Report calls big chunk of tax cap funds ‘illusory’

Estimates refund amount inflated by at least $1.4b

THE STATE is preparing to pay out $1.4 billion in “illusory” funds under the tax cap law, giving wealthy taxpayers a huge windfall, according to a report from the left-leaning Massachusetts Budget and Policy Center.

Officials at the center say they are not accusing state officials of doing anything wrong or making a math error. Instead, they are saying a set of unusual circumstances are combining to inflate the amount of taxes collected in excess of the tax cap, and doing so in a way that shortchanges the state and allows wealthy taxpayers to gain an even bigger benefit than they normally would.

“The affluent win in every way,” said Phineas Baxandall, senior policy analyst and advocacy director at the Budget and Policy Center.

The broad outlines of the situation have been raised before, but the Budget and Policy Center report is the first time the dollar impact has been spelled out. The report calls on state leaders to address the situation, but they have shown little interest so far in intervening to change the tax cap law.

The Baker administration released a statement confirming the numbers cited by the Budget and Policy Center, but adding that  it had followed the tax cap statute in determining how much money to return to taxpayers. The statement also noted that state Auditor Suzanne Bump  independently evaluated and confirmed the administration’s numbers.

The tax cap, a law promoted by Citizens for Limited Taxation and the Massachusetts High Technology Council and passed by voters in 1986, requires the state to return taxes collected over and above a threshold tied to the growth in wages and salaries. The tax cap was triggered once in 1987 and not again until this year.

State Auditor Bump recently certified that the tax cap was triggered in fiscal 2022, prompting the return of $2.9 billion. Gov. Charlie Baker wants to return the money to taxpayers by check and direct deposit in late November.

Bump acknowledged in her certification that the excess tax collections were inflated by an excise tax designed to help wealthy taxpayers get around a federal limit on state and local tax deductions. She also noted that most of those excise tax payments will be offset by tax credits and deductions claimed in future years.

“I would underscore for the Legislature and the public one key element in the FY22 revenue increase,” said Bump in her certification letter. “The change in the taxation of so-called pass-through business entities which just took effect last year generated $2.25 billion in revenue, much of which has yet to be claimed in the form of personal income tax credits and deductions by the business owners.”

Bump chose not to adjust the size of the tax cap giveback even though a big chunk of the excess tax collections will be returned to taxpayers in the next few years.

The Budget and Policy Center analysis puts the amount of money that will be returned to taxpayers as credits at $1.4 billion, nearly half of the amount Baker plans to return to taxpayers in November.

“The governor’s plan to refund this illusory $1.4 billion of ‘excess’ FY 2022 revenue through the [tax cap] process does not change the fact that future fiscal year personal income tax collections will be reduced by some $1.4 billion, as filers claim and apply their outstanding FY 2022 pass-through-entity tax credits. This means there will be $1.4 billion less that is available to address critical needs,” the center’s report says.

The unusual situation arises because a 2017 federal law capped at $10,000 the amount of state and local taxes that individuals could deduct from their federal taxable income. Businesses, however, were allowed to continue deducting all of their state and local taxes from their profits.

Many states, including Massachusetts, responded to the federal cap by approving workarounds to sidestep the cap. In Massachusetts, the workaround allowed individuals who receive pass-through business income to pay their income taxes through their business and thus avoid the cap. The businesses were also required to pay a new excise tax to the state, which would reduce the amount of their income subject to federal taxation. The owners of the businesses would then receive tax credits equal to 90 percent of the amount of their excise tax payments.

Most of these credits will be going to some of the state’s wealthier taxpayers, who also stand to benefit the most from the tax cap giveback.

According to the Budget and Policy Center’s analysis, the tax cap will return to individual taxpayers 13 percent of the money they paid in personal income taxes in 2021. The approach, specified in the law approved by voters, returns the most money to those who paid the most in taxes.

Households with incomes below $25,000 will receive an average of $75 each and half of those households will receive nothing at all. Half of all the refund money will go to the top 10 percent of households by income.