faculty.nesl.edu · 2012-08-07 · 2 house - no. 6386 [october 1986] senc'of john w, ol~er...

(established by item 0185-7822 in section 2of Chapter 234 of the Acts of 1984 and revived andcontinued and membership increased by Chapter 1

of the Resolves of 1985).

6386~

. No.•• •

of the

Relative to

• •

SPECIAL COMMISSION

October 9,1986

•

SECOND INTERIM REPORT

DEVELOPMENT OF A TAX REFORM

THE PERSONAL INCOME TAX AND THE

PROGRAM FOR THE COMMONWEALTH.

HOUSE

I

I

2 HOUSE - No. 6386 [October1986]

Senc'of

JOHN W, OL~ER

Chairman

rei. 722·1532

[~1' CllOUUJUltlWl'tdtlJ Df !tta1i.liar~1Uitttn

SPECIAL COMMISSION ON TAX REFORM

Room 741,100 Boylston Street

Boston, MA 02116

June 24, 1986

leprl!sentoti.".CHARLES FLAHERTY

Cltairmon

rol, 722·2600

Sap. John, Amharl

'/k~

Sen. Paul

~o the Hor.o~p.~le Senate A~j ~ou~e o~ Represent~tives:

/ )I\~

Sen. Richl

We respectfully submit this document entitled Who PaysMassachusetts' Taxes? The Personal Income Tax, as an interimreport of the Special Commission on Tax Reform to be filed withthe Clerk of the House of Representatives of the General Courtof the Commonwealth of Massachusetts. ~

-)

.' f ,'-,-Sen. Paul

Flahel€y, ~Chairman

Rep-: 'Charles F.Cambridge

-f- t·~ \.Sen. John W.

Amherst

')/ ... ',f} ,

~p. ;rOSe). ,

[October1986] HOUSE - No. 6386

Membership of Commission:

3

'-.

Rep. Thomas M. Gallagher -

leprellntotive

CHARLES FLAHERTYCltoirmon

Tol. 722·2600

./ /1 I:' 'it (( . ("( ,t~{~ '( _.Se~. John W. Olver, Chairman

, Amherst

~wcSen. Paul V. Doane - Harwich

Sen. Richard A. Kraus - Arlington

7' Chairman

Rep. Frank N. Costa - Adams

mithrt

CI=:~f€y I ~man

S

Sen. Paul

.·7 ., I

\. / Jl\.L i...L L\..

J. fheehY - Lowell

.' ,.

//'

/I ,---... O·?:~.i~ j/;I !1A!(:.~, 1~<

Rep. Robert A. Durand - Marlborough

- uxbridge

4 HOUSE - No. 6386 [October 1986]I

i• James Segelassachusetts Municipal

Association

Sec. Frank Keefe, Executive Officeof Administration and Finance

./

Mrs. Susan Shaer, MassachusettsLeague of Women Voters

o.~ ~.

John Colman Walsh, Esquire

[October

/

!cutive Off iceld Finance

t:on

ipal

{' ('t>." .'

Id.tute of

1986] HOUSE - No. 6386

Who Pays Massachusetts' Taxes?

The Personal Income Tax

A Report Submitted

to the

Special commission on Tax Reform

Commonwealth ·of Massachusetts

by

Andrew Reschovsky

Department of EconomicsTufts University

March 26, 1986

(with an Introduction and Overview byRobert Tannenwald, Executive Director)

5

6 HOUSE - No. 6386 [October 1986]

TABLE OF CONTENTS

Notes

VII. Low Income Protection

Appendix

Bibliography

Table

Table

Table

Table

Figure

Figure

Figure

Table

Table,

Table

Table I

Table

Table' J

·Table

Table J

Table J

Table J

Table 1

Table 1

Table 1

Table 1

Table 1

Table 2

Table 2

t

II

J

83

88

33

72

78

17

20

31

90

97

99

66

68

3334364043454647

49

525456575860626364

IntroductionI.

V.

II. Who Pays the Income Tax? An Overview

III. Why Do Tax Burdens Differ?

IV. The Analysis of Income Exclusions

Imputed rent on owner-occupied homesCapital Gains ExclusionsCash Benefits from Government Aid ProgramsGovernment Retirement PaymentsTax Deferral of Retirement ContributionsFringe Benefits, primarily for Health CareInterest on Government ObligationsSummary: The Impact of Exclusions

The Analysis of Deductions and Exemptions

The Rent DeductionChild Care Expense DeductionDependent DeductionSocial Security Tax DeductionMedical and Dental Expense ExemptionPersonal ExemptionsDependent ExemptionsElderly ExemptionSummary: The Impact of Tax Preferences

VI. Taxation of 10 Percent Income

VIII. The Taxation of the Elderly

IX. The Taxation of the Family

X. The Impact of tne 1985 Income Tax Changes

XI. Conclusions

[October

17

20

31

33

3334364043454647

49

525456575860626364

66

68

72

78

83

88

90

97

99

1986]

Table 1

Table 2

Figure 1

Figure 2

Figure 3

Table 3

Table 4

Table 5

Table 6

Table 7

Table 8

Table 9

Table'10

.Table 11

Table 12

Table 13

Table 14

Table 15

Table 16

Table 17

Table 18

Table 19

Table 20

Table 21

HOUSE - No. 6386

LIST OF FIGURES AND TABLES

Number of Filing units by Filing status

Average Tax Liabilities

Tax Burdens by Money Income Class

Distribution of Tax Burdens

Tax Burdens With and Without Federal Offset

Average Effective Tax Rates for Filing Unitswith positive Tax Liabilities

Analysis of capital Gains Exclusion

Analysis of Cash Benefits Excluded From AGI

Analysis of Retirement Payments Excludedfrom AGI

Analysis of Tax-Free Interest Income

Exclusions From Adjusted Gross Income

Total Gross and Effective Tax Preferences

Analysis of the Rent Deduction

Analysis of the Child Care Deduction

Analysis of the Dependent Deduction

Analysis of the FICA Tax Deduction

Analysis of the Medical Exemption

The Calculation of Personal Exemptions

Analysis of the Personal Exemption

Analysis of the Dependent Exemption

Analysis of the Elderly Exemption

Analysis of Total Tax Deductions andExemptions

Ten Percent Income by Source of Income

Ten Percent Income as a Percentage ofAdjusted Gross Income and Total Money Income

7

8

Table 22

Figure 4

Table 23

Table 24

Figure 5

Table 25

HOUSE - No. 6386

List of Figures and Tables (Continued)

Number of Filing units by Age

Tax Burdens for Non-Elderly and ElderlyTaxpayers

Adjusted Gross Income by Age

Ten Percent Income by Age

Tax Burdens by Type of Filing Unit

Total Deductions and Exemptions byFamily Type

[October 1986]

Table 26

Table 27

Table 28

Impact of 1985 Income Tax changes: DollarChange in Tax Liabilities Due to Adoptionof "Current Law"

Impact of 1985 Income Tax Changes: Changes inAverage Tax

Impact of 1985 Income Tax Changes: changes inEffective Tax Rates

Appendix Table 1

Appendix Figure A

Number and Percentage of Itemizers, FederalMarginal Tax Rates and Federal Offsets

Distribution of Tax Burdens Within EachIncome Class

[October

lr~ion

res in

res in

Federallets

Each

1986] HOUSE - No. 6386

This introduction is part of an interim report of theMassachusetts Special commission on Tax Reform to befiled with the Clerk of the House of Representativesof the General Court of the Commonwealth ofMassachusetts.

9

10 HOUSE - No. 6386

INTRODUCTION AND OVERVIEW

by

Robert Tannenwald, Executive Director

[October 1986]

o,.;

This report provides a wealth of information useful inevaluating the fairness of the Massachusetts personal incometax. Employing sophisticated techniques to analyze the mostcomplete and current data available, the report explores 1) whopays the tax and who does not; 2) how its burden is distributedby income, age, and family status; and 3) how its rate structureand the exclusions, deductions, and exemptions that shrink itsbase shift tax burdens.

Dr. Reschovsky's study is one of two on the Massachusettspersonal income tax sponsored by the Massachusetts SpecialCommission on Tax Reform. The other is Dr. Richard Tresch's ~Massachusetts Personal Income Tax. Dr. Tresch's study is abackground study covering all issues germane to the tax, whileDr. Reschovsky's study focuses exclusively on the distributionof the tax. Both studies are best read together.

The report shows that:

o The income tax is steeply progressive1 at income levelsbelow $15,000, which contain 40 percent of the Commonwealth's households. 2 The 60 percent with incomes above$15,000 face much milder progressivity. (FIGURE a-1 anda-2]

o The fe~eral tax offset renders the income tax proportional rather than progressive at incomes above$15,000. Every income group in the $15,000+ range facesan average state income tax burden of about 3 percent.[FIGURE b]

o Most households with annual incomes below $10,000 paylittle or no state income tax. However, many low-income,single, working individuals fall through holes in theCommonwealth's "tax safety net," facing state income taxburdens averaging above 2%.

o Many exclusions, exemptions, and deductions have beenbuilt into the income tax to relieve taxpayers subject toparticular hardships, encourage various forms of economicactivity, or protect from taxation income needed to

o...

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nomest1) whoibutedructurek 'its

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1986]

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HOUSE - No. 6386

,Fig~ a-1

'Tax Burdens by Money Income ClassMossodlusetts Pers~1nol ~come Tox. 1986

Tax Burden, equal '1"''' UobnUes os apercentoge 01 loti:li money income

"iONEY INCOME Qn do!lors)

Fig. 8-2

......

11

faces,nt.

layncome,heIe tax

,enect to:onomic

,DISTRIBUTION OF FILING UNITSB'l' \AONEY INCOME (1886)

16 ......-------------...;..------------.

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[October

,1986] HOUSE - No. 6386 13

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acquire the basic necessities of life. Many of theseprovisions focus their benefits on low and lower-middleincome households. Some, such as the capital qainsexclusion and the exemption of interest on qovernment bonds,tend to benefit hiqh income households. All reduce thedeqree to which the income tax treats households with equalincomes equally, a widely-accepted criterion of fairtaxation.

o The lot tax rate on unearned income enhances the proqressivity of the income tax, especially .at the hiqhest incomelevels.

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o On averaqe, the elderly face state income tax burdens thatare one-third the burden faced by the non~elderly. Onlyat annual income levels above $50,000 do the elderly beara hiqher burden. [FIGURE c)

o Married couples tend to be taxed liqhtly relative tosinqles at every level of income. Within each age group,couples with dependent children tend to be taxed morelightly than couples without them.

o The income tax legislation passed in 1985 enhances theprogressivity of the income tax. The impact of the surtaxrepeal is reqressive but is more than offset by theintroduction of a declining personal exemption andincreases in the no tax status thresholds.

WHy IS THE COMMONWEALTH'S INCOME TAX PBOGRESSIVE EVEN THOUGH ITSRATES ARE NOT GRADUATEP?

Primarily because many of its largest eXClusions, exemptions, and deductions concentrate their tax relief on low-incomehouseholds. Those provisions that contribute most to theproqressivity of the income tax are:

1) The recently enacted declining personal exemption.Beginning in 1987, the value of the personal exemptiongranted to each taxpayer will tall as income rises (upto $39,600 for single filers, $79,200 for joint filers)(This report assumes that it will be fully in effect in1986.) The personal exemption is the single mostimportant source of proqressivity in the state incometax.

2)

WHY DC~HE S'l

TltibilJimpor1reaSOI

4)

3)

1986]

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[October

c.... O't O"t~ UD N3a~n8 X'v'l

HOUSE - No. 6386

~i,

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[October 1986] HOUSE - No. 6386 15

WHY DO THE ELpERLY FACE A LOWER STATE INCOME TAX BURDEN THAN THENON-ELDERLY?

WHY POES THE FEDERAL TAX OFFSET ELIMINATE THE PROGRESSIVITY OFTHE STATE INCOME TAX ABOVE $15,OOO?

The rent deduction. 4

3)

4)

2) The exclusion of cash benefits from government aidprograms such as Aid For Families With DependentChildren (AFDC), veterans' pensions income, disabilitypensions, and unemployment compensation.

The exclusion of government retirement income, such aspayments from U.S. government pensions, Massachusettsstate and local government pensions, and pensions fromgovernments in other states, as long as they do not taxgovernment pension income from Massachusetts.

1) Because their average income is about two-thirds thatof the non-elderly, their personal exemption is largerand each dollar of exempted income frees a largerportion of their income from taxation.

2) They enjoy an additional $700 per person exemption.

3) They rely much more heavily on sources of income thatare not fully subject to taxation, especially socialsecurity benefits, interest on tax-free governmentsecurities , and long-term capital gains.

2) The higher one's income, the higher his federal marginal tax rate. The higher the tax rate on a dollar,the greater the tax savings enjoyed when that dollar isdeducted.

1) In order to take advantage of deductibility, a taxpayermust itemize deductions on his federal return. Thehigher his income, the greater the probability that heitemizes.

ARE LOW INCOME HOUSEHOLPS APEQUATELY PROTECTED FROM INCOMETAXATION?

Most are. A little over one million, or approximatelyone-third of all actual and potential taxpayers in the Commonwealth, will pay no state income taxes this year, thanks toexclusions, exemptions, deductions, and the no tax statusprovisions. However, many non-elderly, working, low-incomehouseholds very near the poverty line will bear income taxburdens in excess of 2 percent. These taxpayers receivevirtually no public assistance of any kind.

The reduction in state tax burdens due to the federal deductibility of state taxes is known as the federal tax offset. Theimportance of this offset increases as income rises for tworeasons:

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The elderly (especially those in the highest income classes)do rely relatively heavily on 10% income. Because of thispattern, the elderly with total money incomes in excess of


$50,000 on average pay a higher effective tax rate thannon-elderly with comparable incomes. In low and middle incomeclasses, however, the elderly's lower income and greatereligibility for exclusions outweigh their greater reliance on10' income, ensuring that their tax burdens are on average belowthose of the non-elderly.

FOOTNOTES TO INTRODUCTION

·1. Introdu

In 198

to their s

tax provid

revenue.

residents

lightly?

to provide

tax and it

Fairne

observer 8

1)

2)

3)

4)

A tax is progressive if, the higher a household'.income, the larger his tax liability as a proportion ofincome.

In this introduction, the term "household" issynonymous with the term "filing unit" as used in thebody of the report. Filing units comprise both actualand potential taxpayers. ThUS, an elderly relativeliving in a household with his/her own retirementincome is a separate filing unit, even though he/she isnot a separate household.

A tax is proportional if all income qroups have thesame ratio of the tax liability to income.

Some arque that the benefits of the rent deduction arereally shared by landlords and renters. If this infact is true, the distributional impact of thededuction would be quite different.

analysts t

contribute

First, the

principle!

And secone

aspects 01

faced by e

Much c

policymak_

related tc

horizQnta]

pay face _

defined a!

measures e

that taxpa

burdens.

equals she

arise ovel

example, t

[October

ncome

e one below

1986] HOUSE - No. 6386.

Who Pays Massachusetts' Taxes?

The Personal Income Tax

17

.I. Introduction

In 1986 Massachusetts residents will pay over $8 billion in taxes

to their state and local governments. The state's personal income

tax provides nearly 25 cents of every dollar of state and local

revenue. Who pays the income tax? Will some Massachusetts

of

is

~e

residents face heavy income tax burdens while others get off

lightly? The purpose of this report is to answer these questions and

to provide information to help the reader decide whether the income

tax and its various provisions are fair.

Fairness and equity are subjective concepts; what is fair to one

observer appears grossly unfair to another. It is not the job of tax

analysts to decide whether a tax is fair. Analysts, however, can

contribute to a discussion of tax fairness and equity in two ways.

First, they can provide an analytical structure and a set of

principles to facilitate any discussion of tax equity and fairness.

And second, they can provide information and data about various

aspects of a tax system, inclUding an evaluation of tax burdens

faced by different individuals.

Much of the discussion of tax fairness by economists and by

policymakers is based on the premise that a fair tax is one that is

related to taxpayers' "ability to pay". A tax is considered

horizontally equitable if any two taxpayers with equal abilities to

pay face equal tax liabilities. Alternatively, if tax burdens are

defined as tax liabilities as a proportion of income, or other

measures of ability to pay, fairness is achieved to the extent

that taxpayers with similar abilities to pay face equal tax

burdens. Although there is wide support for the principle that

equals should be treated equally by a tax system, disagreements

arise over the problem of defining "abilities to pay". For

example, to what extent, if any, does the age of a taxpayer, or


the number of dependents, reduce a taxpayer's ability to pay?

This report will provide data that will help the reader assess

the degree to which the Massachusetts personal income tax treats

equals equally.

For many people, the question of fairness centers on

the issue of tax progressivity. A tax is progressive if higher

income taxpayers face higher tax burdens than lower income

taxpayers. Some people believe that the only fair income tax is

one that is progressive, while other people believe that fairness

requires that the income tax be proportional. A tax is propor

tional if all taxpayers face identical tax burdens, regardless of

income.

Supporters of progressive income taxes generally argue that

people with high incomes are more able to help finance pUblic

services. They argue that it is an appropriate function of

government to distribute resources from the relatively affluent to

those who are less fortunate. Opponents of progressivity argue

that all taxpayers should share equally the burden of financing

government, and that progr~sive taxes tend to discourage working

and saving.

No matter what the reader's view of progressivity, it is

important not to evaluate the personal income tax in isolation.

The citizens of Massachusetts pay a number of different taxes in

support of government at both the state and local levels within

the Commonwealth. From the perspective of both the policymaker

and the taxpayer, the focus of attention should be on the distri

bution of the total state and local tax burden. ThUS, people who

believe that Massachusetts should have a proportional system of

taxation may support a progressive personal income tax in order to

counteract the effect of regressive property and sales taxes.

It is also important to place the evaluation of the Massachu

setts income tax in the context of tax changes at the federal

level. For example, Joseph Pechman (1985) has shown that between

1980 and 1985 the federal income tax burdens faced by the poorest

~.......•;...:.•'.......•~!~40 percent

percentage

somewhat 1

the riches

percentage

reform pre

average Ma

Reschovsk~

(especiall

will resul

percent ar

income ta>

This 1

is the til

commissior

major pers

are complE

who pa~

In ore

both tax:

Massachusl

author hal

chusetts 1

Income Ta:

class of 1

designed

surveys.

each taxp

istics of

liabiliti

surveyed

interpret

inflated

evaluatic

[October

,l

1986] HOUSE - No. 6386 19

pay?

ssess

treats

higher

e

tax is

fairness

ropor-

dless of

e that

blic

of

fluent to

argue

ancing

working

is

!1tion.

!1xes in

dthin

~aker

distri-

ople who

tem of

order to

xes.

assachu-

eral

between

poorest

40 percent of taxpayers in the u.s. increased by more than one

percentage point; the burdens of the next 40 percent increased by

somewhat less than one percentage point; while the tax burdens of

the richest 20 percent of taxpayers decreased by nearly one

percentage point. In addition, although President Reagan's tax

reform proposals will reduce the federal income tax burden of the

average Massachusetts resident by 8.2 percent, Chernick and

Reschovsky (1985) have predicted that the Presiden~'s proposals

(especially the elimination of state and local tax deductibility)

will result in pressure to cut state taxes by approximately 6

percent and to substantially reduce the progressivity of the state

income tax.

This report deals exclusively with the personal income tax. It

is the first of a series of reports being prepared for the Special

Commission on Tax Reform on the distributional pattern of the

major personal taxes used in Massachusetts. When these studies

are complete, it will be possible to answer in detail the question

who pays Massachusetts' taxes?

