Massachusetts running out of money

“State to offer early retirement deals; layoffs may follow” is a Boston Globe story about the state government here in Massachusetts facing a $1.5 billion budget gap. With a total population of 6.745 million and a working population of about 3.5 million, that means the average worker in Massachusetts needs to pay $429 more each year in taxes.

Let’s assume that government spending cannot actually be cut. My favorite pet idea for increasing government revenue is congestion pricing for the highways. If the average worker paid $2 per working day in congestion fees, the budget gap would be closed. Traffic jams would be eliminated and people could be more productive, thus generating more income, and paying more income taxes as well.

Another area worth examining might be the Massachusetts alimony system. This New York Times graphic (based on a study by Economics professor Elizabeth Currid-Halkett) shows that people in Boston spend 3.3X as much on alimony payments, relative to their income, compared to citizens of the average American city. When an adult is a dependent on another adult and receives cash payments via a formula based on the difference between their incomes, both have a reduced incentive to work (see this academic paper from the Federal Reserve Bank of Minneapolis, for example). The alimony payor may be in the 80 or 90 percent tax bracket for a marginal dollar of income (i.e., he or she will keep only 10 or 20 cents of an extra dollar earned), thus reducing the incentive to strive for higher pay and therefore higher tax payments to the state government. The alimony recipient will suffer a loss of alimony cash if he or she earns an extra dollar, thus also falling into an exceptionally high tax bracket and resulting in what the Fed economists call a reduction in labor supply (“given the high responsiveness of labor supply to marginal labor tax rates”).

For those who were never married, Massachusetts operates a similar adult-to-adult dependency system through its offer of unlimited child support profits. As in Wisconsin, the Massachusetts citizen who wants to have the spending power of someone in occupation X can either train to become qualified for that occupation and then work full-time or simply have sex with three people in occupation X. Economists would predict that if a person can get tax-free payments for having sex and spending 15 hours per week with children, something that he or she may already have wished to do, that person is less likely to pursue traditional W-2 employment with associated taxes.

As part of our research into family law nationwide we found a fairly typical upper income Massachusetts child support and alimony case where a University of Pennsylvania graduate out-earned her classmates by a factor of roughly 3.2X.  After a four-year marriage with a two-year-old child, she sued her husband and obtained a mostly tax-free annual income of $143,808, plus defendant-paid housing and child-rearing expenses. Judge Maureen Monks of Middlesex County wrote, after the trial “[the plaintiff] now has a responsibility to contribute to her child’s financial needs commensurate with her training and skills. There are no health issues that would prevent her from seeking or maintaining some employment at this time. She is capable of earning at least part-time employment, especially given the employment of the full-time nanny and [the child’s] attendance at pre-school and camps.” The successful plaintiff declined our request for an interview but we tracked down the defendant and learned that, despite the judge’s admonitions, the plaintiff has not chosen to return to work. That’s a lost taxpayer from the Commonwealth’s point of view. (See “Women in Science” for more detail on this case.)

[You might ask how common it is for a Massachusetts resident to be affected by the effective higher tax rates that result from being a child support lawsuit plaintiff or defendant. The U.S. Census March 2014 Current Population Survey shows that 9 percent of women in Massachusetts, age 30-40, said that they were receiving child support. If we correct for the known degree by which Americans under-report alimony revenue, that means roughly 18 percent of Massachusetts women in this prime working-age group receive child support. If we assume that the typical child support plaintiff is collecting from slightly more than one defendant, roughly 15 percent of men in the same age group are paying child support. That’s roughly 16.5 percent of prime working-age people in the state who are discouraged from working. (Slightly higher if you want to include the men receiving child support and the women paying, but Census data show that 97 percent of people collecting child support in Massachusetts are women.)]

Massachusetts is #4 among U.S. states in the percentage of residents on Welfare (article: “Only Tennessee, Maine, and California ranked higher”). If you add in child support and alimony we are probably #1 in officially established adult dependency. (Children are only half as profitable in California and Maine, compared to Massachusetts, and the profitability of children in Tennessee is limited by a $25,200/year cap on child support for a single child.) We could presumably get a lot more people to work and pay taxes if they faced the same economic incentives as people in other states.

Massachusetts could consider trying to boost its competitiveness as a corporate headquarters by eliminating tax on corporations. The tax rate is currently 8 percent of profits, but it can also be 0 percent if a company has the connections and accounting/legal sophistication to qualify for various exemptions. The result is that about 5 percent of state revenue comes from corporate taxes (Tax Foundation). This analysis from Suffolk University characterizes our business tax laws as “a hodgepodge of poorly-conceived measures that violate the most fundamental principles of tax equity. They discourages business from locating in the Commonwealth and serve alternately as a target for revenue-hungry state government and a mechanism for dispensing largess to special pleaders.” Why not just tear it all down and be satisfied with collecting income tax, sales tax, property tax, etc. from the employees of and investors in companies that choose to locate here? Massachusetts could then eliminate all of the special programs (and the bureaucrats to administer them; partial list) that provide tax breaks to companies that are politically connected.

