History of Changes in the Structure and Level of Taxation in Massachusetts

When the composition of total tax revenue in Massachusetts in fiscal year 2006 is compared to that for fiscal year 1977, it can be seen how much the state tax composition changed over twenty-eight years.⁶ (See Figures 1 and 4.)

First and foremost, in the late 1970s — before the property tax-cutting initiative known as Proposition 2 ½ was adopted — Massachusetts depended on property taxes to a far greater degree than it does at present. In fiscal year 1977, property taxes comprised 49.0 percent of total tax revenue, whereas, in fiscal year 2005, it composed 36.0 percent. In addition, in fiscal year 1977, the personal income tax was not nearly as important to the state’s fiscal condition as it is today. It amounted to 20.6 percent of total tax revenue in fiscal year 1977 and 33.7 percent in fiscal year 2005.

While the preceding comparisons reveal both important differences between Massachusetts and the rest of the country and critical changes within the Commonwealth over time with regard to the composition of revenue, it is also useful to examine state and local taxes relative to the size of the Massachusetts economy and how that relationship compares to other states.

Figure 5 displays data on state and local taxes, measured as a share of personal income, for both Massachusetts and the United States as whole for the period fiscal year 1977 to fiscal year 2006. In fiscal year 2006, state and local taxes equaled 10.6 percent of personal income in Massachusetts that year, but were 11.2 percent of personal income nationally.

Such differences may appear quite small, but, had Massachusetts been at the national mark in fiscal year 2006, the Commonwealth, in combination with its cities and towns, would have collected an additional $1.9 billion in revenues.⁷

Figure 5 demonstrates that taxes are lower in Massachusetts, relative to the size of the Commonwealth’s economy, than the national average. It shows as well that within Massachusetts taxes are lower now than they were near the end of the 1970s and for most of the 1980s and 1990s. This reduction in taxes is even more clear when we consider that the personal income measure that is used in Figure 5 — which is the standard measure provided by the Bureau of Economic Analysis (BEA) — does not include income generated from capital gains.⁸ Most capital gains are, however, subject to taxation, so leaving capital gains income out of the denominator tends to exaggerate the amount of taxes as a percent of personal income.

Reliable and comparable state-by-state measures of capital gains are not available, but — using data from the Massachusetts Department of Revenue — we have been able to estimate the effect of including capital gains income in the measure of personal income for Massachusetts in the period from fiscal year 1988 to fiscal year 2006.⁹

Figure 6 shows that the increasing magnitude of capital gains income from the 1990s to 2006 have meant that taxes have actually declined even more as a percentage of personal income (not excluding capital gains income), than just as a percentage of personal income as measured by BEA.¹⁰

Massachusetts-only Personal Income Data

Figure 7, using state tax data from the Massachusetts Department of Revenue, also shows a decline in the percentage of personal income, including capital gains , during the period from 1995 to 2007. In 1995, state taxes were equal to 6.5 percent of personal income including capital gain, and by 2007 it had declined to 5.4 percent. If tax collections in 2007 equaled 1995, in terms of percentage of personal income collected, state revenues would have increased by $3.4 billion. The decline in the percentage of personal income devoted to taxes can be explained by three primary factors:

1. Tax changes, most notably a reduction in the personal income tax rate, have reduced tax revenues;
2. Sales tax revenue has been weak in its growth partly due to the increase in purchases made online;¹¹ and
3. Traditional tax expenditures associated with untaxed capital gains, such as capital gains on home sales and the transfer of capital gains at death, have grown substantially in the past decade. Strong growth in elements of personal income that are not taxed has served to reduce the percentage of personal income paid in taxes.

Figure 8 shows that over the last 29 years Massachusetts has reduced tax revenue relative to economic resources more than any state except Alaska (Alaska is different from other states because much of its tax revenue comes from taxes related to the oil industry). Between fiscal year 1977 and fiscal year 2006 nationally state and local taxes as a share of personal income fell 1.5 percent (from 11.4 percent of personal income in fiscal year 1977 to 11.2 percent in fiscal year 2005). Taxes increased in 30 of the states, but there were large decreases in California and New York which between them represent a large share of the national economy. In Massachusetts, state and local taxes dropped from 13.8 percent of personal income to 10.6 percent, a decline of 23.6 percent, the largest decline seen in any state.

As can be seen in Figure 9, over the medium-term state and local taxes in Massachusetts increased slightly during the fiscal year 2000 to fiscal year 2006 period. Over the course of that six year span, state and local taxes increased from 10.5 percent of personal income to 10.6 percent, an increase of 0.4 percent. State and local taxes nationally over this span rose by 4.6 percent of personal income.

⁶Fiscal Year 1977 is the first year for which detailed state and local finance data is available from the United States Bureau of the Census.

⁷At the 2007 level of personal income this amount would be $2.1 billion, assuming the difference between federal and Massachusetts tax as a percent of personal income has remained the same.

⁸For the purposes of the primer, personal income that excludes capital gains will be referred to as BEA income, while personal income that includes capital gains estimates will be referred to as DOR income.

⁹Capital gains estimates combine non-taxable capital gains data from annual Tax Expenditure Budgets published by the Massachusetts Department of Revenue, and add an estimate for taxable capital gains income, also from the Massachusetts Department of Revenue. For a discussion of adjusting personal income to better reflect growth in the economy, see New England Public Policy Center of the Federal Reserve Bank of Boston, “Assessing Alternative Measures of State Income,” (memorandum), July 30, 2008, available at http://www.bos.frb.org/economic/neppc/memos/2008/weinerpopov073008.pdf. For the analysis in this primer, we follow the methodology recommended by the Federal Reserve Bank.

¹⁰Capital gains income was calculated by using data from the Massachusetts Department of Revenue for collections of taxes on capital gains income, to this were added estimates for non-taxed capital gains from the Massachusetts Tax Expenditure Budget, various years. Not all capital gains income is separable from other kinds of income in the Tax Expenditure Budgets, so it is likely that the estimates of capital gains income used here is somewhat low. Estimates for untaxed capital gains are approximations based on the Department of Revenue Tax Expenditure Report.

¹¹ Massachusetts Department of Revenue, Briefing Book: FY09 Consensus Revenue Estimate Hearing. Available online at: http://www.mass.gov/Ador/docs/dor/Stats/Briefing%20Book/09briefingbook.pdf