In order to analyze the state income tax, one must calculate

both tax liabilities and tax burdens for a broad sample of all

Massachusetts residents. In order to accomplish this task the

author has developed a large-scale computer model of the Massa

chusetts personal income tax system, called the Massachusetts

Income Tax Simulation Model (MITS). The MITS model is one of a

class of models known as microsimulation models. These models are

designed to analyze data from large and complex household

surveys. The MITS model combines detailed data on the sources of

each taxpayer~'s income with information on the legal character

istics of the income tax in order to estimate state income tax

liabilities for a random sample of Massachusetts residents

surveyed by the u.s. Census Bureau. 1 In order to facilitate

interpretation of the results, the census income data have been

inflated to 1986 values. The structure of the model permits the

evaluation of a large range of potential changes in the income tax

II. Who Pays the Income Tax? An Overview

system. Because of the complexity of the system, it is not

possible to predict the outcome of any change in it by analytic

means alone. simulation models of complex tax systems provide a

means of achieving this goal. Both the HITS model and the data

are described in detail in the appendix to this report.

The personal income tax is the single most important source of

state tax revenue. In fiscal year 1986 it will generate

approximately $3.5 billion of revenue. In December 1985 the

Massachusetts legislature enacted several major changes to the

income tax law. These included the elimination of a 7.5 percent

surtax, the implementation of a declining personal exemption, and

substantial increases in levels of income below which no tax must

be paid. Although some of the provisions of the new legislation,

Chapter 593 of the Acts and Resolves of 1985, will not go into

effect until 1987, the analysis of the "current" Massachusetts

income tax reported here will assume that the new law is fully in

effect in calendar year 1986.

The income tax can be described as a modified flat tax because

taxpayers

with a me

ability t

individu2

income 11

to pay a1

example,

pensions

elderly i

The 9

can alSO be

allo~ed for

i 1 aecu:soC a

expenditure

Massachuset

(see Tresch

In orde

setts taJCP8

as taJCPayeI

is a taJCPa)

files a ta'

distributi(

count peop:

file retur1

payers. A

married co

MassachUse

relationsh

dependent.

tax returr

not depenc

of their J

not requil

taxation

1986][OctoberHOUSE - No. 638620

93 percent of income subject to taxation is taxed at a single

rate. Earned income plus interest income from Massachusetts banks

is taxed at a rate of 5 percent. Unearned income, comprising

other interest income, dividends, and 50 percent of long-term

capital gains, is taxed at 10 percent. Income taxed at the lower

rate will be referred to as 5 percent income, and income taxed at

the higher rate, as 10 percent income.

The two rates are applied to income only after a number of

deductions and exemptions are taken. Exemptions include a

personal exemption for both the head and the spouse, a dependent

exemption and an elderly exemption. The head and spouse

exemptions decrease in size as income rises. The medical

deduction taken by itemizers on their federal income tax returns

[October1986] HOUSE - No. 6386 21

lot

lalytic

~ovide a

Ie data

source of

the

o the

percent

ion, and

tax must

islation,

into

setts

fully in

x because

ngle

:tts banks

sing

'term

:he lower

taxed at

ler of

a

ipendent

returns

can also be used as an exemption in Massachusetts. Deductions are

allowed for a number of expenditures, including a portion of

social security taxes (FICA), rental payments, and child care

expenditures. A much more detailed description of the

Massachusetts income tax is included in another Commission report

(see Tresch, 1986).

In order to assess the income tax burdens faced by Massachu

setts taxpayers, one must first consider carefully who are defined

as taxpayers, and how tax burdens are measured. The issue of who

is a taxpayer is more complex than just counting everyone who

files a tax return. In order to get a complete picture of the

distribution of income tax burdens in Massachusetts, one must

count people who either do not owe any tax or are not required to

file returns. All filing units are considered potential tax

payers. A filing unit is defined as all single individuals or

married couples who are not "dependents" of another taxpayer.

Massachusetts uses Internal Revenue Service rules concerning

relationships and financial support to determine who is a

dependent. 2 Filing units thus include taxpayers who file income

tax returns, plus all "potential taxpayers", Le. those who are

not dependents, but who are not required to file returns because

of their low level of income. In Massachusetts filing a return is

not required if no refund is due, and if income subject to

taxation (adjusted gross income) is less than $6,000. For

example, because social security benefits and other government

pensions are not subject to taxation in Massachusetts, many

elderly individuals and couples are not required to file returns.

The general approach in comparing the tax burden faced by two

taxpayers is to compare the taxes they pay (their tax liabilities)

with a measure of their "ability to pay". The best measure of

ability to pay is a measure that includes income available to an

individual or family from all sources, regardless of whether this

income is subject to taxation. A comprehensive measure of ability

to pay should also include income from non-cash sources, such as

times criticized because it fails to account for other factors

income subject to taxation, such as wages, interest, and

and indicates the percentage of a taxpayers' total income that

must be paid in taxes. 3

The use of effective tax rates to measure tax burdens is some-

[October"'j:ri'\

HOUSE - No. 638622

food stamps or housing subsidies. ,Because comprehensive data on

non-cash income is unavailable, total money income is used as an

ability to pay measure in this report. Money income includes

dividends, and income excluded from taxation, such as welfare

payments, workers' compensation, and social security benefits.

Tax burdens are calculated by dividing income tax liabilities by

total money income. This measure is called an effective tax rate,

which may reduce a taxpayer's ability to pay taxes, thereby

increasing the burden of taxation. For example, a 4 percent effec

tive tax rate may place a heavier burden on a taxpayer with 5

children than on an unmarried taxpayer with no dependents. By

providing dependent exemptions the Massachusetts income tax

attempts to take into account the reduced ability to pay taxes

resulting from large family sizes. Nevertheless, in order to

allow the reader to judge the effectiveness of these exemptions,

data on effective tax rates will be presented separately for

various demographic groups, such as families and the elderly.

Table 1 provides background to the simulations of the Massa-

chusetts income tax by listing the number of filing units by

filing status (single or joint returns), and by money income

class. 4 In 1986 there will be slightly more than 3.1 million

filing units in Massachusetts. Nearly 30 percent of the total

have money incomes below $10,000, another 30 percent have incomes

between $10,000 and $25,000, 26 percent have incomes between

$25,000 and $50,000, while 14 percent have incomes over $50,000.

single individuals comprise 61 percent of the total filing units.

It is not surprising that single filers tend to be considerably

poorer than couples (joint filing units). In fact, over

..

[October

data on

1986] HOUSE - No. 6386 23

ad as an

Ludes

Lfare

afits.

lUes by

tax rate,

a that

; is some-

ictors

aby

::ent effec-

lth 5

:>. By

tax

taxes

ar to

nptions,

for

erly.

e Massa-

s by

come

Hion

total

e incomes

ween

$50,000.

ng units.

derably

four-fifth of all single filers have incomes below $25,000

compared to only one-quarter of joint filers.

One third of filing units will owe no state income taxes in

1986. Massachusetts residents are exempted from paying income

taxes for two major reasons. First a number of sources of inbome

such as social security benefits and welfare payments, are not

subject to taxation. In addition, taxpayers whose income is

subject to taxation are exempted from paying taxes if their

income is below $6,000 ($10,000 for those filing joint returns),

or if the sum of their deductions and exemptions exceeds their

adjusted gross income.

Table 1

Number of Filing Units by Filing status

Massachusetts Personal Income Tax, 1986

Total single JointTotal Percent Percent Percent

Money Income Number Q!~ Number Q! :tQYl Number Q! Total

Less than $5,000 446,316 14.2% 437,730 22.8% 8,586 0.7%

$5,000-9,999 476,212 15.2 433,661 22.6 42,550 3.5

$10,000-14,999 342,443 10.9 279,149 14.5 63,295 5.2

15,000 19,999 322,289 10.3 252,381 13.1 69,908 5.7

20,000 24,999 284,982 9.1 171,045 8.9 113,937 9.3

25,000 29,999 225,689 7.2 106,142 5.5 119,547 9.8

30,000 34,999 195,345 6.2 68,667 3.6 126,679 10.4

35,000 39,999 163,861 5.2 53,699 2.8 110,163 9.0

40,000 44,999 125,296 4.0 28,006 1.5 97,290 8.0

45,000 49,999 110,690 3.5 21,769 1.1 88,921 7.3

50,000 74,999 301,946 9.6 46,813 2.4 255,129 20.9

75,000 an over 145,466 4.6 21,970 1.1 123,495 10.1

Total 3,140,522 100.0% 1,921,032 100.0% 1,219,498 100.0%

SOURCE: Massachusets INcome Tax Simulation Model


Table 2 lists both the number and percentage of filing units

in each income class who will face positive income tax liabilities

in 1986. These data show that no Massachusetts resident with

Table 2

Average Tax Liability


money inco'

only 23 pe

$10,000 wi

the averag

class. (':t

ticn of th

will be $J

$30,000 wj

with inco!

NumberTotal

Money Income

Filing units withPositive Tax Liabilities

% of TotalFiling units

Avg. TaxLiability*

Altho\

across inc

payments'

pattern 0

Less Than $5,000 0 0% $ 0

$5,000-9,999 108,054 23 37

$10,000-14,999 240,262 70 250

$15,000-19,999 264,189 82 469

$20,000-24,999 251,157 88 679

$25,000-29,999 211,396 94 847

$30,000-34,999 190,476 97 1,185

$35,000-39,999 160,654 98 1,377

$40,000=44,999 125,296 100 1,736

$45,000-49,999 110,690 100 1,993

$50,000-74,999 299,949 99 2,596

$75,000 and over 145,466 100 5,701

Total 2,107,589 67% $ 1,002

*Averages include taxpayers with zero tax liabilities

SOURCE: Massachusetts Income Tax Simulation Model

pattern 0

!ace high

residents

Massachus

rapidly t

taxpayers

steadily

incomes (

Therl

of progrl

the degr l

distribu'

third of

hence fa

taxes fa

5 percen

the 3 to

range.

burdens

progress


J units

lbilities

dth

money income below $5,000 will have to pay income tax, and that

only 23 percent of filing units with incomes between $5,000 and

$10,000 will face tax bills. The final column in table 2 lists

the average amount of income tax owed by taxpayers in each income

class. (Taxpayers who owe no taxes are included in the calcula

tion of these averages.) The average state income tax liability

will be $1,002. The average taxpayer with money income below

$30,000 will pay less than this amount, while the average taxpayer

with income above $30,000 will pay more.

Although tax liabilities rise as income increases, tax burdens

rapidly to 3 percent in the $15,000 to $25,000 income range. For

across income classes can only be assessed by comparing tax

payments to the level of money income. Figure 1 illustrates the

pattern of tax burdens. The data in figure 1 show a progressive

pattern of income tax burdens1 on average higher in~ome taxpayers

face higher tax burdens than lower income taxpayers. Most

residents with incomes below $10,000 are not required to pay

taxpayers with income above $25,000, tax burdens rise reasonably

steadily to an average rate of nearly 5 percent for taxpayers with

incomes over $75,000.

There is no simple and unambiguous way to measure the degree

of progressivity in a tax system. However one useful way to gauge

the degree of tax progressivity is to look at the range and

distribution of effective tax rates. Figure 2 shows that while a

Avg. TaxLiability.

$ 0

37

250

469

679

847

1,185

1,377

1,736

1,993

2,596

5,701

$ 1,002

Massachusetts income taxes. Above $10,000 tax burdens rise

third of filing units in Massachusetts pay no income tax (and

hence face a zero effective rate), the majority of those paying

taxes face tax burdens in the relatively narrow band of from 3 to

5 percent. In fact, among those paying taxes 35 percent are in

the 3 to 4 percent range, and 41 percent are in the 4 to 5 percent

range. When three-quarters of all those paying income taxes face tax

burdens within two percentage points of each other, the degree of tax

progressivity is clearly limited.

orD

oaD

o,....~

~

~

aJq0'"a::::::::>IIIX

~~

o.-'

q0.11. IDOO

'"'

Fl9ure I

Tax Burdens by Money Income ClassMassachusetts Personal Income Tax, 1986

Tax Burdens equal gr'tlSS lIablities as apert:llntoge of totol money income

'0100,.....

~

N0\

:=o~rJ'j

~

Izo.0\~QC0\

MONEY INCOME (in dollars)

SOURCE: MonoohuooU•.Inoome Tox Simulollon Modal

Flgure 2

Distribution of Tax BurdensU"~C',,,...hl IC'~HC' Pprc(''Innl In~()mp. Tnx. 1986

,....,of')-oC"~...

~·,ic-.,.f;!,-.:4'",,¥,;1i~~$4 ~-.'~' 0 ttlt "'''-y'--:'tttt

~

\QQC0\--..

""' n .. Hit. ..... I.... 2""MONEY INCOME (in dollars)

ocD14')

SOURCE: Monochu.eU. Income To. SlmuloUon Model

Ftguro 2

Distribution of Tax BurdensMassachusetts Personal Income Tax, 1986

1"""""1on-Qcr~...

~

'CQCc:I\......

'''''III

SOURCE: MOllIochua.UlI Income TOll Slmulotlon Modal

o~

ocxi

(f)N

~qa.:C!i

~OlL. 0ON-l~qO~I-

~~U-

ffi0..0

cxi

o~

q

Zero -0-.99 1.0 - 1.99 2.0 - 2.99 3.0 - 3.99 4.0 - 4.99 5.0 - 5.99 6.0 & over

TAX BURDEN On %)

==oe00~

IzQ.c:I\CMQCc:I\

N-...I


Is the Commonwealth's personal income tax more or less progress

ive than the average state personal income tax? This question is

difficult to answer, given the lack of models for other states

comparable in sophistication and detail to the Massachusetts Income

Tax simulation Model. The scant evidence that does exist suggests

that the progressivity of the Massachusetts personal income tax is

below average. Donald Phares (1980) has estimated 1976 effective

income tax rates by income class for alISO states. He found that,

among the 44 states that tax personal income, 36 had personal income

taxes more progressive than the Commonwealths. Feenberg and Rosen

(1985) obtained very similar results when analyzing 1983 tax law.

The data in figure 1 only present a partial picture of the dis

tribution of tax burdens among Massachusetts residents. In 1986 35

percent of filing units will itemize deductions on their federal

income tax returns. 5 As state income tax payments are deductible,

itemizers can in effect reduce the burden of state income taxation.

This can be seen most clearly with a simple example. Assume that a

taxpayer with a $45,000 income faces a state income tax liability of

$2,000, and a federal marginal income tax rate of 30 percent. By

reducing federal income taxes by 30 cents, every extra dollar of

state income tax liability will reduce the taxpayer's after-tax

income by only 70 cents. The $2,000 of deductible state taxes will

reduce the taxpayer's federal income tax liability by $600 (30

percent of $2,000), reducing the net cost to the taxpayer of the

state income tax to $1,400.

The reduction in state tax burdens due to the deductibility ofstate taxes is called the federal tax offset. The average federaloffset increases as income rises because both the proportion of

itemizers and the federal marginal tax rate rise as income rises.Appendix table 1 displays the percentage of itemizers and the average

federal marginal income tax rate for each income class.

Figure 3 illustrates the impact of federal tax deductibility on

the pattern of state income tax burdens. If deductibility is

ignored, the burden of the Massachusetts income tax rises across theentire income distribution. The picture changes dramatically when

-+-I(1)(J)~~

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~ ~of the

the average

federal

and Rosen

ume that a

taxation.

ductible,

stion is

In 1986 35

f the dis-

tax law.

tts Income

tates

suggests

onal income

ound that,

me tax is

ffective

er-tax

iability of

ent. By

lIar of

o (30

taxes will

oility ofa federalion ofa rises.

ibility on'{ is

across the:lIly when


deductibility is considered. Above $15,000 effective tax rates netof the federal offset remain more or less constant. This means thatabove this income level the Massachusetts income tax burden is proportional to income, rather than progressive. The same pattern holdswhen the analysis is limited to filing units with positive taxliabilities. (Table 3)

Table 3

Average Effective Tax Rates for Filing units With

positive Tax Liabilities


general thpayers inin appendieach incollfacing pOEtax burderincome clewithin a :90 percen1and in 3 ;range. Tlincomes blpercent 0

percentag

III. HbY.

In or

TotalMoney Income

Less than $5,000

$ 5,000- 9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

475,000 and over

Average

WithoutFederal Offset

0%

2.12

2.88

3.30

3.42

3.30

3.76

3.73

4.08

4.20

4.41

4.93

3.64

WithFederal Offset

0%

2.12

2.86

3.23

3.20

2.95

3.25

2.97

3.08

2.97

2.93

2.86

2.99

setts res

provision

definitio

determine

will hel~

and provi

possible

TherE

taxpayerl

from tax,

tions fo:

and 10 P'

interact

useful t

SOURCE: Massachusetts Income tax Simulation Model

Tax burdens differ not only across income classes, but amongtaxpayers with similar incomes. These differences may result fromexplicit policies designed to reduce (or raise) the tax burdens oftaxpayers with certain characteristics, such as large families, orthey may be the unintended consequences of other tax policies. In

their ta

Defi

sUbject

and DEDE

Adjustec

taxable

[October

r1986] HOUSE - No. 6386 31

IX rates net.s means that:den is propor:tern holds.ve tax

with

witheral Offset

0%

2.122.86

3.233.202.95

3.252.97

3.082.97

2.93

2.86

2.99

lut among:esult fromburdens oflmilies, or.icies. In

general the horizontal equity of a tax system is increased if taxpayers in the same income class face similar tax burdens. The datain appendix figure A illustrates the distribution of tax burdens ineach income class. The data in the figure show that among taxpayersfacing positive tax liabilities there is fairly little variation intax burdens within income classes. In each of the three highestincome classes, more than 70 percent of taxpayers face tax burdenswithin a 1 percentage point range. In 5 of 11 income classes, over90 percent of the tax burdens fall in a two percentage point range,and in 3 income classes 80 percent of taxpayers face burdens in thisrange. The largest variation in tax burdens is among taxpayers withincomes between $15,000 and $30,000. However, even here more than 70percent of taxpayers in each income class face tax burdens in a 2percentage point range.

III. WhY po Tax Burdens Differ?

In order to understand why tax burdens differ among Massachu

setts residents, it is necessary to look in detail at the various,provisions of the state income tax. To what extent does the

definition of adjusted gross income, or exemptions and deductions,

determine the pattern of tax burdens? Answers to these questions

will help us to better understand the current income tax system,

and provide information necessary to evaluate a wide range of

possible changes to the income tax.

There are three reasons why effective tax rates differ among

taxpayers: variations in the amount of income that is excluded

from taxation, variations in the amount of exemptions and deduc-

tions for which a taxpayer is eligible, and different mixes of 5

and 10 percent income. In order to see how these three factors

interact to generate different effective tax rates it will be

useful to work through the steps taxpayers follow in calculating

their taxes.

Define INC as total money income, EXCL as total income not

subject to taxation, such as welfare or social security benefits,

and DEDEXM as the total of allowable deductions and exemptions.

Adjusted gross income (AGI) is then defined as INC minus EXCL, and

taxable income is defined as AGI minus DEDEXM, or in algebraic


form taxable income = INC - EXCL - DEDEXM. In Massachusetts AGI

is the sum of 5 percent and 10 percent income. If we define A as

10 percent income as a proportion of AGI, we can define the total

tax liability (TAX) as follows:

(1) TAX = 0.05*(1 + A)*[INC - EXCL -DEDEXMJ

Note that if 10 percent of AGI is comprised of 10 percent income,

A = 0.1, and taxable income is taxed at an average rate of 5.56

percent. Alternatively, if AGI is equally divided between 5 and

10 percent income, A - 0.5, and the average tax rate is 7.5

percent. Substituting equation (1) into the definition of the

effective tax rate (t=TAX/INC), yields

.( 2) t = 0.05* (1 + A) * [1 - EXCL/INC - DEDEXM/INCJ

Equation (2) illustrates clearly the three factors that

determine the level of effective tax rates: the mix of 5 and 10

percent income, as represented by A, income exclusions as a

proportion of money income, and deductions and exemptions as a

proportion of money income. Income tax progressivity is increased

if 10 percent income as a proportion of AGI rises as income rises,

or if income exclusions, deductions, or exemptions decline as a

proportion of income as income rises. 7 The following two

sections of this report provide an analysis of the major

exclusions, exemptions, and deductions from the Massachusetts

income tax. A major purpose of this analysis is to determine the

extent to which each of these provisions influences the pattern of

income tax burdens both within and across income classes.