What about an equivalent to taxing natural resource extraction, something that works great for other states because it is tough to move an oil well from Alaska to New Hampshire, for example. Does Massachusetts have anything that is valuable and almost impossible to move? Yes! Universities, elaborate hospitals that are technically non-profits, and private boarding schools such as Phillips Academy in Andover (where King Bush II attended high school). Perhaps there are better ways to tax the profit-making parts of these institutions while leaving them as non-profits (albeit non-profits that have somehow managed to accumulate billions of dollars of what a corporation would call “retained earnings”!). For example, if a student comes to Boston and rents an apartment, he or she pays property taxes indirectly (through the landlord). If the same student comes to Boston and rents an almost identical dormitory room, no property tax is paid. Depending on the state, living in a fraternity or sorority may be be tax-exempt (see this article on a controversy in Vermont). From what I can gather, Massachusetts already collects real estate taxes from college fraternities and sororities. As each college student here requires some expenditures on a variety of public services (police, fire, public transport, etc.), the state could consider a “capitation tax” for everyone above the age of 18 who lives for at least 6 months in Massachusetts. There may be as many as 400,000 students here. An annual tax of $3,750 on each student would close the budget gap (coincidentally this is almost exactly 6.25 percent of the cost of attending Harvard for one year and 6.25 percent is the Massachusetts sales tax rate for general goods).

What do readers think? How does Massachusetts get out of this fiscal hole?

15 thoughts on “Massachusetts running out of money

  1. What about taxing some of the religious institutions littering the state?

    I wouldn’t eliminate corporate taxes, but I would credit them for investors and employees in the state. That way you reduce the chances you wind up a tax haven for corporate shells. If you have all employees and shareholders in state, you have 0% in taxes and a reduction in friction for growth compared to your competitors.

  2. Colin: That does sound like a good idea. Instead of negotiating these sweetheart deals for big companies one-by-one, have a rule that anyone can understand and apply providing tax credits for in-state investors and employees. Even if the Massachusetts corporate tax were eliminated I don’t think that it would make it possible to shelter earnings from operations in other states with a Massachusetts shell company. A Delaware corporation, for example, has to pay corporate taxes in all of the states where it operates, I think.

    As for taxing religious institutions I am not sure that the rationale is as strong as for taxing college students. You don’t need more police and firefighters because a church has been built, do you? But you do need more police and firefighters if hundreds of thousands of additional people come to live in your state as students.

  3. The key to limiting the size of government (and you need to limit it, in order to preserve our freedom and our prosperity – left unchecked it will grow like a cancer until it consumes everything) is to starve the beast. The problem is that there is no end to “good causes”. You could spend 100% of GDP helping “the poor” and at the end of the day they would still be poor (see all the lottery winners who end up penniless again after they blow thru their winnings). MA has plenty of taxes and revenue raising schemes and doesn’t need any new ones (unless they are revenue neutral at most). Instead, we should force the government to do more with less. For example, even accounting for prevailing wage differences, the performance of schools in Shanghai is much better than those in Cambridge and yet they spend a fraction of the $ on them. Same with mass transit, etc. Whatever additional money you raise will just get poured down the rat hole.

  4. Izzie: Cutting government spending is, I am sure, a great idea. But if Massachusetts has never managed to do this in its nearly 400-year history, is it reasonable to put cutting spending forward as a solution to the budget gap? (When politicians talk about a “cut” they usually mean that they will reduce the rate of spending growth or that money they’d planned to spend won’t be spent, but the actual dollars spent still go up (and considering pension obligations, must go up).)

  5. There’s an old saying that things will go on until they can’t anymore. I had lunch from someone from Germany yesterday and he said that if you had asked him in 1988 when the Berlin Wall would come down, he would have said never, or in the far distant future. Probably the system in MA won’t be reformed one bit until it reaches a point of collapse like E. Germany, but wouldn’t it be nice if we could recognize the problem sooner and not wait until things reached that state?

    It’ the nature of ideological systems that when they are threatened they adhere even more to their ideology and refuse all compromise – you must never let the camel’s nose enter the tent.

    Instead what happens is that you endless patches to keep the whole shaky edifice from collapsing. When I was in law school I took a course by one of the fellows who had kept NY City going during its 1970s financial crisis. What they did was resort to all sorts of questionable rationalizations and interpretations of laws. For example, state law forbade long term borrowing to finance operating expenses – only capital investments could be financed. BUT, is not education an investment in human CAPITAL? (BTW, whenever a politician uses the word investment, he does not mean it in the same sense as an economist or businessman. In fact he usually means the opposite. If something was a real investment, it could be financed thru the private sector.)

