This November, Massachusetts residents are voting on an amendment for an additional 4% income tax on annual taxable income exceeding $1 million. Davis Malm's Philip S. Olsen looks at the intricacies of the bill, as well as the public debate surrounding its fairness.
On Nov. 8, Massachusetts voters will have the final say on a proposed constitutional amendment that would establish an additional 4% state income tax on that portion of annual taxable income exceeding $1 million. The rate is currently set at 5%. The Massachusetts Constitution provides that the state income tax rate must be the same for all taxpayers, so an amendment is needed to provide for a graduated rate. If enacted, the ballot measure-referred to as the Fair Share Amendment by some and the Millionaires Tax by others-would be effective Jan. 1, 2023.
Both sides of the public debate have tried to frame the issue in terms of fairness. Proponents claim that millionaires would finally be paying their fair share, while those against the amendment claim that it is unfair to target a small percentage of the population with an increased tax rate.
Efforts to target wealthy residents with a progressive tax have failed in the past due to procedural infirmities or lack of widespread support. This time, the ballot initiative has been framed as an opportunity to target income inequity whereby the wealthiest would finally pay their fair share.
The proposed amendment mandates that the revenue from this tax be used for public education and infrastructure repair and maintenance. It further states that spending would be subject to appropriation by the state legislature. Critics argue that this condition gives the legislature free reign to manipulate spending of the new revenue. The possibility that legislators may use the language as an opportunity to direct state funds to other programs seems remote, at least early on. Many legislators would face repercussions if they blatantly ignored the will of a majority of the state's voters.
While those in favor point to estimates that the surtax could generate $2 billion or more in annual state tax revenue, certain factors could impact this anticipated tax windfall.
Proponents of the amendment argue that the additional burden will only be felt by the state's wealthiest residents. The very richest in Massachusetts-those who make over $1 million a year-will simply pay their fair share. Public education and infrastructure improvements are legitimate considerations for raising revenue, but there are economic concerns associated with the new tax that should not be ignored or discounted.
According to a study by the Tufts University Center for State Policy Analysis, the tax would only apply to around 0.6% of Massachusetts households in any given year. Nevertheless, it could raise a meaningful amount of money because those households account for more than one-fifth of all taxable income in the state.
Advocates say the state's wealthiest residents are deserving targets because they simply do not pay enough income tax to the state. This can be somewhat misleading, given that all residents pay the same percentage of their income to the commonwealth. And it is safe to assume that wealthy individuals would take issue with allegations that they are not paying their fair share. Some may even consider this the last straw in deciding whether to will remain in Massachusetts.
States such as Florida and New Hampshire have long been attractive destinations for Massachusetts residents tired of paying state income tax. Readily available checklists provided taxpayers with the steps to be taken to formally change their residency to another state. For many years, the Department of Revenue periodically examined the returns of individuals who had changed their filing status to nonresident from resident or had filed a final resident return. Disputes and litigation over the issue often followed. If many high-income residents considered moving when the tax rate was 5%, then a 9% tax rate could motivate even more individuals to look for the exit. The expanded remote work options arising from the Covid-19 pandemic would make the transition easier for many, especially those who already maintain a second home in another state.
Business relocation is another consideration. The additional tax will apply to residents who generate their income through pass-through entities such as sole proprietorships, partnerships, limited liability corporations, and S corporations that are taxed at the individual rather than corporate level. Some executives who move their businesses out of state can maintain their workforce remotely or take advantage of more favorable wage scales in states that have lower taxes and a lower cost of living than Massachusetts.
While few people will sympathize with individuals whose annual income exceeds $1 million, a 2014 Department of Revenue study estimated that about one-third of the $2 billion would come from additional taxes on wages and salaries. The remaining two-thirds will come from income from real estate rental, interest and dividends, and capital gains. Small-business owners on the verge of retirement will be particularly impacted. The amendment would result in additional tax being imposed on one-time gains, such as those from selling a business. Individuals whose retirement depends on cashing out of their company will see a reduction in funds available for what they hope will be a 20- or 30-year retirement.
Proponents of the amendment believe the law needs to be changed because the wealthy don't pay their fair share in taxes. Targeting a narrow demographic-the rich-allows for expanded tax revenue with less of the stigma of a general tax increase. Critics argue that it is not fair to only raise taxes on a small group of people. The Massachusetts Taxpayers Foundation predicts that the tax increase on select taxpayers will cause outmigration to continue and possibly accelerate, harming the long-term economic outlook for Massachusetts. Characterizing the dispute as a fairness debate distracts many voters from examining or even considering the potential positive or negative economic consequences of the amendment.
Originally published in Bloomberg Tax Oct. 19, 2022
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