Equation (2) abstracts from the fact that tax liabilities are

reduced to zero for all filing units with incomes below $6,000

($10,000 for those filing joint returns). section VI of this

report provides a detailed discussion of the provisions in the tax

code designed to reduce or eliminate the tax burdens on the poor.

IV. The An

Tax ):)ur

subject to

primarily f

much lower

subject to

generally s

assumption

regardless

sometimes e

but in-kind

the value e

real net in

defined as

economic ir

Massachuset

The pUl

benefits fl

influence 1

these ques1

either retl

Exclusions

cost on al:

sources.

terms of 8t

fairness.

this analy:

It is

excluded f

1. Impute

Econolt

income she

two neight

of their c

[October

f'1986] HOUSE - No. 6386. 33

etts AGI

fine A as

the total

t income,

of 5.56

en 5 and

7.5

f the

hat

5 and 10

s a

s as a

increased

ome rises,

ne as a

o

setts

rmine the

pattern of

ities are

$6,000

this

in the tax

the poor.

IV. the Analysis of Income Exclusions

Tax ~urdens are influenced ~y the fact that not all income is

subject to the income tax. Thus a taxpayer whose income comes

primarily from sources that are excluded from taxation will face a

much lower tax ~urden than a taxpayer whose entire income is

su~ject to taxation. In defininq an exclusion economists

generally start with a very ~road definition of income under the

assumption that individual well-~einq is qained from all income

reqard1ess of its source. This "economic income," as it is

sometimes called, includes not only cash income from all sources,

but in-kind payments such as food stamp ~enefits, fringe ~enefits,

the value of employer provided ~enefits for health care, and the

real net imputed rent on owner-occupied homes. Exclusions are

defined as the difference ~etween this comprehensive definition of

economic income and adjusted gross income as defined under

Massachusetts law.

The purpose of this section is to answer two questions: who

benefits from income exclusions and in what ways do exclusions

influence the patterns of income tax ~urdens? The answers to

these questions will not ~y themselves provide a justification for

either retaininq or a~olishinq particular income exclusions.

Exclusions narrow the ~ase of the income tax, and there~y impose a

cost on all taxpayers whose income comes from non-excluded

sources. The ~enefits of any exclusion should ~e evaluated in

terms of economic efficiency, administrative simplicity, and

fairness. The data presented in this section should facilitate

this analysis.

It is useful to divide all the major source of income that are

excluded from AGI into seven cateqories.

1. Imputed rent on owner-occupied homes

Economists are in wide aqreement that a ~road definition of

income should include imputed rent on owner-occupied homes. If

two neiq~ors decided to switch houses while retaining ownership

of their oriqinal houses, each would receive taxable rental


income. Homeowners differ from renters by the fact that they pay

themselves an (imputed) rent instead of paying rent to someone

else. The problem of including imputed rent in AGI is almost

entirely administrative. It would be both difficult and costly to

calculate an annual imputed rent for all owner-occupied homes.

For this reason the taxation of imputed rent has not been

seriously considered.

2. capital Gains Exclusions

These include the exclusion from AGI of 50 percent of long

term capital gains, the deferral of capital gains on home sales,

and the one-time exclusion of capital gains from the sale of an

owner-occupied house by persons age 55 or older. In 1986 the 50

percent capital gains exclusion will reduce AGI by $2.1 billion.

The data in table 4 show clearly that the primary beneficiaries of

this exclusion are high income taxpayers. Nearly 70 percent of

the capital gains exclusion goes to taxpayers with incomes over

$75,000. Conversely, while 65 percent of all Massachusetts filing

units have incomes less than $30,000, this group receives less

than 10 percent of net capital gains. In fact, below $75,000 of

income relatively few taxpayers receive any income, and hence any

exclusion, from capital gains. Averaged over all taxpayers, the

capital gains exclusion is approximately one percent of money

income for taxpayers in all but the highest income class. In that

class capital gains average about 8 percent of money income,

leading to a substantial reduction in the effective tax rate of

high income taxpayers.

According to the Administration's tax expenditure budget for

fiscal year 1986 (Commonwealth of Massachusetts, 1986), the

deferral of capital gains from the sale of a home reduce state

income tax revenue by $81 million. Although no data are available

on the pattern of these deferrals across income classes, the fact

that home ownership rates and home values increase with income

suggests that this exclusion benefits primarily moderate and high

income taxpayers.

TotalMonev In

Less than

$5,000-9,9

$10,000-H

$15,000-19

$20,000-24

$25,000-29

$30,000-34

$35,000-39

$40,000-44

$45,000-49

$50,000-74

$i5,000 an

Total

Average

SOURCE: M

Taxpay

eXclusion

a home. T

Provision'

Year 1986.

(1985) fin,

with moder.

report tha'

."----~-_.~--------

[October

It they pay

lomeone

almost

r~1

1986] HOUSE - No. 6386

Table 4

Analysis of Capital Gains Exclusion


35

i costly to

homes.

)f long-

~e sales,

Le of an

16 the 50

billion.

Lciaries of

~cent of

~es over

atts filing

as less

75,000 of

hence any

rers, the

money

I. In that

:ome,

rate of

Idget for

the

state

available

I the fact

income

a and high

Filing Units wit~ Capital Gains ExclusionNet Capital Gains as % of Monev Income

AverageTotal Percent Excluded FUs with All

1:1one'1 Income Number of FUs ~ Exclusion Taxt:avers

Less than $5,000 4,603 1 % $ 440 43.3 % 0.5 %

$5,000-9,999 18,543 3 1,258 16.8 0.7

$10,000-H,999 11,998 4 1,745 13.5 0.5

$15,000-19,999 9,376 3 1,799 10.7 0.3

$20,000-24,999 15,72l 5 3,04l 13.8 0.8

$25,000-29,999 2l,822 lO 2,758 9.9 1.0

$30,000-34,999 26,604 14 3,478 ·10.8 1.5

$35,000-39,999 17,331 l1 4,111 10.9 1.2

$40,000-44,999 10,331 8 3,809 8.9 0.7

$45,000-49,999 19,787 18 3,823 8.l 1.5

$50,000-74,999 40,755 13 4,593 7.6 1.0

$i5,000 and over 71,228 50 19,856 15.0 7.5

Total 268,098I

Averaqe 9 % $ 7,652 12.4 % 1.1 ,


Taxpayers over the age of 54 are entitled to a one-time

exclusion of the first $125,000 of capital gains from the sale of

a home. The state tax expenditure bUdqet estimates that this

provision will reduce incom. tax revenue by $43 million in fiscal

year 1986. A recent study by Sandra Newman and James Reschovsky

(1985) finds that this exclusion also benefits primarily taxpayers

with moderate and high incomes. Based on 1980 national data, they

report that only 2 percent of the low income recipients of the


exclusion (those with incomes less than $10,000), receive tax

benefits of more than $3,500. At the same time, 29 percent of

recipients with incomes in the $10,000 to $20,000 range, 55

percent of recipients in the $20,000 to $40,000 range, and 70

percent of recipients with incomes above $40,000 receive over

$3,500 of tax benefits from the one-time capital gains exclusion.

3. Cash Benefits from Government Aid Programs

Cash payments from a number of government programs are

excluded from taxation by both the federal and Massachusetts state

income taxes. These programs include the, Aid for Families with

Dependent Children (AFDC) and Supplementary Security Income (SSI),

veteran's benefits from veterans' pensions, disability pensions,

G.I. benefits, and workers' compensation. In addition, unemploy

ment compensationis totally excluded from adjusted gross income if

the sum of AGI and unemployment compensation is less than "base

amounts" of $12,000 for single returns, and $18,000 for joint

returns. If this sum exceeds the base amount, then AGI will

include either all of a taxpayer's unemployment compensation, or

one-half of the amount by which the sum exceeds the base amount,

whichever is smaller.

In 1986 Massachusetts AGI would be increased by approximately

$1.2 billion if income from these government programs was subject

to taxation. The data in table 5 show that a large portion of

taxpayers who benefit from these government programs have

relatively low incomes. In Massachusetts over one-third of all

recipients have money incomes (including government benefits) in

the $5,000 to $10,000 range. As income rises, both the proportion

of taxpayers receiving benefits from these government programs and

the average size of the benefit declines. The data in the last

two columns. indicate that among benefit recipients, those with

incomes under $10,000 exclude over 50 percent of their incomes

from AGI. Averaging over all taxpayers, exclusions as a

proportion

of exclusic

Massachuset

TotalMone" Inc

Less than $

$5,000-9,99

$10,000-14,

$15,000-19,

$20,000-24,

$25,000-29,

$30,000-34,

$35,000-39,

$40,000-44,

$45,000-49,

$50,000-74,

$75,000 anc

Average

* Includesveterans I

portion (

SOURCE: Me

[October 1986] HOUSE - No. 6386. 37

e tax

ent of

55

nd 70

over

xclusion.

re

etts state

ies with

:ome (SSI),

tensions,

unemploy-

i income if

m "base

joint

will

ltion, or

l amount,

~oximately

is subject

:ion of

,a! of all

9fits) in

proportion

I:'ograms and

t.he last

;e with

lncomes

proportion of money income decline as income rises. This pattern

of exclusions serves to increase the progressivity of the

Massachusetts income tax.

Table 5

Analysis of Cash BenefitsExcluded from AGI*


Filing Units with Cash Cash BenefitsBenefits Excluded from AGI as % o{ Monev Income

Total Average Benefit AllMone" Income Numbe'" Percent Benefit Recipients Tax-cavers

Less than $5,000 38,382 9 % $ 2/'62 76.1 % 6.5 %

$5,000-9,999 136,901 29 3,449 52.0 15.0

$10,000-14,999 49,495 14 2,192 ·17.8 2.6

$15,000-19,999 35,117 11 4,159 23.6 2.6

$20,000-24,999 28,062 10 2,807 12.8 1.3

$25,000-29,999 33,415 IS 2,856 10.7 1.6

$30,000-34,999 19,303 10 3,462 10.6 1.1

$35,000-39,999 27,599 17 4,078 11.0 1.9

$40,000-44,999 9,767 8 1,159 2.7 0.2

$45,000-49,999 693 1 1,760 1.6 0.0

$50,000,-74,999 12,672 4 2,507 4.3 0.2

$75,000 and over 0 0 0 0.0 0.0

Average 391,406 12 % $ 3,132 33.4 % 4.2 %

* Includes all recipients of public assistance (AFDC or SSI),veterans' benefits, workmens' compensation, and the tax-freeportion of unemployment compensation.



The President, as part of his tax reform proposals submitted

to Congress in May 1985, has proposed the full taxation of both

workers' and unemployment compensation. Although the House has

voted to maintain the status guo, it is certainly possible that if

a tax reform bill emerges from Congress in 1986 it may include the

full taxation of workers' and unemployment compensation. At the

federal level there are several arquments for making workers' and

unemployment compensation fUlly subject to taxation. Most compen

sation programs are designed to replace a fixed percentage of

gross earning~, subject to maximum and minimum dollar limits.

Under current law, because compensation payments are not subject

to taxation, some taxpayers, particularly those with relatively

high incomes, receive higher after-tax replacement rates than

lower income taxpayers. The higher a taxpayer's income and

marginal tax rate, the more his after-tax wage replacement rate

will exceed his pre-tax replacement rate. For example, consider

two persons who receive disability payments of 50 percent of their

previous earnings. Because the first person has little income

from other sources, he pays no federal income taxes, and hence

faces an after-tax wage replacement rate of 50 percent. If the

second person's income, perhaps from the earnings of a spouse,

results in a marginal tax rate of 35 percent, he will receive an

after-tax wage replacement rate of over 75 percent. In addition

to the equity concerns created by providing higher income

taxpayers higher after-tax replacement rates, the current system

can create a substantial work disincentive, especially for high

income recipients of unemployment or workers' compensation. 8

Because benefits are mostly nontaxable, wage replacement rates

for unemployment and disability programs are probably lower than

they would otherwise be. This has the effect of indirectly subsi

dizing employers with high injury and layoff rates. This kind of

subsidy clearly decreases economic efficiency and distorts the

allocation of resources.

If Congress decides to inclUde fully unemployment and workers'

compensati l

Massachuse'

to conform

simplicity

federal de

their tax

tates the

Under

unemployme

economy me

is short,

tively sma

$260 milli

from AGI,

between $2

incomes ov

advantage

unemployme

The cc

little or

long dura1

little inc

compensat:

paying st.

provisionl

Alth01

enhance be

income ta:

burdens 01

$10,000 tl

burdens WI

compensat

taxpayers

ment rate


lubmitted

of both

)use has

)le that if

lnclude the

At the

:-kers' and

)st compen-

tge of

lmits.

: subject

Latively

;; than

and

ant rate

consider

:It of their

income

1 hence

If the

spouse,

aceive an

addition

De

:It system

~or high

Lon. S

ament rates

)wer than

:tly subsi

ls kind of

:-ts the

\d workers'

compensation in gross income, there are several strong reasons for

Massachusetts to follow suit. Perhaps the most compelling reason

to conform with the federal definition of AGI is administrative

simplicity. The closer Massachusetts' definition of AGI is to the

federal definition, the easier it is for taxpayers to complete

their tax forms. The conformity .of AGI definitions also facili

tates the enforcement efforts of the Department of Revenue.

Under current law Massachusetts will tax 55 percent of all

unemployment compensation paid in 1986. The strong Massachusetts

economy means that for most people, the duration of unemployment

is short, and thus unemployment compensation comprises a rela

tively small portion of total annual income. Of the approximately

$260 million of unemployment compensation that will be excluded

from AGI, 15 percent will be paid to filing units with incomes

between $20,000 and $25,000, and 35 percent to filing units with

incomes over $25,000. These middle income households enjoy a tax

advantage relative to households with similar incomes but with no

unemployment compensation.

The complete taxation of unemployment compensation will have

little or no impact on the relatively few taxpayers who face a

long duration of unemployment. Most of these taxpayers have

little income from other sources, and hence even if unemployment

compensation is subject to taxation, they would be exempted from

paying state income taxes because of the "no tax status"

provisions of the income tax.

Although the full taxation of unemployment compensation would

enhance both the horizontal equity and the efficiency of the

income tax system, added tax liabilities may place increased

burdens on the "working poor", primarily those with incomes in the

$10,000 to $20,000 range. One way to mitigate these extra tax

burdens would be to adjust wage replacement rates for unemployment

compensation to account for taxpayer economic need. Low income

taxpayers would thus receive slightly higher gross wage replace

ment rates than taxpayers with higher incomes.


In 1986, 15 percent of workers' compensation payments will go

to Massachusetts taxpayers with money incomes in the $20,000 to

$25,000 range, and 47 percent to taxpayers with incomes over

$25,000. There are at least two reasons for the concentration of

benefits among middle and upper income taxpayers: 1) low-income

workers are less likely to have coverage, and 2) most recipients

have steady jobs and are away from work for less than three

weeks. A very small percent of workers are permanently disabled.

The President's tax reform proposal would tax workers'

compensation, but would provide all low income recipients with an

expanded tax credit. In 1987 under the President's plan a worker

who is disabled all year and who has no other source of income

would pay no federal income tax unless his benefits exceeded

$21,200. This figure exceeds the $18,750 current maximum workers'

compensation benefit in Massachusetts.

If Massachusetts were to follow a federal move to tax workers'

compensation, most of the extra tax would be paid by households

with incomes in excess of $25,000. Taxpayers would be spared

additional compliance costs resulting from a discrepancy between

federal and state law. Work disincentives would be diminished,

but financial protection of low income disabled workers would not

be materially diluted.

4. Government Retirement Payments

Massachusetts exclUdes from income SUbject to taxation all

social security benefits and all pension benefits from U.S. govern

ment pensions, Massachusetts state and local government pensions,

and pensions from governments in other states, as long as they do

not tax government pension income from Massachusetts. Since 1984

social security benefits are subject to partial taxation by the

federal income tax. Taxpayers whose incomes are above a threshold

($25,000 for single filers, and $32,000 for joint returns) must

pay federal income tax on up to 50 percent of their social

security benefits. 9

The da

the primar

Government

security b

average re

! Total

l Monev In

l,Less than

. ~ $5,000-9,9

~ $10,000-14.(

$15,000-19

$20,000-24

$25,000-29

$30,000-34

$35,000-39

$40,000-44

$45,000-49

$50,000-74

$75,000 an

Total

Average

SOURCE: M

[October

,!'

1986] HOUSE - No. 6386. 41

imts will qo

~20,000 to

as over

antration of

Low-income

recipients

three

Ly disabled.

leers'

ants with an

Lan a worker

The data in table 6 show that tax-free retirement income is

the primary source of money income for low income taxpayers.

Government retirement payments, primarily in the form of social

security benefits, make up over 80 percent of total income for the

averaqe recipient with income below $10,000. Althouqh 40 percent

Table 6

Analysis of Retirement PaymentsExcluded from AGI


)f income

cceeded

LJlum workers'

Filinq Units with RetirementPayments Excluded from AGI

Retirement Paymentsas % of Monev Inco~e

tax workers'

louseholds

a spared

'lcy between

Lminished,

I:'S would not

ltion all

D u.s. qovern

:'It pensions,

~ as they do

Since 1984

ion by the

e a threshold

I1ms) must

ocial

Total Averaqe pa0!'e:;t AllMonev Income Number Percent Pavment Rec~cl.ents Taxcave!"

Less than $5,000 56,661 13 % $3,209 86.9 % 11.0 %

$5,000-9,999 232,107 49 5,882 82.5 40.2

$10,000-14,999 99,86.4 29 8,375 68.7 20.0

$15,000-19,999 76,322 24 10,347 59.0 14.0

$20,000-24,999 57,250 20 12,272 56.8 11.4

$25,000-29,999 58,714 26 12,766 47.1 12.2

$30,000-34,999 31,150 16 12,869 39.9 6.4

$35,000-39,999 22,785 14 15,036 40.1 5.6

$40,000-44,999 16,028 13 8,381 20.0 2.6

$45,000-49,999 2,457 2 20,973 43.1 1.0

$50,000-74,999 36,407 12 15,624 26.5 3.2

$75,000 and over 17,265 12 13,546 11.1 1.4

Total 707,010

Average 23 % $8,992 63.9 % 14.4 %



of the 707,000 Massachusetts taxpayers who receive social security

benefits and government pensions have incomes below $10,000, over

25 percent have money incomes in excess of $25,000. Social

security benefits and government pensions comprise less than half

of the total income of this relatively affluent group of taxpay

ers. For the rich elderly, those with incomes above $75,000, tax

free pensions average only 11 percent of money income. Although

the average social security or government pension payment tends to

rise as income rises, the heavy concentration of elderly at ~he

bottom end of the income distribution results in 61 percent of

total social security and pension payments going to taxpayers with

incomes below $25,000.

The data in the last two columns of table 6 show that among

elderly taxpayers the exclusion-,of social security and pension

benefits from the tax base dramatically reduces the effective tax

rates faced by the low income elderly. Even when we average in

all taxpayers, both elderly and non-elderly, these exclusions

decline as a proportion of income, as income rises. 10 This

implies that excluding social security and government pension

benefits from the tax base increases the progressivity of the

state income tax.

Although Massachusetts generally adopts federal changes in the

definition of AGI, the General Court chose to diverge from this

pattern by not adopting federal changes in the taxation of social

security benefits. If Massachusetts had conformed with the

federal treatment of social security, in 1986 11 percent of all

filing units with an elderly head or spouse would face higher

taxes. The partial taxation of social security benefits would

affect only those taxpayers with money incomes above $25,000, and

thus would increase the progressivity of the state income tax. In

an analysis of federal data, Chernick and Reschovsky (1985) find

that the partial taxation of social security benefits will

increase federal income tax liabilities of eligible taxpayers by

17 percent. A discussion of the advisability of adding social

security bl

await the:

section VI:

5. Tax De

Privati

both feder;

plans, bot:

percentage

but not th

tions are

employer c

he or she

average em

taxes on a

level most

are retire

The Ad

1986 estiJr

tions and

tax reven\:

earnings c

and life

$213 milU

governmen1

income, t!

that some

other sta1

completel:

Contribut.