  6. You may realize this, but your proposal to tax students contradicts your statements about corporate taxes. Taxing students would discourage enrollment at the state’s colleges and universities, damaging one of the state’s important industries. Parents and teenagers might be willing to pay any price for a degree form MIT or Harvard, but the state’s higher education is much larger than just those two institutions.

  7. Look at any new spending or cost cut bill that get passed, or any other bill that has NOTHING to do with money and you will find a hurdler of sub-bills attached to the main bill. Those sub-bills contain spending in one way or another as a “favor” from one legislator to another. If you want to balance the budget and stop government from overspending, pass a law that prohibit a bill from containing anything other than what the bill is about. How realistic is this? That’s a subject for another topic.

  8. George: says that the kind of “earmarks” that you are describing are less than 0.5 percent of the federal budget. I would imagine that the situation is the same in Massachusetts. So eliminating earmarks doesn’t get rid of a $1.5 billion deficit. Structurally the state needs to spend a lot more money every year because of a growing number of retired public employees (each of whom is living longer than originally forecast, partly because if you retire at age 41 you’re going to be relaxed!) and the higher-than-forecast cost of providing health care/health insurance to those retirees.

  9. Izzie,

    I disagree that “starve the beast” is the way to go. You end up with lower taxes and more spending giving the impression people are getting something for nothing. Limiting the growth of government and then growing the economy around it should work, but as philg point out has never actually happened.

    An “investment” in a public good may be a “real” investment (would provide society more benefits than the initial cost) but nonetheless cannot be undertaken by the private sector.

  10. philg,

    How much of the pension problem is the actuarial failure you point to and how much was the politicians not doing what the actuaries told them was necessary or instructing the actuaries to use unrealistic assumptions?

  11. Anonymous: How much is an actuarial failure? I’m not sure the question makes sense. If you are allowing people to retire as young as age 41, as was the case for many years in Massachusetts, you need a prophet, not an actuary. What will life expectancy look like 50 years from now? How much of a return on investment can we expect to obtain in the public markets of 50 years from now? Let’s look at the events of the past 50 years (since 1965): Collapse of Soviet Union, China developing a larger private sector as a percentage of GDP than the U.S., federal government writing a blank check to the health care industry (Medicare started 1966) and causing this sector of the economy to grow, Islam going from a religion prevalent in some mostly poor countries to a worldwide military power (measured by how much we spend to defend against it!), introduction of no-fault divorce, social acceptance of unwed pregnancy and child-rearing in rich countries, massive government investment in higher education, etc. All of these could affect life expectancy or expected return on investment and yet who could have predicted them?

    Pensions and Social Security were set up in an era when the expected time between retirement and death was 5-10 years. That’s a totally different challenge than budgeting for a world where it could be 60 or 70 years from retirement to death. (Remember that General Motors had retirees older than 110 when they got bailed out by the taxpayers and that, perhaps due to being able to retire at age 48, GM retirees had longer life expectancies than Americans in general.)

  12. The present value of payments owed in 50 years isn’t very significant. The present value costs are dominated by payments required over the next few decades and insurance companies still make plenty of money selling policies with 20 year terms. If the problem is that labor and management collude to underfund a pension system (assuming it will be bailed out down the road) it isn’t really fair (or useful) to blame the actuaries. Of course, if collusion is the problem it does appear that we don’t seem to know how to prevent that collusion. In any case, I think that getting the diagnosis right is important to getting the solution right.

  13. Anonymous: “The present value of payments owed in 50 years isn’t very significant.” That’s true if you are friends with God and she tells you that future investment environments will look like the post-World War II U.S. stock market. Note that the NASDAQ just today reaching the value (5000) that it had 15 years ago (i.e., the return over 15 years, after inflation, was negative (dividends on NASDAQ stocks tend to be lower than the CPI; currently the NASDAQ 100 is yielding 1.22%)).

    Offering to pay an annuity until someone dies makes good sense if you are a life insurance company and will save a lot of payouts if people live longer on average. It doesn’t make sense for anyone else, other than perhaps God, to make that kind of an offer, especially to people in their 40s.

  14. The problem with giving pensions to people in their 40s is that you are swapping 20-25 years of contributions for 20-25 years of payouts.

  15. >The problem with giving pensions to people in their 40s is that you are swapping 20-25 years of contributions for 20-25 years of payouts.

    Government pension plans are rarely fully funded – the contributions, whether for 20 years or 40, are rarely sufficient to fully pay the promised pensions. Future taxpayers will have to make up the difference.

    Private industry long ago switched to 401(k) type plans because they realized it was impossible to predict returns, inflation, etc. and promise that a certain fixed amount would be paid decades in the future. The government should roll their current pension contributions into current pay each week (no future contributions) and allow each worker to contribute to his own 401(k) out of his salary – that way the worker can decide whether he wants to spend or save instead of having that decision made for him. Ditto for health plans, etc. This will also have the virtue that the public will know how much each employee is making – that the $20/hour toll taker (already overpaid) is really making $35/hr.

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