Executive Summary

Updated November 2009

Much of the debate over taxation tends to focus on particular taxes and tax rates. This misses both the purpose of taxation — to combine resources to achieve certain public purposes — and the fact that taxes exist as a part of a tax system consisting of many different elements.

This report will look at the entire state and local tax system in Massachusetts, which collected $30.6 billion in fiscal year 2006.¹ It will also look at the history and structure of individual state and local taxes, including the property tax, sales tax, personal income tax, and corporate income tax. These taxes will be examined using criteria broadly used by public finance experts.

Fairness, adequacy, simplicity, efficiency, and stability are among the most important principles that have been identified for judging the relative merits of taxes.

• Fairness — a tax system should not arbitrarily target any groups of residents. There are two aspects of fairness that are the most relevant here: horizontal equity says that taxpayers in similar financial situations should be taxed equally; vertical equity deals with the treatment of taxpayers in different financial situations and the ideas of progressive, regressive, and proportional taxation.

• Simplicity — a tax system should be easy to understand and comply with. It should be transparent in its purpose and operations.

• Efficiency — a tax system should raise the required resources for government with as little distortion to the economy as possible. Usually a horizontally equitable and simple tax system will fulfill this criterion.

• Adequacy — a tax system should provide sufficient revenue to pay for the things that people want to achieve through government. This sufficiency should be sustained over time.

• Stability — a tax system should maintain itself through short-term economic fluctuations such as recessions, usually by having a mix of taxes that respond differently to economic changes. This may also involve the creation of budget reserves.

The Massachusetts tax system depends on several taxes for the generation of revenue. Looking at fiscal year 2006 state and local tax collections, the property tax is the predominant local tax and accounted for 35 percent of total state and local taxes. The largest state tax is the personal income tax, which made up 34 percent of total state and local taxes. Another 13 percent was from the general sales tax. Excise taxes on items such as motor fuels, tobacco and alcohol made up seven percent. Six percent was from corporate income taxes. The remaining five percent of total state and local taxes was from various minor taxes.

Over the last 29 years the share of income that was collected as taxes in Massachusetts declined by 24 percent. This is the sharpest drop in state and local taxes as a proportion of personal income among all fifty states (see figure 8). There has also been a shift in the mix of state and local tax shares over the same period. In fiscal year 1977, the property tax made up fully 49 percent of state and local taxes, while the personal income tax made up only about 21 percent.

• Property Tax — a very stable tax, but one which is questionable on the criteria of fairness. Since this tax is levied in local jurisdictions, there can be significant variations in rate of taxation on similar properties. The property tax can be somewhat regressive because property value can take up a larger percentage of total net worth for low income property owners.

• Sales Tax — the general sales tax, currently five percent of most items purchased in Massachusetts — exceptions include food, drugs, clothing items under $175, and most services — is a very stable tax. It is also very regressive, since higher income taxpayers tend to consume less and save more of their income. The sales tax has also been declining in adequacy over the long term as the service portion of the economy grows more quickly than the portion that is covered by the sales tax, and as Internet and other remote sales — usually not covered by the sales tax — have also become more and more significant.

• Personal Income Tax — this tax is very good in providing adequate resources for government, but it tends to have significant stability problems — tending to grow rapidly in good economic times and then decline sharply in recessions. The personal income tax in Massachusetts has a flat 5.3 percent rate, but is still progressive in its application, due to provisions that reduce or eliminate income taxes on lower income people, and exclusions and deductions that have a greater relative impact on low and middle-income taxpayers. This tax has been the target of cuts over the last decade and more, including large cuts in the rate of taxation of dividends and interest.

• Corporate Income Tax — usually seen as a very progressive tax, but one with even more significant stability problems than the personal income tax. This tax is vulnerable to tax avoidance by corporations that can take advantage of weaknesses in tax laws to reduce or even eliminate their payments, although the state recently passed a law to reduce such techniques. In recent years there have been a series of specific tax cuts for particular types of corporations. These trends can undermine the horizontal equity of this tax and the adequacy over time.

 ¹ Fiscal year 2006 is the latest year for which U.S. Census data is available for state and local government finances. This data is used for most of this report, except when more timely data is available from other sources.