The do

Survey, d,

earnings,

income fr

assess pr

[October

,Fi

II 1986] HOUSE - No. 6386 43

earnings of Individual Retirement Accounts (IRAs), KEOGH plans,

and life insurance policies reduces tax revenue by an additional

$213 million. It should be noted that whereas the federal

government eventually recoups some revenue by taxing pension

income, this possibility is limited in Massachusetts by the fact

that some residents will choose to spend their retirement years in

other states. Residents who retire in other states thus avoid

completely Massachusetts state income taxation of employer

contributions and earnings of pension and retirement plans.

The data source used in this report, the CUrrent Population

Survey, does not include information on employer contributions or

earnings of pension plans. It is thus not possible to include

income from these sources in the definition of total income, or to

assess precisely the distributional impacts of excluding this type

security benefits to the income tax base in Massachusetts will

await the fuller discussion of the tax treatment of the elderly in

section VII.

5. Iax Deferral of Retirement Contributions

Private retirement pensions receive favorable treatment under

both federal and state income tax law. Under most private pension

plans, both the employer and the employee contribute specified

percentages of gross earnings into the plan. Only the employee,

but not the employer, contributions are taxable when the contribu

tions are made. The employee is liable for income tax on the

employer contribution and on the earnings of the pension plan once

he or she retires and begins drawing pension income. Thus the

average employee is able to defer for many years paying income

taxes on a portion of his income. In addition, at the federal

level most taxpayers will face a lower marginal tax rate when they

are retired than during their working years.

The Administration's tax expenditure bUdget for fiscal year

1986 estimates that the deferral of taxes on employer contribu

tions and earnings of private pension plans reduces state income

The deferral of taxes on thetax revenue by $873 million.

oome tax. In

axpayers by

ng social

pension

th the

! higher

its would

r of the

ent of all

This

Although

$25,000, and

(1985) find

will

langes in the

from this

:m of social

l pension

~fective tax

Lxpayers with

lverage in

75,000, tax-

of taxpay-

s than half

ocial

:lusions

,ent tends to

ial security

0,000, over

:hat among

'ly at the

ircent of


of income from taxation. Nevertheless, available evidence

suggests that the partial deferral of taxation on pension benefits

primarily middle and upper income taxpayers. Noto (1980) provides

data on the distribution of federal tax expenditures by money

income class for fiscal year 1978. Inflating these data to 1986

value suggests the following distribution of tax benefits from the

net exclusion from AGI of pension contributions and earnings: 5

percent of total benefits to taxpayers with incomes below $15,000,

27 percent to those with incomes between $15,000 and $35,000, 28

percent to taxpayers in the $35,000 to $50,000 range, 20 percent

of total benefits tor those with incomes between $50,000 and

$80,000, and 20 percent ot benetits tor those with incomes in

excess of $80,000.

These results are not surprising in light ot the fact that

private pension plans are not available to many lew wage

employees, and among those who do participate in private pension

plans, the tax benefit is proportional to earnings. In addition,

IRA and KEOGH plans are held primarily by middle and high income

taxpayers. Thus although an exact estimate is not possible, it

appears that the exclusion of employer contributions and pension

plan earnings trom AGI substantially reduces the progressivity of

the state income tax.

Although the partial exclusion of pension benefits from the

tax base may serve no state function and substantially reduces the

progressivity of the income tax, any change from current law would

involve substantial compliance and enforcement costs. Massachu

setts has adopted, with minor exceptions, the federal tax treat

ment of pension plans. Any divergence from the federal treatment,

such as the taxation of employer contributions to pensions, would

involve dramatic increases in the record keeping burden of both

individuals and business firms and make enforcement more difficult

for the Department of Revenue.

6. rting

Both

exclude f

form of e

and medic

commuter

bUdget, E

state inc

year 198E

The t

for leadj

larly in

health cc

tion of ]

everyone,

benefits.

has stim,

tax base

items ha'

The'

horizont.

current

employer

health c

tax doll

percenta

benefits

rises (T

indicate

$10,000

Sixty pe

receive

those wj

[October r..tj.'f

1986] HOUSE - No. 6386. 45

mce

.on benefits

10) provides

, money

:a to 1986

.ts trom the

'nings: 5

ow $15,000,

5,000, 28

o percent

o and

mes in

ct that

e

e pension

addition,

;Jh income

ibIs, it

1 pension

ssivity of

from the

r:educes the

to law would

'1assachu

IX treat-

treatment,

)ns, would

of both

a difficult

6. Iringe Benefits. primarily for Health Care

Both the federal income tax and the state income tax currently

exclude fringe benefits from taxation. These exclusions take the

form of employer contributions for benefits such as medical care

and medical insurance, group legal services, dependent care, and

commuter transportation. According to the State's tax expenditure

budget, excluding these benefits from the tax base will reduce

state income tax revenue by approximately $263 million in fiscal

year 1986.

The tax exempt status of these benefits has been criticized

for leading to excessive consumption of certain services, particu

larly in the area of health care. Providing health insurance and

health care on a tax-tree basis has tended to distort the alloca

tion of resources and has raised the cost of healtb care to

everyone, including those without employer provided health care

benefits. The favorable tax treatment afforded to fringe benefits

has stimulated their provision and, concomitantly, erosion of the

tax base. In recent years tax-free fringes for non-health related

items have grown especially rapidly.

The taX-free treatment of fringe benefits reduces both the

horizontal and the vertical equity of the income tax. Under

current law, those taxpayers who are self employed or whose

employers do not provide a health insurance plan must pay for

health care or health insurance with after-tax, instead of pre

tax dollars. The Treasury Department has estimated that both the

percentage of families receiving employer contributions for fringe

benefits and the value of the tax-free benefits increase as income

rises (The Presidents Tax Proposals, 1985). Treasury's estimates

indicate that 14 percent of families with economic incomes below

$10,000 receive tax-free fringe benefits averaging $60 per month.

Sixty percent of families in the $20,000 to $30,000 income range

receive fringes that average $100 per month, while 86 percent of

those with incomes between $50,000 and $100,000 receive average


monthly fringe benefits of $190. These national data show clearly

that the tax treatment afforded fringes has the effect of reducing

the progressivity of the income tax. (A precise estimate of the

impact of fringes on tax progressivity in Massachusetts is not

possible because the Current Population Survey does not include

data on employer contributions for fringe benefits.)

As is the case with employer contributions to pension plans,

compliance costs would increase substantially if Massachusetts

chose not to conform with the federal tax treatment of fringe

benefits. However, it should be noted that the President's tax

reform proposal calls for the limited taxation of some fringe

benefits, including the partial taxation of employer contributions

for health insurance, and the full taxation of employer provided

commuting services. If Congress adopts these provisions, both the

efficiency and the progressivity of the Massachusetts income tax

can be increased by adopting the federal changes.

7. Interest on Government Obligations

Massachusetts excludes from gross income interest on obliga-

tions (primarily notes and bonds) of the U.S. government and of

the state and local governments in Massachusetts. No direct data

exist on the receipt of tax-free interest income by Massachusetts

residents. However, using U.S. Treasury Department estimates of

tax expenditures by AGI class for the major types of tax-free

interest, it is possible to impute tax-free interest to Massachu

setts taxpayers. Although the total amount of tax-exempt interest

is probably underestimated, the estimates in table 7 provide a

reasonably accurate picture of the pattern of tax-free interest

income in Massachusetts.

Table 7 shows clearly that interest on tax-exempt government

obligations is earned primarily by those with very high incomes.

In 1986 88 percent of the more than $250 million of tax-exempt

interest will be earned br Massachusetts taxpayers with money

incomes over $50,000. In fact most of the tax-free interest will

be earned by those with incomes in excess of $75,000. The last

TotalMonev Inc

Less than

$5,000-9,

$10,000-1

$15,000-1

$20,000-2

$25,000-:1

$30,000-::

$35,000-::

$40,000-4

$45,000-<

$50, OOO-~

$75,000

Average

SOURCE: l'

column of

more than

taxpayer w

interest 0

the state

incomes in

§,ynunary:

Becaus

non-cash s

Pension pI

Of owner-c

[October

lOW clearly

:>f reducing

te of the

1986] HOUSE - No. 6386

Table 7

Analysis of Tax-Free Interest Income


47

is not

include

m plans,

lusetts

~ringe

'lt's tax

~ringe

ltributions

provided

~, both the

ncome tax

n obliga

t and of

irect data

sachusetts

imates of

x-free

Massachu-

pt interest

ovide a

interest

overnment

incomes.

-exempt

money

erest will

The last

Tax-Free Interestas a to of

Money Income

WithTotal Average Tax-Free to of Tax-Free AllM.,onev Income Interest Income ~ Interest Taxpavers

Less than $5,000 $ 0 0 to 0 % 0 %

$5,000-9,999 0 0 0 0

$10,000-14,999 2 0 0 0

$15,000-19,999 5 0 0 0

$20,000-24,999 15 1 0.1 0

$25,000-29,999 20 1 0.1 0.1

$30,000-34,999 44 2 0.1 0.1

$35,000-39,999 56 3 0.2 0.1

$40,000-44,999 56 2 0.1 0.1

$45,000-49,999 59 2 0.1 0.1

$50,000-74,999 178 19 0.3 0.3

$75,000 and over 1,294 69 1.0 0.9

Average $ 171 100.0 to 0.2 to 0.1 to


column of table 7 indicates that tax-exempt interest comprises no

more than one-tenth of one percent of income for the average

taxpayer with income less than $50,000. Thus the exclusion of

interest on government obligations from the tax base only reduces

the state income tax burdens of high income taxpayers, those with

incomes in excess of $50,000.

Summary: The Impact of Exclusions

Because the CUrrent Population Survey does not provide data on

non-cash sources of income, such as employer contributions to

pension plans and health insurance, and the imputed rental value

of owner-occupied housing, it is not possible to provide a com-


plete picture of the effect of exclusions on the pattern of tax

burdens created by the Massachusetts income tax. In fact, the

exclusions for which we do not have data are larger than the

exclusions for which data exist.

Table 8 summarizes the data for measurable exclusions, which

are defined as total money income minus adjusted gross income.

This total includes several minor miscellaneous income exclusions

in addition to those discussed above. For taxpayers with incomes

between $5,000 and $40,000, total measurable exclusions equal

between $3,500 to $4,500. Total exclusions are lowest for those

with incomes between $40,000 and $50,000, and rise dramatically

for taxpayers with incomes over $75,000. The relatively high

level of exclusions among high income taxpayers is attributable

primarily to the untaxed portion of capital gains and to

tax-exempt interest income.

Table 8

income axc:

tax. Maas1

income risl

have the e

Recent

income exc

might chan

that show

tion recei

fringe ben

received 5

the other

smaller, t

stamp, Mec

greater at


Exclusions from Adjusted Gross Income

Total Monev Income

Less than $5,000

$5,000-9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

$75,000 and over

Average

Total Exclusions

$ 762

4,256

3,430

3,661

3,383

4,574

3,605

3,777

1,743

1,302

3,009

12,812

$ 3,559

. Exclusionsas a % of

Mane'! Income

21.4 %

60.5

27.8

20.8

15.5

16.8

11.2

10.1

4.1

2.7

5.1

9.9

22.4 %

top. Altl:

likely th2

benefits 1

bottom of

In ade

exclusionl

taxpayers

AGIs if 0:

latter se'

of the im:

taxpayers

v. ~

Taxpa

exemption

will addt

exemptior

the pattE


r[October 1 1986] HOUSE - No. 6386. 49

.rn of tax

'act, the

.an the

ons, which

income.

exclusions

ith incomes

s equal

for those

matically

ly high

ributable

to

Exclusionsas a % of

Mone'T Income

21.4 %

60.5

27.8

20.8

15.5

16.8

11. 2

10.1

4.1

2.7

5.1

9.9

22.4 %

The right-hand column of table 8 shows that overall measurable

income exclusions increase the progressivity of the state income

tax. Measurable exclusions as a proportion of income falls as

income rises from $5,000 to $50,000. Above $50,000, exclusions

have the effect of reducing the progressivity of the income tax.

Recent research suggests that if data were available on all

income exclusions, the pattern of exclusions shown in table 8

might change dramatically. Daniel Weinberg (1985) presents data

that show that in 1979 the poorest 40 percent of the U.S. popula

tion received only 5.1 percent of the federal tax expenditures on

fringe benefits, while the richest 20 percent of the population

received 54.6 percent of total tax expenditures on fringes. On

the other hand, although the total dollar amounts are much

smaller, the value of noncash transfers received f~om the food

stamp, Medicaid, Medicare, and housing assistance programs are

greater at the bottom end of the income distribution, than at the

top. Although it is impossible to say with certainty, it is

likely that the exclusions nQt included in table 8 provide greater

benefits to middle and high income taxpayers than those at the

bottom of the income distribution.

In addition to their impact on tax progressivity, income

exclusions almost invariably increase horizontal inequities. Two

taxpayers may have identical total incomes, but very different

AGIs if one taxpayer can exclude some of his income from AGI. In

latter sections of this report we shall explore several examples

of the impact of exclusions on the tax burdens of groups of

taxpayers with different patterns of exclusions.

V. The Analysis of peductions and Exemptions

Taxpayers are allowed to take a number of deductions and

exemptions in calCUlating their taxable state income. This report

will address three questions with respect to deductions and

exemptions: (1) how many taxpayers benefit from each, (2) what is

the pattern of benefit across income classes, and (3) what is the

so HOUSE - No. 6386 [October 1986]

impact of each on the progressivity of the income tax? No attempt

will be made in this report to evaluate each comprehensively.

One should draw a distinction between taxpayers who claim a

deduction or exemption on their returns, and taxpayers who

"effectively benefit" from the deduction or exemption. There are

three reasons why a taxpayer may derive less than full benefit.

First, no income tax is levied on taxpayers with AGls of less than

$6,000 ($10,000 for those who file joint returns). For these low

income taxpayers, all deductions and exemptions are irrelevant, as

they will pay no income tax anyway. Second, some taxpayers receive

no benefit or only partial benefit from a deduction or exemption

because other deductions or exemptions have already reduced their

tax liability to zero. Thus an extra dollar of tax deduction will

provide them with no extra benefit. For example, a taxpayer with a

$1,500 rent deduction would only benefit from $300 of the rent

deduction, if after taking her personal exemption but before

applying the rent deduction, her taxable income were $300.

In the following series of tables the value of an "effective

deduction" is defined as the amount of the deduction that results

in a direct reduction in a taxpayer's tax liability. The effective

deduction mUltiplied by the tax rate will provide an estimate of

the cost to other taxpayers of providing a particular deduction or

exemption.

The third reason why the effective benefit from a deduction or

exemption may be less than its face value is that price changes may

shift some of the benefit away from the taxpayer. The rent

deduction again provides a good example. Taxpayers are entitled to

deduct 50 percent of their rent up to a limit of $2500 per year.

The rent deduction thus effectively reduces rent by two and

one-half percent (the 5 percent tax rate times the 50 percent rent

deduction), for taxpayers with annual rents below $5,000 per year.

If this relatively small reduction in rent has no impact on the

rental market in Massachusetts, tenants will receive the full value

of their rent deduction (subject to the two factors discussed

above). Ho~

housing, anc

demand, gros

rent deducti

half percent

higher rent

deduction wi

In the E

benefits of

possible exe

is probably

child care cbenefit redc

tively. Unt

quantify thE

The eigh1

foregone rev,

rent deducti<

deduction, tl

taxes (FICA),

dependents, I

deductions c:

data on the ~

cost of each

These ei~

from the incc

deduction mal

tions and eXI

because they

ities. Mult;

Percent yielc

JnilUon. Th:

becaUse each

Jnarginal one,

apove). However, if the rent deduction increases demand for rental

housing, and unless the market is very responsive to this new

demand, gross rents will be pushed upward. The net result of the

[October

~o attempt

rely.

:laim a

r1986]IiI

HOUSE - No. 6386 51

10

rhere are

mefit.

less than

lese low

Levant, as

ars receive

(emption

:ed their

:tion will

lyer with a

! rent

Eore

) .Efective

~ results

! effective

Lmate of

iuction or

iuction or

:hanges may

mt

ltitled to

ar year.

md

"cent rent

per year.

on the

full value

lssed

rent deduction will then be a tax reduction equivalent to two and a

half percent of rent, which will be at least partially offset by

higher rent payments. Thus part of the benefit of the rent

deduction will be shared by landlords in the form of higher rents.

In the empirical analysis that follows it is assumed that the

penefits of tax preferences fall directly on taxpayers. With the

possible exceptions of the rent and the child care deductions, this

is probably the correct assumption. In the case of the rent and

child care deductions it is possible that some portion of the tax

penefit redounds to landlords and child care providers, respec

tively. Unfortunately, it is not possible with available data to

quantify these shifts in benefits.

The eight most costly deductions and exemptions, in terms of

foregone revenue, will be discussed in this report. They are the

rent deductions, the child care expense deduction, the dependent

deduction, the deduction for social security and railway retirement

taxes (FICA), personal exemptions for head of household and spouse,

dependents, and elderly persons, and an exemption for medical

deductions claimed on federal income tax returns. Table 9 provides

data on the value of total gross and effective benefit, and the tax

cost of each deduction and exemption.

These eight deductions and exemptions will remove $18.5 billion

from the income tax base in 1986. Personal exemptions and the FICA

deduction make up about 80 percent this total. Effective deduc

tions and exemptions are lower than gross deductions and exemptions

because they include only those that directly reduce tax liabil

ities. MUltiplying effective deductions and exemptions by 5

percent yields a total tax cost of the eight provisiions of $650

million. This figure is an underestimate of their true tax cost

because each deduction and exemption has been considered as the

marginal one, in other words, taken after all other deductions and


exemptions. This procedure is appropriate when evaluating

individual deductions and exemptions, but it underestimates the

size of total effective deductions and exemptions taken together.

Table 9

Total Gross and Effective Tax Preferences


(in millions of dollars)

TotalTotal Gross Effective Tax Cost ofPreferences Preferences Preferences

Rent Deduction $ 730.4 $521.5 $26.1

Child CareDeduction 255.0 253.8 12.7

DependentDeduction 237.1 197.0 9.9

FICA Deduction 3,191.1 3,125.1 156.3

PersonalExemption 11,660.0 6,974.5 348.7

DependentExemption 1,210.3 1,038.9 51.9

ElderlyExemption 482.8 170.8 8.5

Medical ExpenseExemption 729.4 709.6 35.5

Total MajorTax Preferences $18,496.1 $12,991.2 $649.6


The Rent Deduction

Massachusetts renters are entitled to deduct one-half of their

total annual rental payments up to a ceiling of $2,500. Slightly

over 750,000 filing units are eligible for the rent deduction. AS

shown in table 10, approximately one-third of filing units with

incomes between $5,000 and $25,000 are eligible. Not surprisinglY,

above $25,000 the proportion of renters declines as income rises.

It is important to emphasize that only taxpayers who directly paid

rent are,

filing un.

approxima'

another p,

The d,

the rent I

reflects

the fact·

full bene:

tax law hi

Tota]Monev Ir

Less than

$5,000-9,~

$10,000-1L

$15, OOO-l~

$20, 000-2~

$25,OOO-2~

$30,OOO-3~

$35,000-3~

$40,000-4,

$45,000-4!

$50,000-7.

$75,000 a1

Total

Average

S°tJRCE: }

1986] HOUSE - No. 6386. 53

Ilating

l:imates the

Icen together.

erences

, 1986

Tax Cost offreterences

$26.1

12.7

9.9

156.3

rent are entitled to the deduction. Thus, although nearly all

filing units with incomes below $5,000 live in rental units,

approximately 80 percent of this group live in households where

another person (usually a relative) pays the rent. 11

The data in the third column of table 10 show that the value of

the rent deduction tends to increase as income rises. This

reflects both the higher rents paid by higher income renters and

the fact that many low and moderate income renters do not get the

full benefit of the rent deduction because other provisions of the

tax law have reduced their state income tax liabilities to zero.

