Taxes in Massachusetts

Personal Income Tax

The personal income tax tends to be a very good tax from the standpoint of adequacy. A personal income tax generally grows with personal income, allowing revenue to keep pace with increases in costs. It is also excellent from the standpoint of horizontal equity - people with the same taxable income will pay the same taxes. This may be modified by definitions of taxable income, but the tendency of the personal income tax is toward a high level of horizontal equity. The personal income tax is usually somewhat to very progressive, depending on the exact design. All personal income taxes in the United States have exemptions and deductions that exclude some income; many – including the federal individual income tax – have higher rates for higher incomes.

Personal income taxes have stability problems. While they tend to grow faster than the economy in periods of economic expansion, they also tend to decline very rapidly in times of recession. This instability is due largely to the taxation of capital gains, bonuses, and other kinds of investment related income, which can soar or plunge depending on the state of the stock market and the general economy. The bulk of personal income tax collections are from salaries and wages, and are much more stable – though still influenced by economic events.

Massachusetts has a flat rate income tax system, meaning there is only one rate for all levels of income. This is in contrast to the federal individual income tax and many other states' income taxes, which have higher rates at higher levels of income – usually called progressive income taxes. However, there are features of the Massachusetts income tax that also make it progressive. There is a personal exemption that means that a fixed amount of all incomes are not subject to the tax – in 2008 it is $4,400 for single taxpayers and $8,800 for married couples filing jointly. This exemption affects lower income earners more than higher income earners since the exemptions will be a larger portion of lower income earners' incomes. When a taxpayer’s income is under a particular threshold for a year, they qualify for No Tax Status and pay no income tax for that year. The thresholds in 2007 were $8,000 for single taxpayers and $15,850 plus $1,000 per dependent for married couples filing jointly. Taxpayers who do not qualify for No Tax Status are eligible for a low income tax credit up to thresholds of $14,000 for single taxpayers and $27,738 plus $1,750 per dependent for married couples filing jointly. There is also an earned income tax credit that further reduces the share of taxes paid by lower income persons. In the past, Massachusetts also had a higher rate for dividends and interest, which also added to progressivity of the personal income tax.

The Institute on Taxation and Economic Policy data shows the current progressivity of the personal income tax in Massachusetts (see Figure 14). On average, taxpayers with the lowest 20 percent of incomes pay only 0.2 percent of their incomes in personal income taxes. The middle 20 percent pays 3.5 percent of their incomes in personal income taxes, and the top 20 percent pays about 4.3 percent of their incomes in income taxes.

A Brief History of the Personal Income Tax in Massachusetts

Massachusetts adopted a personal income tax in 1916. The constitution of Massachusetts requires that this be a flat tax, meaning that all levels of income pay the same rate. However, there is a personal exemption and various deductions that keep the Massachusetts personal income tax progressive in effect (see discussion above). The rate has varied over time. In the period from 1977 to 2007 it was as high as 6.25 percent and as low as 5 percent. As of 2008 it is 5.3 percent.

Before 1999, Massachusetts had a higher tax rate on income from dividends and interest, roughly double the rate on wage and salary income. Most dividend and interest goes to persons at the high end of the income scale (see Figure 15).¹⁶ Starting in 1999 this income was taxed at the same rate as other income. Figure 16 shows how combined federal and Massachusetts tax rates for dividends have declined over the last 15 years. The highest tax brackets are represented, since most dividend income goes to persons with marginal incomes in this bracket. The effect of the deductibility of state income taxes on federal returns is also shown. The decline in the Massachusetts rate from 12 percent to 5.95 percent in 1999 and the cut in the federal rate from 38.6 percent to 15 percent in 2003 are the two biggest changes in this chart. The reduction in the state rate cost the Commonwealth $534 million in fiscal year 2006.

Recent Personal Income Tax Changes in Massachusetts¹⁷

Changes in Massachusetts' personal income tax structure between 1991 and 2007 reduced collections by about $3 billion annually.

• The effect of reductions in the income tax rate, on both wages and salaries (“part B income”) and capital gains, worth about $1.34 billion a year.
• The personal exemption was doubled in 1998, reduced by 25 percent in 2002, and then increased each year from 2005-2008. The net effect of this was to reduce collections by $440 million a year.
• The reduction of the rate on interest and dividend income from 12 percent to 5.3 percent, worth about $720 million a year.
• There were also many smaller changes to deductions, credits and other features of the personal income tax, for a net reduction of over $700 million a year altogether.

The appendix at the end of this primer provides the official cost estimates by the state Department of Revenue of these changes and all other tax changes made between 1991 and 2006.

Effect of Personal Income Tax Changes in Massachusetts¹⁸

• A one percentage point change in the personal income tax rate (which was 5.3 percent in fiscal year 2007) would increase or decrease collections by about $1.97 billion.
• Each one percentage point change in the tax rate on dividends and interest would be worth about $105 million. Restoring it to 12 percent would be worth $720 million; less revenue would be generated if the state exempted low income taxpayers with interest or dividend income.
• Massachusetts also has a personal exemption, for which a certain amount of income is not subject to the 5.3 percent personal income tax rate. In 2008 this personal exemption is $4,400 for single taxpayers and $8,800 for married couples filing jointly. The personal exemption cost the state $830 million in 2008.¹⁹ A 25 percent change in the single filer, head of household and the married filer personal exemptions would increase or decrease revenue about $231 million.

How Massachusetts Measures Up in Personal Income Taxes

Massachusetts collected $10.5 billion in personal income taxes in fiscal year 2006. This was 24.7 percent of state and local own-source revenue and 34.2 percent of state and local taxes. This was entirely collected at the state level.

Personal income taxes were 15.5 percent of national state and local own-source revenue, and 22.5 percent of national state and local taxes. State governments collected 91.5 percent of this tax revenue.

Massachusetts has a flat personal income tax rate of 5.3 percent. Most other states have graduated rate structures with top rates as high as the 9.9 percent rate in Rhode Island – California has a 9.3 percent top rate, plus an additional 1 percent tax on incomes over $1 million, for an effective 10.3 percent rate. Top rates for other states that adjoin Massachusetts are: 9.5 percent in Vermont, 6.85 percent in New York, and 5 percent in Connecticut. New Hampshire has an income tax limited to dividends and interest income. Each state also has different thresholds for the top rate, amounts for personal exemptions, and deductions.

For fiscal year 2006, personal income taxes in the Commonwealth yielded an amount of revenue equal to 3.6 percent of personal income. Only five states – New York, Oregon, Maryland, Ohio, and California – generated more revenue from the personal income tax than Massachusetts when measured as a share of personal inco