Millionaire Tax Wrong Way to Play Robin Hood
For all these reasons voters will likely find it attractive but there are good reasons not to do it. The new federal tax law has dramatically changed the rules in a way that undercuts an important part of the original rationale for the new 4 percent surtax on high earners. In addition, the rigid structure of this permanent new tax is unprecedented. It will impede Massachusetts from taking essential steps to modify its own tax policies in a way that protects its citizens from disproportionate federal taxation as other states are now contemplating.
The vote on the millionaire tax will occur in November if the proposal survives an ongoing review by the Supreme Judicial Court. This is not a typical referendum to modify a statute but is a proposed amendment to the Massachusetts Constitution. It is intended to circumvent a 100-year-old provision of the constitution called Article 44 that requires income tax in the state to be imposed at a “uniform rate.” Massachusetts cannot have progressive income taxation unless that language is changed, something that voters have been asked to do five times over the past 50 years. They have declined each time but, given the present-day politics, they might well acquiesce this year. The current proposal doesn’t permit progressive taxation but imposes a flat 4 percent surcharge on income over a million dollars. This constitutionally mandated, inflexible flat tax presents serious problems in the context of the new federal law.
One of the main arguments supporters of the amendment made is that the impact of their new tax on the small group of Massachusetts citizens who will pay it would be mitigated by the “federal offset.” Until now, US taxpayers were permitted to deduct their state and local tax (SALT) payments and thereby reduce their federal income tax liability. Someone paying the Massachusetts millionaire tax could have deducted that expense against their top bracket federal tax of 39.6 percent. Thus, according to the amendment’s sponsors, the federal government would have subsidized almost 40 percent of the new tax revenue generated by the millionaire tax and dramatically lowered the impact on people subject to the surtax.
The real cost of the millionaire tax just went up by that same 40 percent because the new federal tax law limits SALT deductions to a maximum of $10,000. Targeted taxpayers will have long used up that deduction before they start paying the surcharge. The dramatic increase in the effective cost of the tax merits reconsideration of its wisdom and a better understanding of its consequences on taxpayers.
The sponsors of the new tax may disdain the idea of being sympathetic to the impact on high earners who will benefit from lower federal rates. But there is another good reason to rethink the surcharge. Doing so could help many more people. While fewer than 20,000 Massachusetts filers are expected to pay the millionaire tax, a much higher number are now penalized by the low limit on SALT deductions. A study by the Government Finance Officers Association found that 37 percent of Massachusetts filers used the SALT deduction on their federal returns with an average amount of $15,571. The new $10,000 limit will therefore cost those filers more than a third of their deductions and the aggregate cost is enormous. According to the Massachusetts Taxpayers Foundation, the state’s filers will lose approximately $7.5 billion in deductions under the new law.
Only four states, New York, Connecticut, California, and New Jersey, have a higher average SALT deduction than Massachusetts. In those jurisdictions and several others with high SALT usage, conversations have begun about how to modify state tax laws to protect local taxpayers – including non-millionaires – from changes in the federal law. The initial ideas focus mostly on how to raise money in alternative ways that would still allow state taxpayers effectively to deduct that expense on their federal returns. For example, the Department of Taxation and Finance in New York has raised an option that would replace part of the state’s income tax with a payroll tax. Because employers can still deduct payroll taxes from their corporate returns, reducing an employee’s compensation by the amount due to the state would preserve the tax advantage without net cost to the employee.
Other novel ideas are floating around in high-SALT states. One involves creating an offset opportunity for people who make contributions to newly created nonprofit organizations that support local school systems. This would create deductible charitable contributions in lieu of local real estate taxes that support schools. Without something like this in expensive states such as Massachusetts, real estate taxes will contribute significantly to increased federal taxation because of the new SALT limits. There are other creative options to mitigate the impact on state taxpayers but they are not yet well developed and evaluated.
The real question is whether enshrining an immutable 4 percent surtax on high earners in the Massachusetts constitution makes sense at a time when the state may have to undertake a comprehensive review of its tax structure. All other taxes collected in the Commonwealth are authorized by statute and are subject to modification at any time by legislative action. If the amendment is adopted, Massachusetts will become the only state in the country with such a tax permanently embedded in its Constitution.
Even if it soon makes policy sense to modify the millionaire surcharge, the state’s ability to adapt its tax structure to the new federal law will be dramatically limited because of the difficulty of amending the Constitution. Change would require votes in two successive legislative sessions followed by another statewide vote in a general election. Even if support for the change were unanimous, the constitutional modification would take five years to enact.
Envision a situation that could occur in Massachusetts over the next year. The millionaire tax becomes part of the constitution requiring targeted taxpayers to pay 4 percent on top of the statutory 5.1 percent income tax. As is happening in other states, the Legislature decides to adopt alternative tax methods to help taxpayers, including non-millionaires, adapt to the loss of the SALT deduction. They can modify the terms of the base income tax, sales taxes, or real estate taxes, but they have no capacity to modify the constitutional surcharge in any way. Because only Massachusetts has such a constitutionally required tax, this is a mess that no other state will face. We shouldn’t face it either.