Table 10

Analysis of the Rent Deduction

Massachusetts Personal Income Tax; 1986

Filina units with Deduction

348.7

51.9

TotalMonev Income Number

AverageEffective

Percent Deduction

Effective Deductionas % of Monev Income

FUs with Allpeduction TaxDave~s

Less than $5,000 59,491 13 % $ 0 0.0 % 0.0 %

8.5

35.S

$649.6

iel

-half of their

00. Slightly

~eduction. As

units with

l: surprisingly,

income rises.

$5,000-9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

$75,000 and over

Total

Average

149,267

108,278

105,347

88,077

51,999

48,266

46,370

20,869

24,285

44,584

9,306

756,137

31

32

33

31

23

25

28

17

22

15

6

24 %

123

626

887

1,014

945

984

1,113

1,349

810

1,082

882

$ 690

1.7

5.1

5.2

4.5

3.5

3.0

3.0

3.2

1.7

1.9

0.8

3.2 %

0.6

1.6

1.7

1.4

0.8

0.8

0.8

0.5

0.4

0.3

0.1

0.8 %

directly paid SOURCE: Massachusetts Income Tax Simulation Model


E'or example, the average gross rental deduction for those with

incomes below $5,000 is $684. But because of the "no tax status"

provision of the state income tax, all filing units with money

incomes below $5,000 pay no income tax, and hence receive no extra

benefit from the rental deduction. For those in the $5,000 to

$10,000 income class the $123 average effective rental deduction

compares with an average gross deduction of $868.

The data in the last two columns of table 10 allow us to assess

the impact of the rent deduction on the pattern of tax burdens

across income classes. The larger a deduction is as a proportion

of money income, the greater the reduction in tax burden attribu

table to that deduction. Thus among renters with incomes over

$10,000 the impact of the rent deduction is progressive. In other

words, the deduction has the effect of reducing tax burdens more

for low income renters than for high income renters. As shown by

the last column of data, this pattern is re-enforced when we look

at all taxpayers. Because renters are concentrated in the bottom

half of the income distribution, the rent deduction reduces tax

burdens the most for taxpayers with incomes between $10,000 and

$25,000.

Child Care Expense peduction

Child and dependent care expenses are deductible in Massachu

setts for single parents and for couples, when both spouses work.

Deductions are allowed for children under the age of 15 and for

disabled dependents regardless of age. Deductions are limited to

the first $2,400 of child care expenses ($4,800 if child care

expenses were paid for two or more children). Only five percent of

all filing units have deductible child care expenses, and the

proportion of filing units with these deductions rises with income

to a peak of 19 percent for the $45,000 to $50,000 income class.

Our estimates indicate that only about one-half'of eligible

households have qualifying child care expenses. Many families

either cannot afford paid child care expenses, or rely on no-cost

alternatives, such as care provided by relatives, neighbors, and

occasionally

table 11) ama

average value

In part 1:

care deductic

income tax b\l

$20,000. Holt

payers are eJ

reduce slight

seen by lookj

child care dE

TotalMonev Incom

Less than $5,

$5,000-9,999

$10,000-14,99

$15,000-19,99

$20,000-24,99

$25,000-29,99

$30,000-34,99

$35,000-39,99

$40,000-44,9~

$45,OOO-49,9!

$50,OOO-74,9!

$75, 000 and (

Total

Average

SOURCE: Mas:


,e with

status"

money

'e no extra

000 to

,eduction

s to assess

urdens

roportion

attribu-

occasionally by public programs or by employers. As expected, (see

table 11) among those eligible for the child care deduction, the

average value of the deduction rises with income.

In part because of the ceiling placed on deductions, the child

care deduction is most beneficial (in terms of reducing the state

income tax burdens) for taxpayers with incomes between $10,000 and

$20,000. However, because very few low and moderate income tax

payers are eligible for the deduction, its overall impact is to

reduce slightly the progressivity of the income tax. This can be

seen by looking at the last column of table 11, where we see that

child care deductions average only 0.1 percent of money income for

Table 11


Analysis of the Child Care Deduction

s over

In other

ens more

shown by

n we look Filing units with peductionEffective Deductionas % of Monev Income

he bottom

ces tax

000 and

TotalMane'! Income

Less than $5,000

Number

o

AverageEffective

Percent Deduction

o % $ 0

FUs withDeduction

o %

AllTaX"Cavers

o %

$5,000-9,999

$10,000-14,999

1,410

3,439

o

1

o

898

o

7.3

o

0.1

Massachu-

,ses work.

and for

mited to

care

percent of

d the

ith income

.e class.

$15,000-19,999 3,149

$20,000-24,999 6,021

$25,000-29,999 9,653

$30,000-34,999 15,189

$35,000-39,999 26,318

$40,000-44,999 9,124

$45,000-49,999 21,339

$50,000-74,999 28,121

$75,000 and over 20,856

1

2

4

8

16

7

19

9

14

1,156

582

1,008

1,527

1,734

1,344

1,663

1,969

2,961

6.0

2.5

3.7

4.6

4.6

3.2

3.5

3.5

2.6

0.1

0.1

0.2

0.4

0.7

0.2

0.7

0.3

0.4

ble

milies

n no-cost

Total

Average

144,618

5 % $1,754 3.8 % 0.2 %

)rs, and SOURCE: Massachusetts Income Tax Simulation Model


filing units with incomes between $10,000 and $25,000, but equal

0.7 percent of income for those in the $45,000 to $50,000 income

range.

Dependent Deduction

Every filing unit with at least one dependent under the age of

12 is entitled to a deduction of $600 if they do not claim a

deduction for child care expenses. Only one $600 deduction is

allowed, even if a taxpayer has more than one dependent under 12

years old. with the exception of filing units with very low

incomes any fixed dollar deduction will reduce tax burdens more for

taxpayers with lower incomes. This can be seen from the data in

the next to last column of table 12, where the dependent deduction

Table 12Analysis of the Dependent Deduction

Massachusetts Personal rncome Tax, 1986

as a percentag,

$10,000-$15,00

income above $

individuals wh

they would pay

Table 12 s:

little impact

all taxpayers,

reasonably con

the income dis

proportion of

tends to rise

Social Securit

Deductions

contributions

a per person ~

taxpayers filj

least $2,000 j

table 13 indic

increases as j

Total

Average

395,184

13 % $ 498 1. 7 % 0.2 %

by all indivic

with the excel

are eligible :

proportion of

social securi'

ot slowly ris

income of $50

percentage of

deduction lim

income among

deduction has

taxpayers, an

income tax fo



" but equal

,,000 income

ier the age of

claim a

iuction is

!nt under 12

rery low

lrdens more for

the data in

lent deduction

.on1986

,"ive Deduction~f Monev Incone

lith All~ion

nxnave!:'s

% 0 %

.2 0.1

,4 0.3

,9 0.2

6 0.4

2 0.4

8 0.2

6 0.3

4 0.3

3 0.2

0 0.3

6 0.1

7 % 0.2 %

as a percentage of income falls from 4.4 percent for those in the

$1 0 ,000-$15,000 income class to 0.6 percent for taxpayers with

income above $75,000. (The only exception to this pattern is poor

individuals who do not benefit from the dependent deduction because

they would pay no taxes even if they did not take the deduction).

Table 12 shows that overall the dependent deduction has very

little impact on the distribution of tax burdens. Averaged across

all taxpayers, the deduction as a proportion of money income is

reasonably constant, ranging from 0.2 to 0.4 percent over most of

the income distribution. This uniform pattern occurs because the

proportion of taxpayers benefiting from the dependent deduction

tends to rise as income rises.

~cial security Tax Deduction

Deductions are allowed for social security (FICA) taxes and for

contributions to certain government retirement systems, subject to

a per person $2,000 limit. Thus the maximum deduction for

taxpayers filing a joint return is $4,000, if each spouse paid at

least $2,000 in social security taxes during the year. The data in

table 13 indicate that the average social security tax deduction

increases as income rises. As social security taxes must be paid

by all individuals who have earnings, it is not surprising that,

with the exception of those with very low incomes, most taxpayers

are eligible for this deduction. The combination of the rising

proportion of taxpayers with earnings and the rising amount of

social security taxes paid as income increases results in a pattern

of slOWly rising deductions as a proportion of income up to an

income of $50,000. Above that income, the deduction as a

percentage of money income falls because of the $2,000 per person

deduction limit and the relatively small share of earnings in total

income among high income taxpayers. Thus the social security tax

deduction has the effect of reducing tax burdens for most

taxpayers, and of slightly reducing the progressivity of the state

income tax for incomes below $50,000.


Table 13

Analysis of the FICA Tax Deduction


Filing units with Deduction Effective Deductionas % of Monev Incone

AverageTotal Effective FUs with All

Mone'}' Income Number Percent peduction Deduction Taxoave;-s

Less than $5,000 270,504 61 % $ 3 0.1 % 0.1 %

$5,000-9,999 219,414 46 207 2.8 1.3

$10,000-14,999 259,956 76 566 4.6 3.5

$15,000-19,999 259,094 80 854 4.9 4.0

$20,000-24,999 251,770 88 1,131 5.0 4.4

$25,000-29,999 190,253 84 1,382 5.1 4.3

$30,000-34,999 177,920 91 1,583 4.9 4.5

$35,000-39,999 155,880 95 1,835 4.9 4.6

$40,000-44,999 119,725 96 2,088 4.9 4.7

$45,000-49,999 110,690 100 2,243 4.7 4.7

$50,000-74,999 291,498 97 2,471 4.2 4.1

$75,000 and over 140,927 97 2,670 2.5 2.4

Total 2,447,628

Average 78 % 1,277 4.0 % 3.1 %


Medical and Dental Expense Deduction

Taxpayers who itemize deductions on their federal income tax

returns are allowed to deduct medical and dental expenses

(inclUding medical insurance premiums) that are in excess of 5

percent of their federal adjusted gross income. Among taxpayers

claiming the deduction with incomes over $15,000 these "excess"

medical and dental expenses are an increasingly smaller portion of

total income as income rises. Table 14 shows that excess medical

expenses fall from 3.6 to 0.7 percent of income as income rises

from $15,000 to over $75,000. The picture is quite different

when we aVI

payers. Tl

eligible fl

Only 9 perl

income rani

over $40,0'

medical ex,

that becau

itemizers,

relatively

this exemp

taxpayers

TotalMonev In,

Less than

$5,000-9,9

$10,000-14

$15,000-19

$20,000-24

$25,000-29

$30,000-34

$35,000-39

$40,000-44

$45,000-49

$50,000-74

$75,000 ar

Total

Average

SOURCE: M


1

1986

ive Deductionf Monev Incone

th AlliQn Tax'Oave~s

% 0.1 %

1.3

3.5

4.0

4.4

4.3

4.5

4.6

4.7

4.7

4.1

2.4

) % 3.1 %

ncome tax

as

ss of 5

taxpayers

"excess"

portion of

ss medical

me rises

ferent

when we average the medical and dental exemption over all tax

payers. The data indicate that the proportion of taxpayers

eligible for the medical exemption rises steadily as income rises.

only 9 percent of taxpayers with incomes in the $15,000 to $20,000

income range are eligible for this exemption. However, at incomes

over $40,000 at least three-quarters of all taxpayers can take the

medical exemption. 12 The data in the last column of table 14 show

that because the medical exemption is only available to federal

itemizers, low and moderate income taxpayers, including those with

relatively high medical expenses, receive little or no benefit from

this exemption. (At the federal level low and moderate income

taxpayers who cannot itemize are entitled to a standard deduction.)

Table 14

Analysis of the Medical Exemption


Filing Units with peduction Effective Deductionas % of Monev Inco~e

AverageTotal Effective FUs with All

Monev Income Number Percent peduction peduction TaX'Oave:;s

Less than $5,000 1,701 ° % $ ° 0.0 % 0.0 %

$5,000-9,999 2,752 1 69 1.2 0.0

$10,000-14,999 9,556 3 405 3.0 0.1

$15,000-19,999 27,527 9 594 3.6 0.4

$20,000-24,999 81,911 29 658 2.9 1.0

$25,000-29,999 98,078 43 604 2.2 1.1

$30,000-34,999 107,882 55 628 1.9 1.1

$35,000-39,999 114,466 70 614 1.6 1.1

$40,000-44,999 93,465 75 625 1.5 1.1

$45,000-49,999 93,661 85 645 1.4 1.2

$50,000-74,999 260,660 86 695 1.2 1.0

$75,000 and over 136,935 91 788 0.7 0.7

Total 1,028,594

Average 33 % $ 660 1.6 % 0.6 %



Personal Exemptions

with the passage ot Chapter 593 in December 1985, Massachusetts

has adopted a system ot declining personal exemptions. Under a

system ot declining exemptions, the size ot the exemption is reduced

as adjusted gross income rises. Table 15 describes how the personal

exemptions are calculated. For those tiling single returns the

TotalMonev IncomeLess than $5,

$5,000-9,999

Table 15


SINGLE RETURNS

The Calculation ot Personal Exemptions$10,000-14,9S

$15,000-19,9S

$20,000-24,9S

$25,000-29,9S

$30,000-34,9S

$3S,000-39,9S

$40,000-44,9S

$45,000-49,9S

$50,000-74,9S

$75,000 and c

Exemption

$3,800

$3,800 minus $20 tor each extra $100 of AGI


$600Over $39,600

Less than $6,000

$6,000 - $9,000

$9,000 - $39,600

Adjusted Gross Income

JOINT RETURNS Average

Ad;usted Gross Income

Less than $10,000

$10,000 - $18,000

$18,000 - $79,200

Over $79,200

Exemption

$8,000


$6,400 minus $17 tor each extra $200 ot AGI

$1,200

SOURCE: Mas:

Whose AGI is

tax, and henc

The avera

function ot t

in each class

personal exemption is $3,800 tor low income taxpayers, and talls to

$600 for taxpayers with incomes over $39,600. For taxpayers tiling

joint returns, the maximum exemption is $8,000, and the minimum exemp

tion is $1,200 tor those with incomes over $79,200. By design exemp

tions that are inversely related to income will result in a more

progressive tax than exemptions that are invariant to income. Table

16 shows the average effective exemption by income class. Effective

exemptions equal actual exemptions for all taxpayers except for those

whose low levels ot AGI qualities them tor "no tax status", and those

taxpayers wit

average exemp

not directly

effective exe

over the uppe

The data

important rol

progressivity

[October

Isachusetts

1986] HOUSE - No. 6386 .

Table 16Analysis of the Personal Exemption


61

1nder a

1 is reduced

:he personal

~s the

1 $100 of AGI

1 $200 of AGI

1 $100 of AG!

1 $200 of AG!

Id falls to

'ers filing

linimum exemp-

lesign exemp-

1 a more

:ome. Table

Effective

lpt for those

I", and those

EffectiveAverage Personal

Average Effective ExemptionTotal Personal Personal as a % of

Honev Income Exemptions Exem'Otions Monev IncomeLess than $5,000 $3,88J. $ 0 0.0 %

$5,000-9,999 4,110 799 10.8

$10,000-14,999 4,042 2,412 19.7

$J.5,000-1.9,999 3,742 2,547 1.4.9

$20,000-24,999 4,012 3,227 14.4

$25,000-29,999 4,227 3,720 13.9

$30,000-34,999 4,099 3,900 12.J.

$35,000-39,999 3,780 3,624 9.7

$40,000-44,999 3,621 3,62J. 8.5

$45,000-49,999 3,350 3,350 7.1

$50,000-74,999 2,759 2,706 4.7

$75,000 and over 1,159 1,159 1.1

Average $3,701 $2,214 %J.O.O


whose AGI is less or equal to zero. These taxpayers pay no income

tax, and hence can receive no benefit from the personal exemptions.

The average personal exemption in each money income class is a

function of the average AGI, and the mix of sinqle and joint returns

in each class. The average exemption is approximately $4000 for

taxpayers with incomes below $35,000. Above $35,000 the size of the

average exemption declines steadily. As many low income taxpayers do

not directly benefit from the personal exemptions, the average

effective exemption grows as income rises to $35,000, and declines

over the upper portion of the income distribution.

The data in the last column of table 16 illustrate clearly the,important role that personal exemptions play in increasing the

progressivity of the state income tax. They reduce taxable income by


a much larger percentage for low income than for high income

taxpayers. For taxpayers in the $10,000 to $15,000 income class,

personal exemptions equal 20 percent of money income. This percent

age falls steadily as .income rises, so that for taxpayers with

incomes over $75,000 they average only one percent of income.

~dent Exemptions

Massachusetts taxpayers are entitled to a $700 exemption for each

dependent claimed on their state income tax return. The effective

dependent exemption also equals $700 per dependent except in the

cases where a filing unit is eligible for "no tax status" or when AGI

reduced by the personal exemption is less than the value of the

dependent exemption. Table 17 shows that both the proportion of

Table liAnalysis of the Dependent Exemption


filing units.

the average e:

exemption is I

burdens decli]

table 17 indic

on tax burdenl

$20,000 and $,

Elderly Exemp1

Each taxpl

extra $700 ex,

two $700 exem]

sUlIl1lIarizes thl

exemption has

Filing units with Exemption Effective Deductionas % of Money Inccne

AverageTotal Effective rus with All

Money Income Number Percent Exemption Deduction TaxoaversLess than $5,000 37,154 8 % $32 0.7 % 0.1 %

$5,000-9,999 80,922 17 188 2.3 0.4

$10,000-14,999 47,792 14 772 6.1 0.9

$15,000-19,999 59,801 19 966 5.6 1.0

$20,000-24,999 88,312 31 1,310 5.9 1.8

$25,000-29,999 74,496 33 1,351 5.0 1.7

$30,000-34,999 77,797 40 1,290 4.0 1.6

$35,000-39,999 80,231 49 1,414 3.8 1.8

$40,000-44,999 54,229 43 1,297 3.0 1.3

$45,000-49,999 65,439 59 1,409 3.0 1.8

$50,000-74,999 162,940 54 1,369 2.3 1.3

$75,000 and over 74,463 51 1,462 1.4 0.7

Total

Average

903,576

29 % $ 1,146 3.5 % 1.0 %

TotalMonev IncomE

Less than $5,0

$5,000-9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,995

$30,000-34,995

$35,000-39,995

$40,000-44,995

$45,000-49,995

$50,000-74,995

$75,000 and 0"

Total

Average

SOURCE: Massachusetts Income Tax Simulation Model SOURCE: Massa


.ncome

:ome class,

This percent

irs with

.ncome.

iption for each

.e effective

:pt in the

.s" or when AGI

,e of the

ortion of

filing units entitlea to take the depenaent exemption and the size of

the average exemption rise with income. However, because the

exemption is a fixea aollar amount per dependent, its impact on tax

buraens declines as income rises. The data in the last column of

table 17 indicate that the dependent exemption has the largest impact

on tax burdens for middle income taxpayers with incomes between

$20,000 and $40,000 •

Elderly Exemption

Each taxpayer who i. at least 65 years old is eligible for an

extra $700 exemption. Taxpayers filing joint return are entitled to

two $700 exemptions if both spouses are age 65 or over. Table 18

summarizes the impact of this exemption. The data suggest that the

exemption has a relatively minor impact on the tax burdens of

n986

ive eeauctionf Money Incor::e

th Allion Taxoavers% 0.1 %

0.4

0.9

1.0

1.8

1.7

1.6

1.8

1.3

1.8

1.3

0.7

0.2 %

0.1

0.1

0.0

0.2

0.2

0.2

0.5

0.4

0.4

0.0

0.4

AllTaxooyers

0.0 %

1.0

2.0

2.1

1.4

1.8

;2.9

2.9

1.5

2.0

1.5

FUs withpeauction

0.0 "

0.1

Table 18Analysis of the Elderly Exemption


Effective eeduc~ion

as % of Monev IncomeFilina Units with Exemption

AverageTotal Effective

Monev Income Number Percent ExgptionLess than $5,000 35,981 8 % $ 0

$5,000-9,999 189,246 40 6

$10,000-14,999 92,273 27 192

$15,000-19,999 61,739 19 350

$20,000-24,999 45,195 16 335

$25,000-29,999 38,700 17 756

$30,000-34,999 26,535 14 933

$35,000-39,999 14,312 9 764

$40,000-44,999 10,094 8 890

$45,000-49,999 1,440 1 700

$50,000-74,999 22,665 8 1,073

$75,000 ana over 14,044 10 1,094

Total 552,224

Average 18 " $ 3081.0 %%



the elderly. Approximately 40 percent of all elderly filing units

(defined as filing units with at least one spouse over the age of

64), have money incomes below $10,000. Most of these elderly

taxpayers would face zero tax liabilities even in the absence of

the elderly exemption. The exemption leads to the largest

reduction in tax burdens for the elderly with incomes between

$25,000 and $35,000.

