131 million	-$1.00 billion
2000	$4.0 billion	98,210	$17.0 billion	-$1.63 billion	$195 million	-$1.44 billion
2001	$4.3 billion	101,205	$18.2 billion	-$1.75 billion	$208 million	-$1.54 billion
2002	$4.6 billion	103,239	$19.4 billion	-$1.87 billion	$222 million	-$1.64 billion
2003	$4.9 billion	105,315	$20.7 billion	-$1.99 billion	$238 million	-$1.76 billion

* Analysis was conducted using BHI's econometric State Tax Analysis Modeling Program.

Other tax cut proposals now under consideration by the Massachusetts Legislature offer either smaller cuts in tax rates or fewer immediate benefits to the economy. For example, a proposal by acting Governor A. Paul Cellucci would reduce the tax on earned income to 5.0% over a period of four, rather than three, years. ^[3]

The immediate benefits of the Cellucci plan would be correspondingly weaker. The cut in the tax on earned income included in his plan would create fewer new jobs – 67,577 – and less in additional new capital – $11.5 billion – by 2000. See Table 2. The benefits offered by his plan would not match those offered by BHI until 2001. At that time, both plans would have created 101,205 jobs and $18.2 billion in new capital.

Calendar Year	Cumulative Change in Payroll	Cumulative Change in Jobs	Cumulative Change in Capital Stock	Cumulative “Static” Tax Revenue Effect	Cumulative “Dynamic” Tax Revenue Effect	Cumulative Net Tax Revenue Effect
1998	$909 million	24,828	$3.8 billion	-$297 million	$51 million	-$247 million
1999	$1.8 billion	45,726	$7.4 billion	-$636 million	$94 million	-$542 million
2000	$2.7 billion	67,577	$11.5 billion	-$1.02 billion	$140 million	-$880 million
2001	$4.3 billion	101,205	$18.2 billion	-$1.60 billion	$208 million	-$1.39 billion
2002	$4.6 billion	103,239	$19.4 billion	-$1.79 billion	$222 million	-$1.57 billion
2003	$4.9 billion	105,315	$20.7 billion	-$1.99 billion	$238 million	-$1.76 billion

Both proposals would cause revenue losses. See Tables 1 and 2. The relatively small revenue losses associated with the Cellucci proposal reflect the correspondingly smaller immediate benefits to the economy. For the years 1998 through 2002, the revenue loss from the BHI plan would be greater than the revenue loss from the Cellucci plan. However, by the year 2003, the revenue loss from both plans would be $1.76 billion per year. ^[4]

The BHI plan would not require cuts in state spending, but only a reduction in the growth of state spending. Table 3 offers projections showing that the BHI plan would, assuming modest growth of revenues and of state expenditures, cause the state initially to run small deficits that would be offet by surpluses in later years. The new debt incurred as a result of the initial deficits would be paid off entirely by 2003. ^[5] Assuming that inflation remains at 2.5%, the level it is expected to be in 1999, ^[6] these projections assume a slight shrinkage in government spending, in real inflation-adjusted dollars, over the period FY99 to FY03.

If tax revenues grow at a rate exceeding that assumed in Table 3, the increase in expenditure could be correspondingly greater. If, for example, tax revenues grow by 6% annually after FY99 – the rate at which they grew from FY94 to FY98 – the BHI plan would allow the state to break even by FY03 even if spending increased at an annual rate of 3.8%.

Paying for the BHI plan means keeping state government at about its present size in real dollars. However, if the Governor signs a budget with spending greater than $19.061 billion in FY99, the growth in tax revenue will have to be much higher to pay for any tax cuts. An expansion of state government, as seems to be taking shape in the House and Senate's budget proposals, will require a much higher growth in revenue to finance itself, making meaningful tax reduction of the kind proposed here unaffordable. The question is whether the additional benefits made possible by this expansion of state government are large enough to justify the sacrifice in new jobs and capital spending that less meaningful tax reduction would entail.

Table 3–Budget Projections for Massachusetts Under BHI Tax Cut by Fiscal Year

Fiscal Year	Spending ($ millions)	Tax Revenue Before Tax Cut ($ millions)	Other Revenue ($ millions)	Total Revenue Before Tax Cut ($ millions)	Net Effect of Tax Cut on Tax Revenue ($ millions)	Total Revenue After Tax Cut ($ millions)	Surplus ($ millions)	Additional Debt ($ millions)
	A	B	C	D = B+C	E*	F = D+E	G = F+A	H**
FY1998	18,848	13,380	5,595	18,975	-311	18,664	-185	185
FY1999	19,061	14,081	5,762	19,843	-812	19,032	-29	229
FY2000	19,499	14,651	5,935	20,258	-1,221	19,366	-133	380
FY2001	19,948	15,245	6,113	21,358	-1,489	19,869	-78	489
FY2002	20,406	15,862	6,297	22,159	-1,591	20,568	161	367
FY2003	20,876	16,504	6,486	22,990	-1,700	21,290	414	-18

* Estimated effect of the tax cut on tax revenue for the indicated fiscal year. For example, the -$812 million effect estimated for FY1999 is an average of the -$621 million effect for calendar year 1998 and -$1.00 billion for calendar year 1999, as estimated in Table 1.

* *Calculated by subtracting the surplus from existing level of debt due to the tax cut and multiplying by 1 plus the interest rate (assumed to be 8%).

^[1] This does not include the tax rate on long-term capital gains which presently has rates from 5% to 0% on a declining scale. Neither the BHI tax plan nor the Cellucci plan changes this rate.

^[2] We do not attempt to estimate these benefits here. However, a study by DRI/McGraw Hill estimates that a cut in the tax on dividends and interest income from 12% to 5.95% phased in over five years (starting in 1998) would create about 15,100 jobs by 2003. For details, see “The Economic Benefits of a Reduction in Massachusetts' 12% Tax on Investment Income,” DRI/McGraw Hill, September 1997.

^[3] The Cellucci plan lowers the tax rate on earned income to 5.7% in 1998, to 5.5% in 1999, to 5.3% in 2000 and to 5.0% in 2001. Under the same proposal, the tax on unearned income remains at 12% in 1998 and is lowered to 10.6% in 1999, to 9.2% in 2000, to 7.8% in 2001, to 6.4% in 2002 and to 5% in 2003.

^[4] This overestimates the revenue losses that would stem from either plan because it does not account for the beneficial economic effects of cutting the tax on unearned income.

^[5] The table assumes that tax revenues grow at the low end of the range projected by the Massachusetts Department of Revenue for FY98 and FY99 and at the modest rate of 4.05% after that. It assumes that nontax revenues grow at 3%. It further assumes that state spending in FY99 is $19.061 billion, as proposed by the Governor in his FY99 budget, and that spending increases by 2.3% each year thereafter through 2003.

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