Why MA should not change to a graduated income tax rate
One of the wonderful things about Massachusetts is its long tradition of being full of deep thinkers. We thought up the Bill of Rights before the rest of the country got it. We thought up Obamacare, first, too. We also have a really decent income tax system that was created completely separately from the monster that is the U.S. tax code and is vastly superior in its effects and fairness. One of the wiley and wonderful things about the MA tax code is that it specifies in the constitution that every class of income must be taxed at the same rate. Period. Done.
The beauty of this is that it prevents the legislature from mucking around in the tax code pulling the wool over people's eyes the way the Federal legislature has. For example, right now we have a Federal 0% rate on long-term capital gains and qualified dividends for families that make modest amounts of income. But, guess what? If you live on a trust fund (the very thing that kicks off dividends and long-term capital gains) then you usually don't NEED an income... every trust fund baby I know qualifies for this 0% rate. What the unsophisticated person listening to soundbites doesn't understand is that the truly rich do not have a high income. They don't need to work! They just withdraw cash rather than earn it!
There certainly are people who are high earners from time to time, but they tend to be short-term in duration. The year you cash out your retirement account to buy into an assisted living center. (Graduated income tax rates are particularly hard on retirees cashing out their life's savings from retirement plans... fancy that this should be suggested just as Baby Boomers start to retire!) But there are lots of other reasons you might have a high earning year without necessarily being rich. The year you win the lottery (right before you squander it) or sell the family farm or finally get that high paying job after being in college for 10 years... and then you only keep it for five years before you quit to have a baby or change careers or get sick or whatever. High earners tend to be the strivers, they aren't the rich. "Rich" refers to net worth. High earners just happen to have a lot of cash pass through their lives that year... cash that got taxed again by whoever received it as the earner spent it.
Graduated income tax rates punish the strivers. I see this every day in my tax practice as my self-employed clients total up their marginal bracket and reflect on why they should bother to get up in the morning. Once you get to a specific point they have enough. Why work that extra little bit if they're going to get taxed at 30% Federal and 15% social security and 5% MA AND lose financial aid for their children AND get itemized deductions phased out? Somewhere around 50% marginal rate most sane people just start figuring it isn't worth it to work that hard. And so they don't. They don't hire that next guy, they don't create wealth in the community. (This, by the way, is my principle problem with the health care reform: the top of the subsidized level of health care has emerged as the TOP amount my tradespeople want to earn. After that there's no point taking any more work.)
Another thing that people don't realize is that MOST taxpayers are low to middle income. There just aren't enough high income earners to carry the nut that is the state budget. But the ones who ARE high earners are often very powerful. Allow the powerful to control the income tax rates and they will inevitably weight it slyly towards the middle earners in nearly impossible to detect ways. (For example, at the Federal level there is an extra effective 5% surcharge on middle earners when itemized deductions phase out.) When the rich share the same fate as the middle class you end up with the fairest tax rate.
I am totally in favor of avoiding the regressiveness of an income tax, but do it by raising the standard exemption. No one in MA should pay income taxes on the first $20K or so that they earn. (Dividends and capital gains are a separate story!) Furthermore, if you earn under $20K, skip filing the income tax return at all. There are massive compliance costs associated with income tax filings. Raise the standard exemption and reduce those compliance costs. Make a huge 0% bracket. But don't go mucking around with graduated rates. Not only will it get perverted sooner or later, but it will have unintended consequences straight out of an Ayn Rand novel.
Our framers understood RealPolitik when they made the income tax rate the same for everyone. Please don't let naive idealism screw it up. Just look at the horrific mess that is the Federal tax code at this point and you will understand why I caution you against this path.
The beauty of this is that it prevents the legislature from mucking around in the tax code pulling the wool over people's eyes the way the Federal legislature has. For example, right now we have a Federal 0% rate on long-term capital gains and qualified dividends for families that make modest amounts of income. But, guess what? If you live on a trust fund (the very thing that kicks off dividends and long-term capital gains) then you usually don't NEED an income... every trust fund baby I know qualifies for this 0% rate. What the unsophisticated person listening to soundbites doesn't understand is that the truly rich do not have a high income. They don't need to work! They just withdraw cash rather than earn it!
There certainly are people who are high earners from time to time, but they tend to be short-term in duration. The year you cash out your retirement account to buy into an assisted living center. (Graduated income tax rates are particularly hard on retirees cashing out their life's savings from retirement plans... fancy that this should be suggested just as Baby Boomers start to retire!) But there are lots of other reasons you might have a high earning year without necessarily being rich. The year you win the lottery (right before you squander it) or sell the family farm or finally get that high paying job after being in college for 10 years... and then you only keep it for five years before you quit to have a baby or change careers or get sick or whatever. High earners tend to be the strivers, they aren't the rich. "Rich" refers to net worth. High earners just happen to have a lot of cash pass through their lives that year... cash that got taxed again by whoever received it as the earner spent it.
Graduated income tax rates punish the strivers. I see this every day in my tax practice as my self-employed clients total up their marginal bracket and reflect on why they should bother to get up in the morning. Once you get to a specific point they have enough. Why work that extra little bit if they're going to get taxed at 30% Federal and 15% social security and 5% MA AND lose financial aid for their children AND get itemized deductions phased out? Somewhere around 50% marginal rate most sane people just start figuring it isn't worth it to work that hard. And so they don't. They don't hire that next guy, they don't create wealth in the community. (This, by the way, is my principle problem with the health care reform: the top of the subsidized level of health care has emerged as the TOP amount my tradespeople want to earn. After that there's no point taking any more work.)
Another thing that people don't realize is that MOST taxpayers are low to middle income. There just aren't enough high income earners to carry the nut that is the state budget. But the ones who ARE high earners are often very powerful. Allow the powerful to control the income tax rates and they will inevitably weight it slyly towards the middle earners in nearly impossible to detect ways. (For example, at the Federal level there is an extra effective 5% surcharge on middle earners when itemized deductions phase out.) When the rich share the same fate as the middle class you end up with the fairest tax rate.
I am totally in favor of avoiding the regressiveness of an income tax, but do it by raising the standard exemption. No one in MA should pay income taxes on the first $20K or so that they earn. (Dividends and capital gains are a separate story!) Furthermore, if you earn under $20K, skip filing the income tax return at all. There are massive compliance costs associated with income tax filings. Raise the standard exemption and reduce those compliance costs. Make a huge 0% bracket. But don't go mucking around with graduated rates. Not only will it get perverted sooner or later, but it will have unintended consequences straight out of an Ayn Rand novel.
Our framers understood RealPolitik when they made the income tax rate the same for everyone. Please don't let naive idealism screw it up. Just look at the horrific mess that is the Federal tax code at this point and you will understand why I caution you against this path.