Summary: The Impact of peductions and ExtmPtions

Table 19 summarizes the combined impact of all deductions and

exemptions. As we have done before, we distinguish between gross

and effective deductions and exemptions. All taxpayers who have a

zero AGI or whose AGI is low enough for them to qualify for "no tax

status" receive no benefit from any of the deductions and exemp

tions. In other words, for these taxpayers effective deductions

and exemptions equal zero. The average effective

Table 19

Analysis of Total Deductions and Exemptions


deduction/.

$50,000.

The lal

deductions

of the sta1

proportion

(above $10,

Deductions

for those 11

only about

$75,000. ~

burdens WO\

taxpayers I

slightly hj

exemptions

reducing rz

moderate ir

The anz

assumes thz

TotalMoney Income

I~ss than $5,000

$5,000-9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

$75,000 and over

Average

Average GrossDeductions and

Exemptions

$ 4,234

5,118

5,204

5,311

6,299

6,727

',004

',466

7,168

',584,,OS,

5,910

$5,876

Average GrossDeductions and

Exemptions

$ 0

952

3,223

3,856

5,330

6,117

6,772

',270

7,168

',584

',057

5,910

$4,116

EffectiveDeductions and

As a , of Income

0.0'

12.8

26.3

22.5

23.8

22.'

20.9

19.4

16.9

16.0

12.1

5.5

15.9%

exemptions

may not be

a BUbstantj

deductions,

For examplf

percent of

available j

low income

credit thar

pattern of

setts, the

this report

Revenue to

DUllIber of t

SOURCE: Massachusetts Income Tax simulation Model


iling units

~he age of

lderly

::lsence of

est

atween

:tions and

leen gross

who have a

for "no tax

ld exemp

aductions

Effectiveeductions and

a 1 Qf Income

0.0%12.826.3

22.523.8

22.720.919.416.916.012.15.5

15.9%

deduction/exemption total increases as income rises from zero to

$50,000. Above $50,000 it decreases.

The last column Qf table 19 shQWS clearly that taken together

deductions and exemptions substantially increase the progressivity

of the state income tax. Total deductions and exemptiQns as a

proportion Qf money income are greater fQr low income taxpayers

(above $10,000) than for middle and high income taxpayers.

DeductiQns and exemptions cQmprise over 25 percent of money income

for thQse with incomes between $10,000 and $15,000, but average

only abQut 5 percent of income fQr thQse with incomes Qver

$75,000. This implies that without deductiQns and exemptiQns, tax

burdens would be substantially higher fQr low and moderate incQme

taxpayers (with incQmes between $10,000 and $25,000) While only

slightly higher fQr high incQme taxpayers. If all deductiQns and

exemptions were eliminated, but tax revenue were held constant by

reducing rates, tax burdens WQuld rise for thQse with low and

moderate incQmes and fall fQr thQse with high incomes.

The analysis Qf deductiQns and exemptions presented above

assumes that all taxpayers who are eligible fQr deductions and

exemptiQns use them to the full extent of the law. This assumptiQn

may not be correct. There is SQme evidence from Qther states that

a substantial number Qf taxpayers dQ not take advantage of all the

deductions, exemptions, and credits to Which they are entitled.

For example, Rubinfeld and Vishny (1982) report that only 59

percent of eligible households filed for a property tax credit

available from the State of Michigan. Furthermore, they find that

low income taxpayers were less likely to take advantage Qf the

credit than moderate or high income taxpayers. If a similar

pattern of under-utilizatiQn of tax preferences exists in Massachu

setts, the income tax is in fact less prQgressive than the data in

this repQrt suggest. Although recent efforts by the Department of

Revenue .to simplify and clarify the tax forms should reduce the

number of taxpayers who fail to use all the tax preferences to

._-------------


which they are entitled, further efforts at taxpayer education and

assistance may be warranted.

Y1L The taxation of 10 Percent Income

As shown in section III, state income tax burdens differ

because different taxpayers have different amounts of income

exclusions, deductions, and exemptions and mixes of 5 and 10

percent income. This section briefly explores the impact of

different income compositions on the pattern of tax burdens in

Massachusetts.

Table 20 lists the three types of 10 percent income, interest

not from Massachusetts banks (referred to as 10 percent interest),

Table 20

Ten Percent Income by Source of Income


Total:Interest·Money :Income 10% pividends Capital Gains+

Less than $5,000 $ 12 $ 4 $ -12

$5,000-9,999 27 15 49

$10,000-14,999 88 58 -54

$15,000-19,999 169 55 -76

$20,000-24,999 207 123 147

$25,000-29,999 347 281 218

$30,000-34,999 567 644 455

$35,000-39,999 587 127 368

$40,000-44,999 493 395 289

$45,000-49,999 514 185 606

$50,000-74,999 1,332 1,101 447

$75,000 and over 3,496 5,392 9,714

Average $ 470 $ 471 $ 594

* Includes all taxable interest income except interest income fromaccounts in Massachusetts banks.

+ Only 50% of long term capital gains are subject to taxation.


dividends, a

realized lon

percent of t

31 percent f

gains. Rece

concentrated

is a relativ

poor, while

rich. The r

with incomes

high levels

this range.

in the incom

For the

percent of A

clearly that

Ten Percer

TotalMonev IncLess than

$5,000-9,

$10,000-1

$15,000-1

$20,000-2

$25,000-2

$30,000-3

$35,000-3

$40,000-4

$45,000-4

$50,000-7

$75,000 a

Average

SOURCE:


::ation and

ffer

::ome

1 10

~ of

ans in

interest

interest),

apital Gains+

$ -1.2

49

-54

-76

147

218

455

368

289

606

447

9,714

$ 594

ncome from

ation.

dividends, and capital gains. (In Massachusetts only 50 percent of

realized long-term capital gains are subject to taxation.) 31

percent of total 10 percent income comes from 10 percent interest,

31 percent for dividends and 38 percent from taxable capital

gains. Receipt of 10 percent income from all three sources is

concentrated among high income taxpayers, although interest income

is a relatively more important source of unearned income for the

poor, while capital gains are relatively more important for the

rich. The relatively high level of dividend income among taxpayers

with incomes between $30,000 and $35,000 is attributable to very

high levels of dividend income among the elderly with income in

this range. The reasons for the bulge in dividends at this point

in the income distribution is not known.

For the average taxpayer, 10 percent income comprises 5.5

percent of AGI, and 3 percent of money income Table 21 shows

clearly that 10 percent income gruws in importance relative to both

Table 21Ten Percent Income as a Percentage of Adjusted Gross Income

and Total Money IncomeMassachusetts Personal Income Tax, 1986

Total 10% Income 10% :Income as aMonev Income as a % of ACI % of Money IncomeLess than $5,000 2.8 % 1.6 %

$5,000-9,999 5.9 1.3

$1.0,000-14,999 5.0 1.6

$15,000-19,999 3.5 1.5

$20,000-24,999 4.8 2.3

$25,000-29,999 7.1 3.3

$30,000-34,999 7.5 5.2

$35,000-39,999 5.0 3.0

$40,000-44,999 3.6 2.8

$45,000-49,999 3.4 2.9

$50,000-74,999 6.2 4.9

$75,000 and over 17.3 14.1

Average 5.5 % 3.0 %



AGI and money income as the level of total income rises. 13

The data also show that only above $75,000 of money income does 10

percent income become an important part of AGI. Below $75,000, 10

percent income comprises considerably less than 10 percent of AGI.

Thus the major impact of taxing 10 percent income at the twice the

rate of 'taxation of 5 percent income is to increase effective tax

rates at the very top end of the income distribution. The data on

10 percent income as a percentage of money income illustrate the

fact that the system of dual rate taxation has very little impact

on the pattern of tax burdens for taxpayers with incomes below

$75,000.

VII. Low Income Protection

Eonomists and policymakers tend to agree that those with very

low incomes should not be subject to taxation. In other words, the

"payment" for government services should only come after the basic

necessities of life such as food, clothing, housing, and medical

care, are provided for.

In designing a tax system that would exempt from taxation those

households with inadequate income to provide for basic necessities,

one must determine both a person's total available resources, and

an estimate of the cost of providing basic necessities. Available

resources should inclUde, in addition to AGI, all cash income not

subject to taxation, such as social security benefits, and the

value of "non-cash" income from food stamps and other sources.

Perhaps the best indicator of the cost of providing basic

necessities is to use the official government poverty level, which

is designed to indicate the income level necessary to meet a "bare

subsistence" standard of living.

Although achieving the goal of exempting the poor from taxation

is conceptually easy, no actual tax system requires the reporting

of income from all sources or uses estimated poverty levels to

determine tax paying status. It should not be surprising,

therefore, if some people with inadequate resources to meet basic

needs are r

with a subs

income taxa

The pur

Massachuset

people and

achieving t

The off

too low to

as being to

"non-cash"

sidies, and

would at le

necessary t

it is not p

analysis.

households

those who f

As we h

very import

tax burden

allow taxpa

exemptions

3,140,500 f

One-quarter

gross incolll

people with

not subject

paying no t

but taxable

S\ll1l of ded\l

income to 2

To guat

positive ta


13

)me does 10

~75,000, 10

~nt ot AGI.

~ twice the

~ctive tax

rhe data on

:rate the

:le impact

5 below

with very

words, the

the basic

medical

cation those

lecessities,

lrces, and

Available

,ncome not

md the

)urces.

.c

Ive1, which

tet a "bare

:om taxation

reporting

'e1s to

19,

leet basic

needs are required to pay state income taxes, while other people

with a substantial excess of resources over needs are exempt from

income taxation.

The purpose of this section is to review the provisions of the

Massachusetts income tax which are designed to protect low income

people and to assess the effectiveness of these provisions in

achieving this goal.

The official poverty level has been criticized both as being

too low to provide even a barely acceptable standard of living, and

as being too high, because it does not include the cash value o·f

"non-cash" sources of income such as food stamps, housing sub

sidies, and medicaid. Despite its inadequacies, poverty level data

would at least provide an estimate for each family of the income

necessary to support a "poverty" standard of living.. Unfortunately

it is not possible in this report to integrate these data into the

analysis. We will, however, look closely at the tax liabilities of

households with low levels of money income and the income level of

those who face zero tax liabilities.

As we have seen in the previous sections of this report, two

very important mechanisms for reducing or eliminating the income

tax burden on the poor are to exclude income from taxation and to

allow taxpayers to reduce taxable income through the use of various

exemptions and deductions. Nearly 1,033,000 of the state's

3,140,500 filing units will pay no state income tax in 1986.

One-quarter (258,000) of those paying no taxes will have adjusted

gross income that are less than or equal to zero. In most cases

people with zero AGls will have sources of money income that are

not subject to taxation. Two-thirds (685,000) of the filing units

paying no taxes will have adjusted gross incomes greater than zero

but taxable incomes equal to zero. For all these filing units the

sum of deductions and exemptions exceeds AGI, reducing taxable

income to zero.

To guarantee that no filing unit with a low AGI faces a

positive tax liability, the Massachusetts income tax defines a "no


tax status" level ot AGI below which no tax is levied. No tax

status is defined as AGI below $6,000 for single returns and

$10,000 for joint returns. These income limits are approximately

equal to the estimated official u.s. poverty level income threshold

for 1986, estimated at $5,675 for a single individual and $11,310

for the average family of four. In 1986 the tax liabilities of an

estimated 90,100 taxpayers will be reduced to zero because of the

no tax status provisions. This number includes all those filing

units who, after applying all applicable exemptions and deductions,

would have to pay state income tax in the absence of the no tax

status provisions. 14

Although the no tax status provisions guarantee that no one

with a low level of AGI will have to pay state income tax, these

provisions have the potential to create serious work disincentives

for households whose incomes are just below the no tax status

levels. By accepting a job that would increase income from just

below to just above the no tax status income level , a worker may

increase his tax liability by more than his increase in income. In

other words, a worker may face a marginal tax rate that is greater

than 100 percent.

In order to minimize this problem the Massachusetts income tax

includes a "limited tax reduction" provision. It stipulates that

no taxpayer must pay a tax that would reduce his or her AGI below

the no tax status limits. Thus a taxpayer filing a single return

with an AGI equal to $6050 would under no circumstance be required

to pay a state income tax of more than $50. As explained in detail

by Tresch (1986), this limited tax reduction provision has the

effect of limiting the maximum marginal tax rate a taxpayer might

face to 100 percent.

Although in principle a 100 percent marginal tax rate would be

expected to provide a substantial work disincentive, there are

several reasons to believe that in practice, little if any disincen

tive effect is created by these provisions of the Massachusetts

income tax. Our simulations indicate that in 1986 only 6,510 tax-

payers will

Although oth

relatively h

that can tal<

indicates tr.

disincentive

liability of

tion is $66.

liability we

It is hi

high margina

how much to

of the poten

not face mar

To the exten

important, t

potential so

than by the

Despite

eliminate th

low income }01

high tax bur

units with i

most of the

burdens that

$173. In ac

$10,000 and

money income

liability of

Who are

taxes when t

little or ne

non-elderly

almost excl\;


No tax

, and

'oximately

Ie threshold

d $11,310

.ties of an

.se of the

e filing

deductions,

no tax

no one

x, these

incentives

tatus

rom just

orker may

lncome. In

ls greater

lncome tax

ites that

~GI below

Le return

~ required

i in detail

is the

'fer might

e would be

t"e are

tly disincen

:lusetts

5,510 tax-

payers will take advantage of the limited tax reduction provision.

Although other taxpayers, with slightly higher incomes, will face

relatively high marginal tax rates, the low number of taxpayers

that can take advantage of the limited tax reduction provision

indicates that the potential number of taxpayers facing strong work

disincentives is relatively small. In addition, the average tax

liability of taxpayers taking advantage of the limited tax reduc

tion is $66. In the absence of this provision, the average tax

liability would only increase by $12.

It is highly unlikely that many taxpayers will in fact take

high marginal tax rates into account when making decisions about

hoW much to work. At the low levels of income, where the problem

of the potentially high marginal tax rate arises, most people do

not face marginal work decisions. A job can be accepted or not.

To the extent that the tax treatment of potential employment is

important, the taxpayer is much more likely to be affected by the

potential social security (FICA) or federal income tax liabilities

than by the much lower state income tax.

Despite the various provisions outlined above, which reduce or

eliminate the tax burdens faced by the poor, there are a number of

low income Massachusetts residents who continue to face relatively

high tax burdens. Specifically, although four-fifth of all filing

units with incomes between $5,000 and $10,000 pay no income tax,

most of the remaining one-fifth (101,580 filing units) face tax

burdens that average 2.2 percent and an average tax liability of

$173. In addition, 45 percent of filing units with income between

$10,000 and $15,000 face tax burdens in excess of three percent of

money income. These 154,000 taxpayers have an average income tax

liability of $427.

Who are these low income taxpayers Who must pay state income

taxes when the majority of people with similarly low incomes pay

little or no tax? The answer is that they are, without exception,

non-elderly persons filing single returns, whose total income comes

almost exclusively from sources that are SUbject to taxation. They


range in age from 17 to 61, with an average age of 27. Most are

single with no dependents, although 7 percent of them are single

parents with one or two dependent children. They receive almost no

income from government welfare programs or workers' or unemployment

compensation. Almost all their income comes from earnings, with

only negligible amounts from interest and dividends. Their capital

losses outweigh their capital gains.

The most important characteristic distinguishing these taxpayers

is that 99 percent of their total money income is included in AGI,

contrasting sharply with the situation faced by most low income

filing units. On average AGI comprises only 40 percent of total

income for those in the $5,000 to $10,000 income range and 72 percent

of income for those in the $10,000 to $15,000 income range. It is

thus only the working poor that pay income taxes; those with non-wage

sources of income, such as welfare recipients and the low-income

elderly, pay little or no income taxes.

VIII. The Taxation of the Elderly

The average elderly tax filing unit (defined as any filing unit

where the head 2X spouse is over the age of 64), faces a state income

tax burden of 0.9 percent. This tax burden is only one-third the

burden faced by the average non-elderly taxpayer. In this section we

will explore the reasons why elderly taxpayers in Massachusetts face

such relatively low income tax burdens. We will also ask whether,

despite low average tax burdens, some elderly residents continue to

face high burdens.

The first answer to the question of why the average elderly tax

burden is low is provided by the data in table 22. On average

elderly taxpayers are poorer than non-elderly taxpayers. The average

total money income of the elderly is $19,292, compared to an average

of $28,407 for the non-elderly. Whereas 41 percent of all elderly

filing units have total incomes of less than $10,000, only 27 percent

of non-elderly filing units have such low incomes. Because the

average income of the elderly is relatively low, their personal

exemption frees a larger portion of their income from taxation.

TotalMonev Incorn

Less than $

$5,000-9,99

$10,000-14,

$15,000-19,

$20,000-24,

$25,000-29,

$30,000-34,

$35,000-39,

$40,000-44,

$45,000-49,

$50,000-74,

$75,000 anc

Total

*A filing uis over the

SOURCE: Ma

Figure

between the

explanation

controlling

the average

$50,000. a

average bur

Differe

average eld


:>st are

single

almost no

employment

s, with

lr capital

taxpayers

i in AGI,

lncome

~ total

i 72 percent

e. It is

lth non-wage

-income

iUng unit

state income

nird the

s section we

usetts face

whether,

ontinue to

lderly tax

erage

The average

an average

1 elderly

y 27 percent

S8 the

rsonal

ation.

Table 22

Number of Filing Units by Age*


Non-Elderly Elderly

'totalMonev Income Number % of Total Number % of Total

Less than $5,000 410,336 15.9 % 35,981 6.5 %

$5,000-9,999 286,966 11.1 189,246 34.3

$10,000-14,999 250,171 9.7 92,273 16.7

$15,000-19,999 260,551 10.1 61,739 11.2

$20,000-24,999 239,787 9.3 45,195 8.2

$25,000-29,999 186,989 7.2 38,700 7.0

$30,000-34,999 168,810 6.5 26,535 4.8

$35,000-39,999 149,549 5.8 14,312 2.6

$40,000-44,999 115,201 4.5 10,094 1.8

$45,000-49,999 109,249 4.2 1,440 0.3

$50,000-74,999 279,280 10.8 22,665 4.1

$75,000 and over 131,421 5.1 14,044 2.5

Total 2,588,305 100.0 % 552,224 100.0 %

*A filing unit is classified as elderly if either the head or spouseis over the age of 64.


Figure 4 shows that differences in the distribution of income

between the elderly and the non-elderly provide only a partial

explanation for lower elderly tax burdens. The data show that

controlling for income the average elderly tax burden is lower than

the average non-elderly burden for taxpayers with incomes below

$50,000. Only above $50,000 do elderly taxpayers face higher

average burdens.

Differences in the composition of money income between the

average elderly and non-elderly taxpayer provide the most important


reason for lower elderly tax burdens. In general, a much larger

portion of the total money income of the elderly is excluded from

AGI and thus not subject to taxation. The most important of these

exclusions is tax-free retirement income in the form of social

security and supplementary security income benefits. For high

income elderly taxpayers, the untaxed portion of capital gains, and

interest from tax-free government bonds becomes an important part

of income excluded from taxation. This differential pattern of

income by source can be seen clearly in table 23 by observing that

in each money income class elderly taxpayers have lower levels of

AGI than non-elderly taxpayers. On average only 31 percent of

Table 23

Adjusted Gross Income by Age·


31 %

AGI as %Monev Inc

12 %

11

28

39

36

47

60

50

77

77

80

81

Elderly

Avg. AdjustedGross Income

$ 1,464 68 t $ 370

4,248 60 761

11,014 90 3,564

15,492 90 6,888

21,143 94 8,258

24,901 91 12,809

30,688 95 19,449

35,333 94 18,801

41,502 98 32,493

46,599 98 14,304

56,656 96 48,844

102,133 91 95,029

$ 26,241 85 % $ 9,699

Non-Elderly

Avg. Adjusted AGI as t ofGross Income Money Income

Average

$75,000 and over

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

$15,000-19,999

$5,000-9,999

$10,000-14,999

Less than $5,000

Total.Monev Income

'i."

~C

~~SUl

~•E8.E

~••::I'5o••o:2:

l:i(JII:::loIII

Io •o •o •• •

I •0:•

O'

Io •o •o.• •.,;~~..

I

g :o •

Io",,}o~~: it

9;..o •. ~,. .




total income is included in the AGI of the elderly, compared to 85

percent for the non-elderly. For every income class at least 60

percent of the income of the non-elderly is included in AGI.

However, only for the relatively few elderly with incomes over

$30,000 (16 percent) does AGI make up as much as 60 percent of

total money income.

In Hassachusetts, because most unearned income is taxed at

twice the nominal rate on earned income, tax burdens also depend on

the composition of AGI. Everything else equal, those with a higher

proportion of income from capital will face higher tax burdens.

Table 24 shows that, as expected, unearned income accounts for a

larger share (16.5 percent) of the elderly's AGI than the non

elderly's AGI (32 percent. It should be noted, that among filing

units with incomes below $10,000, unearned income comprises a

smaller share of the elderly's money income than the non-elderly's

because the former rely so much less on income sources included in

AGI.

At each income class, the fact that the elderly generally enjoy

less earned income and are eligible for an extra $700 exemption

result in lower tax burdens on 5 percent income for the elderly as

compared to the non-elderly. The picture is reversed with respect

to 10 percent income. Here the higher levels of 10 percent income

earned by the elderly lead to generally higher tax burdens for the

elderly. However, because 5 percent income is much larger than 10

percent income for most taxpayers, the net impact of the Massachu

setts income tax is that, with the exception of taxpayers with

incomes over $50,000, elderly taxpayers face lower tax burdens than

non-elderly taxpayers with similar incomes.

Even though the average elderly household faces a considerably

smaller tax burden than that faced by the average non-elderly

taxpayer, there are some elderly taxpayers who face relatively high

tax burdens. For example, although the average tax burden faced by

the elderly in the $15,000 to $20,000 income class is 0.8 percent,

TotalMonev Income

Less than $:

$5, 000-9 199~

$10,000-14,!

$15,000-19,~

$20,000-24, ,

$25,000-29,

$30,000-34,

$35,000-39,

$40,000-44,

$45,000-49,

$50,000-74,

$75,000 anc

Average

*A filing uris over the

SOURCE:: Mal

24 percent c

burdens of

single retul

their incoml

facing burd,

income, com

of 39 perce

6,700 t

tax burdens

[October

red to 85

east 60

::;I.

over

1986] HOUSE - No. 6386

Ten Percent Income by Age*


17

nt ot Non-Elderly Elderly

!d at

depend on

:1 a higher

t:'dens.

!I tor a

non-

~ tiling

es a

elderly's

:::luded in

ally enjoy

mption

Iderly as

n respect

nt income

s tor the

r than 10

Massachu-

with

rdens than

slderably

erly

ively high

n faced by

percent,

Average 10% Income Average 10% IncomeTotal 10% as a 10% as a

Monev Income Income % of AGI Income % of AGI

Less than $5,000 $ 2 2.7 % $ 21 3.1 %

$5,000-9,999 101 2.7 75 10.8

$10,000-14,999 -31 -0.3 423 14.8

$15,000-19,999 -41 -0.2 943 15.1

$20,000-24,999 422 2.9 768 14.7

$25,000-29,999 413 2.8 2,935 28.0

$30,000-34,999 1,002 3.7 5,890 31.2

$35,000-39,999 806 3.1 3,95·9 24.9

$40,000-44,999 688 1.8 6,758 24.0

$45,000-49,999 1,244 2.9 5,938 41.5

$50,000-74,999 1,881 4.0 15,174 32 .9

$75,000 and over 15,881 14.2 44,077 46.1

Average $ 1,278 3.2 % $ 2,740 16.5 %



24 percent of the 62,000 elderly in that income class face tax

burdens of 2 percent or more. This group ot taxpayers all file

single returns and, compared to the average elderly taxpayer in

their income class, have high AGIs. For those elderly taxpayers

facing burdens ot over 2 percent, AGI equals 67 percent of total

income, compared to an average for the elderly in that income class

of 39 percent.

6,700 taxpayers with incomes between $30,000 and $35,000 face

tax burdens of over 4 percent. As in the previous example, these


taxpayers all file single returns and have smaller than average

exclusions from income. In addition, a larger than average

proportion of their AGIs is composed of 10 percent income.

with the exception of some taxpayers with incomes in excess of

$50,000, most of Massachusetts' elderly citizens face state income

tax burdens that are considerably lower than those faced by the

non-elderly with similar incomes. Whether this pattern of tax

burdens is considered fair depends on whether one believes that age

per se should be a criterion for determining tax burdens.

One possible mechanism for increasing the tax burdens on the

non-poor elderly relative to the non-elderly is to adopt the recent

changes in federal income tax treatment of social security

benefits. At the federal level up to one-half of social security

benefits are now subject to taxation if income exceeds a threshold

level of $32,000 ($25,000 for single filers). If Massachusetts had

adopted these federal provisions, in 1986 61,350 elderly taxpayers,

or 11 percent of all elderly filing units, would face higher

taxes. None of those facing higher taxes would have money incomes

below $25,000, and one-half would have incomes in excess of

$50,000. The partial taxation of social security would result in

an average state income tax increase of $166, which equals 6.2

percent of current tax liabilities. Even if social security

benefits were subject to taxation, the average elderly taxpayer

with income below $50,000 would continue to face lower tax burdens

than the average non-elderly taxpayer with similar income.

IX. The Taxation of the Family

At each level of income the Massachusetts personal income tax

provides favorable tax treatment to married couples and to couples

or single individuals with dependent children. The usual justifi

cation for this special treatment is that at any given level of

income, larger filing units require more money to provide for the

basic necessities of life than smaller filing units. Thus

increased family size decreases the ability to pay taxes, and

justifies lower income taxes for larger families.

Massach,

reduce the'

individuals

personal ex

exemption g

individual

married cou

earnings wi

only take a

where both

security ta

The tax

units with

available t

spouses wox

with childx

care deduct

for each dE

In ordE

successful

single ind:

to those w:

single ind

single heal

18) (3) rna:

couples wi'

the averag

groups, re

First,

average ta

households

higher rat

children.


verage

ge

excess of

te income

by the

f tax

s that age

on the

the recent

'I

security

threshold

usetts had

taxpayers,

tler

'I incomes

of

ssult in

s 6.2

ity

lCpayer

Ie burdens

come tax

o couples

justifi

vel of

for the

s

and

Massachusetts income tax law includes two provisions that

reduce the tax liabilities of married couples relative to single

individuals. At every level of income, a married couple receives a

personal exemption that is at least twice as large as the personal

exemption going to a single individual. The $2,000 limit on

individual social security tax (FICA) deductions also benefits

married couples. For example, a single individual with $50,000 of

earnings will pay $3,000 in social security taxes in 1986, but can

only take a $2,000 deduction. On the other hand, a married couple

where both spouses earned $25,000 will be eligible for a social

security tax deduction of $3,575.

The tax code also includes three provisions that benefit filing

units with dependent children. The child care deduction is

available to single working parents, and to couples where both

spouses work. The $600 dependent deduction is available for those

with children under the age of 12 who do not qualify for the child

care deduction. Finally all taxpayers can take a $700 exemption

for each dependent.

In order to see whether these provisions have in fact been

successful in reducing tax burdens for married couples relative to

single individuals, and for those with dependent children relative

to those without, we divided all filing units into four groups: (1)

single individuals with no dependents under the age of 18 (2)

single heads of households (those with dependents under the age of

18) (3) married couples without dependent children, and (4) married

couples with dependent children under 18. Figure 5 which displays

the average tax burdens across income classes for each of these

groups, reveals three general points.

First, at every income class single taxpayers face higher

average tax burdens than married couples. Second, heads of

households face lower rates than single individuals, but

higher rates than married couples, both with and without dependent

children. And third, at incomes below $40,000 couples without


children fa

$40,000 thi

The fil:

Lower tax l:

and single

designed tc

all levels

higher for

taxpayers ,.

Less than $

$5,000-9,99

$10,000-14,

$15,000-19,

$20,000-24,

$25,000-29,

TotalMonev Incom

$30,000-34,

Average

$50,000-74,

$75,000 anc

$45,000-49,

$35,000-39,

$40,000-44,

"Ii."

~Co:::~

~.B•Eou

.El!'0..:::sg....o

::E

Wua:::;)oIII

,00:•

,00O.0 ..0 ...... ...

,000 ..00.... ..

'U)'I

• ..2: :0=:-0....

•oo ..o •.. .... .

,0000o •.. .. ...

0'0O'~O~ O~ O~

(% U!) N3m:ln8 X'v'lO'g0'9

Note: For ~

the a

SOURCE: Mas

[October1986] HOUSE - No. 6386. 81

children face lower tax burdens than couple with children. Above

$40,000 this pattern is reversed.

The first two conclusions are consistent with expectations.

Lower tax burdens for married couples than for heads of households

and single individuals are the result of specific provisions

designed to achieve this goal. The data in table 25 show that at

all levels of income the sum of all deductions and exemptions are

higher for couples than for single individuals, and higher for

taxpayers with children than for taxpayers without children. For

Io.o • Table 25o •• •.. ..'E'

0 Total Tax Preferences by Family TypeJ. .=0.0::-0 Massachusetts Personal Income Tax, 1986....I::.:.=.-

J. .w Total Head of Couple, Couple,: :::::E==0 Monev Income Single Household No Children with Children(,)

6 Less than $5,000 $ 4,096 $ 6,390 $ 8,652 $ 11,243

$5,000-9,999 4,557 6,745 9,230 11,077'"i"0 5,858 9,193 10,5270 $10,000-14,999 4,146::Iic0 $15,000-19,999 4,072 5,494 8,935 10,069l::I

S $20,000-24,999 4,071 5,718 8,716 10,195II'l

~ $25,000-29,999 3,852 4,831 8,496 10,157•E

4,835 8,009 9,9540 $30,000-34,999 3,635u.E!l $35,000-39,999 3,466 6,001 8,115 10,098"0•;:)

$40,000-44,999 3,507 7,375 9,334.= 3,087ug

•• $45,000-49,999 3,270 0 7,337 9,361g:l:

W $50,000-74,999 3,329 4,600 6,973 8,442uII:~

0 $75,000 and over 3,374 0 5,108 7,612II'l

0'0

Average $ 4,107 $ 5,697 $ 7,813 $ 9,333

Note: For purposes of classification, dependent children must be underthe age of 18.



example, average total deductions and exemptions for taxpayers

with incomes between $15,000 and $20,000 are $4,072 for single

returns, $5,494 for heads of households, $8,932 for couples

without children, and $10,069 for couples with children. The data

also show that at all levels of income the extra tax preferences

for being married are considerably larger than the extra tax

preferences received for having children.

The one surprising result is that among taxpayers with low and

moderate incomes, married couples without dependent children have

lower tax burdens than couples with children. The reason for

these lower tax burdens is that couples without children have

dramatically lower adjusted gross incomes than couples with

children. For example, in the $10,000 to $15,000 income class,

the former group has an average AGI of $5,026, and the latter

group (those with children), an AGI of $12,150. Similarly, in the

$15,000 to $20,000 income class, the two AGIs are $8,410 and

$15,175, respectively. Given these AGI figures it is not

surprising that in the $10,000 to $15,000 income class AGI is only

39 percent of money income for couples without dependents, as

compared to 97 percent of money income for couples with children.

The primary reason for the low levels of AGI among couples

without children is that a large proportion of low and moderate

income taxpayers without dependent are elderly. In the $10,000 to

$15,000 income class, 58 percent of this group are elderly, and in

the $15,000 to $20,000 income class 55 percent are elderly. As we

saw in the previous section, a sizeable share of the income of

most elderly taxpayers is retirement income that is excluded from

AGI. We conclude that when we compare two couples with the same

level of AGI, the couple with dependent children will in fact face

a lower tax burden. The data in figure 5 however illustrates the

fact that in general elderly taxpayers are treated even more

favorably than taxpayers with dependent children by the


x. The Imp

In Dece

which manda

tax. The n

Acts and Re

had been ill

exemptions,

$5,000 to ~

to $10,000

gross inco!

indicator (

prior

single ret,

regardless

entitled tl

than $1,20

was $3,200

system of

personal e

adjusted 9

returns wh

taxpayers

personal E

The ar

prior to ~

income ta)

"current:

income ta:

would hav.

the 1986 '

law. 15

Full

ities by


'ers

Lgle

'he data

'ences

.x

low and

:n have

'or

ve

ass,

er

in the

d

is only

as

ldren.

les

rate

,000 to

and in

As we

of

Ii from

same

ct face

as the

e

x. The Impact of the 1985 Income Tax Changes

In December 1985 the Massachusetts Legislature enacted a bill

which mandated a number of major changes in the personal income.

tax. The new legislation (officially know as Chapter 593 of the

Acts and Resolves of 1985), eliminates a 7.5 percent surtax which

had been in effect since 1975, establishes a system of declining

exemptions, and raises the "no tax status" income levels from

$5,000 to $6,000 for those filing single returns and from $8,300

to $10,000 for those filing joint returns. Furthermore, adjusted

gross income replaces a more comprehensive income measure as the

indicator of whether no tax thresholds have been exceeded.

Prior to the newly enacted changes, each taxpayer filing a

single return was entitled to a $2,200 personal exemption

regardless of income. Taxpayers filing joint returns were

entitled to a $4,400 personal exemption if each spouse earned more

than $1,200. If one spouse earned less than $1,200, the exemption

was $3,200 plus the earnings of the lower-earning spouse. The new

system of declining personal exemptions increases the value of the

personal exemption for taxpayers filing single returns who have

adjusted gross incomes below $20,600, and for those filing joint

returns who h~ve adjusted gross incomes below $41,400. All

taxpayers with incomes higher than these levels receive smaller

personal exemptions under the new law.

The analysis in this section will compare the income tax law

prior to the recent changes (referred to as the "old law") to the

income tax law fully reflecting these changes (referred to as the

"current law"). To facilitate analysis of the changes in the

income tax we make a comparison between the tax liabilities that

would have resulted had the old law been in effect in 1986, and

the 1986 tax liabilities generated under terms of the current

law. 15

Full implementation of the current law will reduce tax liabil

ities by $278 million. As no filing units with money income under


$5,000 faced positive tax liabilities under the old law, these

poor filing units receive no benefit from the new legislation.

The data in table 26 show that taxpayers with incomes between

$5,000 and $25,000 receive 32 percent of the total tax reduction,

Table 26

Impact of 1985 Income Tax Changes


Dollar Change in Tax Liabilities due to Adoption of "Current Law"

TotalTotal Change % of

Monev Income (millions of $) ~

Less than $5,000 $ 0.0 0.0%

$5,000-9,999 -14.1 5.1

$10,000-14,999 -23.2 8.3

$15,000-19,999 -24.0 8.5

$20,000-24,999 -28.6 10.3

$25,000-29,999 -26.9 9.7

$30,000-34,999 -26.0 9.4

$35,000-39,999 -20.4 7.3

$40,000-44,999 -16.7 6.0

$45,000-49,999 -14.1 5.1

$50,000-74,999 -42.2 15.2

$75,000 and over -41.9 1!5.1

Total $ -278.0 100.0 %


taxpayers with incomes between $25,000 and $50,000 receive 38

percent of the total tax cut, and taxpayers with incomes over

$50,000 benefit from 30 percent of the total tax cut.

The avel

tation of tl'

the average

the old law:

$30,000 and

in a tax ret

above $75,0

column of T

ities that

Totall10nev Incor

Less t.~an !

$5,000-9,9!

$10,000-14

$15,000-19

$20,000-24

$25,000-29

$30,000-34

$35,000-39

$40,000-44

$45,000-4!

$50,000-7'

$75,000 al

Average

NOTE: ThecalwitLeqRes

SOURCE:


hese

ion.

een

Llction,

The average reduction in tax liabilities due to the implemen

tation of the current law is $89. The data in table 27 show that

the average reduction, (or average tax increase if we reverted to

the old law), increases as income rises to $30,000. Between

$30,000 and $75,000 the implementation of the current law results

in a tax reduction of about $130. For taxpayer. with income.

above $75,000, the average tax cut is nearly $300. The last

column of Table 26 shows the percentage increases in tax liabil

ities that would result from reverting to the old law. The~rent Law"

Table 27ftl Impact of 1985 Income Tax Changes

0% Massachusetts Personal Income Tax, 1986Changes in Average Tax

1Tax Changes from Reversion

3 Average Tax to Old LawTotal

S Monev Income Old Law current Law Average Chanae , Chanae

3 Less than $5,000 $ 0 $ 0 $ 0 0.0 %

7 $5,000-9,999 67 37 30 81.1

4 $10,000-14,999 318 250 68 27.2

3 $15,000-19,999 543 469 76 16.2

0 $20,000-24,999 779 679 100 14.7

1 $25,000-29,999 966 847 119 14.0

2 $30,000-34,999 1,318 1,185 133 11.2

L $35,000-39,999 1,SOl 1,377 124 9.0

$40,000-44,999 1,869 1,736 133 7.7J %

$45,000-49,999 2,121 1,993 128 6.4

$50,000-74,999 2,736 2,S96 140 5.3

$75,000 and over S,989 5,701 288 5.0

Average $ 1,091 $ 1,002 $ 89 8.8 %

38

NOTE: The "old law" refers to the income tax code in effect duringcalendar year 1985. The "current law" refers to the income taxwith full implementation of the income tax changes passed by theLegislature in December 1985 (Chapter S93 of the Acts andResolves of 1985).



percentages fall as income rises. For example, taxpayers with

incomes between $20,000 and $25,000 would face tax increases of

over 25 percent, taxpayers with incomes in the $30,000 to $40,000

range would face tax increases of approximately 10 percent, while

the tax increases for those with incomes over $75,000 would

average only 5 percent.

One way to evaluate whether the recently enacted tax changes

will have any impact on the progressivity of the income tax is to

look at the changes on the pattern of effective tax rates across

income classes. Table 28 shows that the implementation of the

current law will reduce the average effective rate, or tax burden,

from 2.8 to 2.5 percent. The last column of table 28 illustrates

the percentage point change in average effective rate by income

class. It can easily be shown that these numbers are equivalent

to the dollar changes in after-tax income as a proportion of money

income. Larger changes at low incomes than at high incomes

indicate that the income tax is becoming more progressive. The

data do indicate that the implementation of the current law will

result in an increase in tax progressivity. Among those who pay

state income taxes, the largest reduction in taxes as a proportion

of income occurs at the $10,000 to $15,000 income range, while the

smallest reduction occurs at income over $50,000.

Why do the 1985 income tax changes increase the progressivity

of the tax? To answer this question we compared the current law

with a simulation that included only the repeal of the surtax.

The comparison shows that surtax repeal without implementation of

a declining exemption results in a pattern of tax reductions that

provide significantly greater tax reductions to high income

taxpayers. The taxpayers with incomes over $50,000 would receive

slightly over 50 percent of the total dollar value of the tax

reduction resulting from surtax repeal. Recall that with the

implementation of the current law, this group of high income

taxpayers receives only 30 percent of the total tax reduction.

Measured by the change in effective tax rates, the repeal of

TotalMoney IncomE

Less than $!

$5,000-9,99!

$10,000-14,~

$1.5,000-1.9, !

$20,000-24, ,

$25,000-29,

$30,000-34,

$35,000-39,

$40,000-44,

$45,000-49,

$50,000-74,

$75,000 anc

Average

NOTE: Effec'money

The II,

calenlwithLegisResol'

SOURCE: Mas

the surtax

size of th_

the surtax

repeal of 1

taxpayers 1

The tac

increase pl

reduce pro~

[October

with

.es of

1986] HOUSE - No. 6386

Table 28

Impact ot 1985 I~come Tax Changes

87

Massachusetts Personal Income Tax,Change in Effective Tax Rates

Effective Tax Rates

NOTE: Effective rates are defined as tax liabilities divided by totalmoney income.

$40,000

0' while

,d

:hanges

,x is to

across

the

burden,

strates

ncome

valent

of money

The

rI will

10 pay

,portion

lile the

TotalHonev Income

Less than $5,000

$5,000-9,999

$10,000-14,999

$15,000-19,999

$20,000-24,999

$25,000-29,999

$30,000-34,999

$35,000-39,999

$40,000-44,999

$45,000-49,999

$50,000-74,999

$75,000 and over

Average

Old Law

0.0 %

0.9

2.6

3.1

3.5

3.5

4.1

4.0

4.4

4.5

4.6

5.2

New Law

0.0 %

0.5

2.0

2.7

3.0

3.1

3.7

3.7

4.1

4.2

4.4

4.9

2.5 %

1986

Tax Change as aProportion ot

Money Income

0.00

-0.44

-0.55 .

-0.43

-0.45

-0.44

-0.41

-0.33

-0.31

-0.27

-0.24

-0.24

-0.34

;sivity

lt law

:ax.

:ion of

1S that

~eceive

:ax

:he

ae

Lon.

!al of·

'l'he "old law" reters to the income tax code in ettect duringcalendar year 1985. The "current law" reters to the income taxwith full implementation of the income tax changes passed by theLegislature in December 1985 (Chapter 593 at the Acts andResolves of 1985).

SOURCE: Massachusetts Income 'l'ax Simulation Model

the .urtax will decrease the progre••ivity of the income tax. Th.

.ize Of the reduction in .ff.ctive tax rates due to the repeal of

the surtax rises steadily a. income ri.... In other words, the

repeal of the surtax will reduce tax burdens more tor high income

taxpayer. than for moderate or low income taxpayers.

The fact that the implementation of the current law will

increase progr••sivity, while the repeal of the surtax would

reduce proqres.ivity, demonstrates the importance ot the declining


personal exemptions in influencing the distributional pattern of


The increase in the value of the personal exemptions for low

income taxpayers, and, to a lesser extent, the increase in the "no

tax status" income levels have the effect of reducing the nUlllber

of poor filing units Who face positive income tax liabilities. In

the $5,000 to $10,000 income range 42,000 filing units who had to

apy state income taxes under the old law will be exempt from

taxation under the provisions of the current law. Under the old

law 26 percent of filing units with incomes between $5,000 and

$10,000 faced tax burdens of over 2 percent. Under the provisions

of the current law this nUlllber is reduced to 12 percent.

XI. Conclusions

This report uses a microsimulation model o·f the Massachusetts

personal income tax and data from a large random sample of

Massachusetts residents to analyze the pattern of tax burdens

created by the income tax. Measured in terms of the average tax

burdens faced by taxpayers in each income class, the tax is mildly

progressive. However, when account is taken of the tact that the

state income tax is deductible by itemizers on their federal

income tax returns, the income tax is shown to be proportional

above $30,000 of money income.

The tax is quite successful in protecting the poor from

taxation. Eighty-eight percent of tiling units with money incomes

below $10,000 will owe no tax in 1986. Below money incomes of

$15,000, most of those who do pay taxes are wage earners who tile

single returns.

Among those who pay income taxes in Massachusetts there is

relatively little variability in tax burdens, with three-quarters

of all taxpayers facing burdens between three and five percent of

money income.

The report also evaluates the income exclusions, deductions,

and exemptions that are part of the personal income tax in Massa

chusetts. On the Whole these provisions add to the progressivity

of the tax.

this report (

benefits, th,

presented he

Finally,

$50,000, eld

lower than t

controlling

burdens that

duals, and 1

taxpayers w:

Althougl

income tax]

question: i',

does provid

question fo

provisions

to allow th

a large rar


:ern of

~or low

1 the "no

number

:ies. In

) had to

'om

~he old

I and

'ovisions

:husetts

ens

qe tax

• mildly

hat the

al

onal

11

incomes

s of

10 file

l is

larters

:ent of

:ions,

Massa

Isivity

of the tax. On the other hand, because the income measure used in

this report does not include most employer provided fringe

benefits, the tax is less progressive than indicated by the data

presented here.

Finally, the data indicate that below money incomes of

$50,000, elderly taxpayers face tax burdens that are considerably

lower than the burdens faced by the non-elderly. Also, after

controlling for income and for age, married couples face tax

burdens that are lower than the burdens faced by single indivi

duals, and taxpayers with children face lower tax burdens than

taxpayers without children.

Althouqh this report presents data on the distribution of

income tax burdens in Massachusetts, it does not answer the

question: is the personal income tax fair? However,. hopefully it

does provide SUfficient data for the reader to answer this

question for him/herself. The detailed analysis of the individual

provisions of the tax should also provide SUfficient information

to allow the reader to evaluate the distributional consequences of

a large range of potential changes to the tax.


APPENDIX

Description of the Massachusetts Income Tax Simulation Model

The Massachusetts Income Tax Simulation Model (MITS) is alarge scale computer model designed to evaluate the distributionof tax burdens generated by the Massachusetts personal incometax. The model is designed to calculate state income tax liabilities for a random sample of Massachusetts residents. The modelreflects in great detail nearly all the specific provisions of thestate income tax code. Its structure permits evaluation of thecurrent law and a wide range of possible reforms.

The MITS model is constructed as a series of new subroutinesto the Transfer Income Model (TRIM); a model developed during theearly 1970s by the Urban Institute and the (then) U.S. Departmentof Health, Education, and Welfare. Since its development, theTRIM model has been used to evaluate proposals for a large numberof federal government programs. The MITS model is written inFORTRAN and operates on a large IBM mainframe computer.

In order to get a complete picture of the distribution ofincome tax burdens, it is important to account for all stateresidents, including those who do not owe any tax, or are notrequired to file returns. As discussed in section II of thereport, the model defines as filing units all single individualsor married couples who are not dependents of another taxpayer.The MITS model determines tax dependency status by using data onthe family relationships and income of each person within ahousehold.

After defining tax filing units, the model calculates adjustedgross income (AGI) by dividing income into two classes: 5 percentincome, .which includes all earned income plus interest income fromaccounts in Massachusetts banks, and 10 percent income, whichincludes other interest income, dividends, and taxable capitalgains. Interest income is allocated between 5 and 10 percentincome on the basis of data from a national survey of assetcomposition (curtin and Newbig, 1979).

After determining AGI the model calculates total deductionsand exemptions for each filing unit. The amount of each f1lingunit's social security (FICA) tax deduction is calculated by aseparate FICA model. The rental deduction is calculated on thebasis of econometrically estimated rental payments with data fromthe Survey of Income and Education. The deduction forwork-related child care expenditures is based on a three-stageestimating procedure that first determines whether a filing unitis eligible for the deduction, then estimates, using a logitregression, the probability of that filing unit (characterized byits income and demographic composition) having eligible child careexpenditures, and finally, estimates the amount of the allowablededuction. The econometric estimates of work-related child careexpenditures are based on data from the Michigan Panel study ofIncome Dynamics.

Massachusetts taxpayers who itemize deductions on theirfederal return can use the amount of their medical deduction as anexemption in calculating state taxable income. The MITS model islinked to a federal income tax model which estimates each filingunit's itemization status. The model estimates medical deductionson the basis of unpublished Internal Revenue Service data on theaverage deduction for each of 1,700 demographic/income classes.

ApplyiX'lmodel calclJfiling unittotal statE

In ordEthe MITS mesurvey (CPfCensus Bur,size, age,data are f(separatelytaxation, I

taxation, I

an's benef:the CPS arlbased on dlThe propor'governmenton tax expincludes da weightedpopulation

In ordthe incomeusing databetween 19income forTRENDLONG0

, Estimathe MITS Jl

tax constIHunter Colitemizerseach classrate, anditemizersoffset ishis or hel


L

a.1tionnelabilnodelof thethe

:ines~g theC'tmentthe~umber

In

!r.:a on

ijustedlrcent~e from:h:alit

:ions.ing, athe

L from

Lgeunit.t:ed by.d carerablel care. of

L as anlel is.lingLctionsL the;e5.

IIjII!!11

Applying the appropriate deductions and exemptions, the HITSmodel calculates taxable 5 and 10 percent income, checks eachfiling unit's "no tax status", and as a final step, calculatestotal state income tax liabilities.

In order to generate the results presented in this report,the MITS model was run on data from the 1984 Current PopulationSurvey (CPS). The CPS is a large survey conducted by the U.S.Census Bureau. It includes information on family structure andsize, age, race, sex, ethnic background, and income. The incomedata are for the year 1983. The CPS income data, which are listedseparately by source of income, includes income subject totaxation, such as wages and dividends, and income excluded fromtaxation, such as welfare payments, social security, and veteran's benefits. The only source of money income not included inthe CPS are capital gains. These however, have been estimatedbased on detailed data provided by the Internal Revenue Service.The proportion of interest income that comes from tax-freegovernment obligations has also been estimated based on IRS dataon tax expenditures. The Massachusetts sample of the 1984 CPSincludes data on 1,475 families and 3,645 persons. The sample isa weighted random sample, with the person weights summing to thepopUlation of the state.

In order to provide policy simulations for calendar year 1986,the income data on the 1984 CPS have been inflated to 1986 valuesusing data on per capita personal income growth in Massachusettsbetween 1983 and 1986. Estimates of 1986 per capita personalincome for Massachusetts are from the Data Resources, Inc.TRENDLONG0985 regional forecast •

. Estimates of the federal tax offset are generated by linkingthe MITS model with a microsimulation model of the federal incometax constructed by the author and Professor Howard Chernick ofHunter College. Appendix table 1 presents data on the number ofitemizers by money income class, the proportion of taxpayers ineach class who are itemizers, the average federal marginal taxrate, and the average dollar value of the federal offset foritemizers in each income class. For each taxpayer the federaloffset is equal to the taxpayers's federal marginal tax rate timeshis or her state income tax liability.

92 HOUSE - No. 6386

Appendix 'rable 1

[October 1986]

Number and Percentage of Itemizer.Federal Marginal 'rax Rates and Federal Offsets

Massachusetts Personal Income 'rax, 1986

+temizers on Federal Returns

AverageFederal Average

'rotal % of 'rotal Marginal FederalM::ne'T 'Inc::~.e NU;:lbe;,- Taxt::a'Ters Tax Rate or~set

Less t."1an $5,000 1,701 ° % 0 % $ 0

$5,000-9,999 2,752 0 6 0

$10,000-14,999 9,556 3 13 55

$15,000-19,999 27,527 9 18 109

.$20,000-24,999 81,911 29 20 156

$25,000-29,999 101,035 45 22 205

$30,000-34,999 107,882 ;:- 23 290-;)

$35,000-39,999 .121,152 74 26 .381

$40,000-44,999 105,027 84 29 508

$45,000-49,999 102,067 ·92 31 633

$50,000-74,999 285,256 94 35 931

$75,000 and over 145,465 100 42 2,427

Average 90,944 49 % 22 % $ 475


$0 - $4,999

$5,000 - $9,999

$'0,000 - $14,99


~pencltlC FtllU", A

.ets Distribution of Tax Burdens 'Nithir) EachIncome Class

Massachusetts Personal Income Tax. 1986

AverageFederalOf"'set

$ 0

o

55

109

lc:~_0

205

$0 - $4-,999

290

508

633

931

2,427

$S,OOO - $9,999

3.0 - 3,99 5.0 - 5.994.0 - 4.DG 8.0 a: oy.,.0-.00

$10.000 - $14,999

$ 475

TAX BURDEN On %)

SOURCE: Wa••CIClhu.etta Inoom. Tax SImulation Wodel


AppendIx Fi;u... A (cont.)



$15,000 - '19,999$30.000 - $34.

$20,000 - $24,999$.35,000 - $39,!

$40.000 - $44,

3.0 - 3.99 5.0 - 5.994.0 - 4.99 6.0 '" over0-.119

~,ooo - $29.999

TAX BURDEN (in %)

SOURCE: Uo..oc:hue.tta Income Tax SImulation Wodel5(

[October

:ach

3

1986]

od

(/)0a:UJ o~u:i0..:'"

~~-J 0",00~

$:30.000 - $:34.999 g ~u.. ...o~~

HOUSE - No. 6386

Appendi" FlQuns A (cont.)



95

- 5.996.0 a: over

Zero 1.0 - 1.99 3.0 - 3.B9 5.0 - 5.99o- .8B 2.0 - 2.98 4.0 - 4.99 6.0 a: over

TAX BURDEN (in %)

SOURCE: "CIIDOchuDett:a Income TCIIC Slmulotlcn Model


L Thepasta:xtllCinccalCOIl

so\:secrei!datta::-a f

sul:

2. ThEona 1

3. Toar,prE

4. Th!COlar,ho'COl

5. Noes·wi

6. Eqofpepe

7. ThdedeFcrefe

(:l

wl:fc

"pj2.tli~

. (,

wIwIPi0i1Y

TAX BURDEN (in %)


Zero 1.0 - 1.99 J.O - J.99 5.0 - 5.99o- .99 2.0 - 2.99 ••0 - ••99 8.0 .t oyer

Distribution of Tax Burdens 'Nithin EachIncome Class

SOURCE: NoallGChuaetta Income Tax Slmulatlon Nod"

$50.000 - $704-,999

$75.000 c!c over


NOTES

cch

5

~. There are several advantages to using mic~osi:ulat~on~o ,based on household surveys as opposed to data frc~ inc__de _stax returns. First, tax return data are only availa.bl;···~~~ose taxpayers who file returns. Hany people wi~~ low orincomes are not required to file returns. Second, t.~~

calc~lation of tax burdens requires an income measure ascomprehensive as possible. It shoul~ include inco~e frc~sources t~at are excluded fro~ taxat~on such as socialsec~rity benefits, welfare paynents, and one-half ofrealized capital gains. Analyses ~at are based solelv c~

data fro::. income tax ret~=:1s will seriously overstate the"tax burdens of many taxpayers, especially the poor, Who ce~

a su=stantial portion of ~~eir incomes from sources not ~ subject to taxation.

2. The HITS model uses data fro~ the Current population SU~:ev

on the fa~ily relationships and income of each person withlna household to deter:ine tax dependency stat~s.

3. To increase readability in presentation, ef=ective tax ratesare mUltiplied by 100. Thus a 3 percent tax rate ispresented in tables as 3.0 ra~~er ~~an 0.03.

4. The HITS model does not allow identification of marriedcouples who file separate ret~rns. Thus all married couplesare assumed to file joint ret~rns. It should be notedhowever, that in recent years more ~~an 97 percent of allcouples filed joint returns.

where MTR is the taxpayer's federal marginal tax rate. Thusfor a taxpayer with an MTR equal to 30 percent, deducti-

-bility of state taxes reduces a 4 percent effective rate to2.8 percent (70 percent of 4). For any given income class,the average effective tax rate net of the federal tax of:setis given by

tfo - tel - MTR),(3)

7.

5. Not all filing units actually file ret~rns. Thus, weestimate that close to 44 percent of all federal ret~rns

will be filed by taxpayers who ite~ize deductions.

6. Equation (1) is a slight simplification of the calc~lation

of tax liabilities. Deductions are subtracted only from 5percent income, and exemptions are subtracted from 10percent income only after 5 percent taxable income equals z~~~

The calculation of effective tax rates in equation (2)does not account for ~~e fact that state income taxes aredeductible in calc~lating federal income tax liabilities.For taxpayers who ite~ize deductions on t.~eir federalreturns, the effective state income tax rate net of t.~e

federal Offset, tfo' is defined as

•-5.9~9---·8.0 & over'

tfo - tel - ~MTR),

where ~ is the proportion of taxpayers in t~at income classwho itemize deductions on their federal returns. It shouldbe noted that the value of tfo in equation (4) is the valueof tfo as defined in equation (3) times the proportion ofitem~zers, e, plus t times the proport~on of ncn-ite~i=ers,

1 - e. Combining te~s and simplifying this e~~ression

yields equation (4).


8.

9.

10.

11.

12.

13.

14.

15.

Taxing unemployment compensation above an income thresholdcan create a particularly strong work disincentive. For acouple whose AGI plus'unemployment compensation is slightlygreater than ~~e threshold amount of $18,000, every extradollar of earnings will bring an extra 50 cents ofunemployment compensation into ~~e tax base. In otherwords, each extra dollar of earnings will increase taXableincome by $1.50, in effect mUltiplying the marginal tax rateby 1.5.

The threshold amounts are defined in terms of modifiedadjusted gross income, which is the sum of AGI, tax-free,interest income, and one-half of social security benefits.Income tax is calculated on one-half of the smaller ofsocial security benefits, and the different between modifiedAGI and the threshold levels.

Although the general patterns implied by the data in ~'le

table are valid, the small sample sizes at the top end ofthe income distribution require us to interpret t.'le pointestimates with p~icular care.

We have assumed that the primarj individual or family ineach household pays the entire rent. This implies that anadult child living with his or her parents, or elderlyparents living with their children, pay no rent. To theextent that rent payments are shared by all tax payinghousehold members, we have underestimated the number offiling units .li~ible for the rent deduction.

The MZTS ~odel somewhat overestimates the proportion ofhigh income taxcayers who take the medical deduction.Never-...heless, the general pattern of eligibility shown intable 13 is correct.

The decline in the ratio of 10 percent income to both AGIand money income in the $40,000 to $50,000 range may be due

'to the fact that this income range includes a relativelylarge proportion of two-earner families who have little or no unearned income.

Because "no tax status" is defined in terms of AGI ratherthan total income, a number of filing units with low AGIrelative to total income benefit from the no tax statusprovisions. In fact, a few filing units Whose income taxliabilities are reduced to zero by the no tax statusprovision have money incomes in excess of $20,000.

This comparison is between ~~o hypothetical situations. Infact, in 1986 the personal income tax in Massachusetts is acombination of provisions from the "old" law and t.'le"current" law. In 1986 only one-half of the surtax iseliminated, and the 014 personal exemptions are applicable.Full surtax repeal and t.'le declining exemptions will not beimplemented until 1987.

Chernick, Eand thprepa:z:Econolt

Chernick, F.Socia]

Commonwealtstabi]FiscaJ

curtin, T.MonitcInsti1

Feenberg, IIncomlcambr:

Newman, SalMobil:Capit;Insti'

Noto, NonnIntenLow Iservi

Pechman, JDC:

Phares, 00Massa

The Presid.wJ5L§Offie

Rubinfeld,Reducstrucunrve

Tresch, Ri_Repo:z:

[October

sholdFor aightlyxtra

1986] HOUSE - No. 6386

BIBLIOGRAPHY

99

rxableax rata

dreefits.f,odified

t."le,d ofoint

in,at anythe,qof

of

rn in

L AGIbe Clue'ely:1e or .

LtherAGI:usI tax

15. In:s is a

~s

Lcable.not be

Chernick, Howard and Andrew Reschovsky, 1985. "Federal Tax Reformand the Financing of State and Local Governments", Paperprepared for presentation at the annual meetings of the AmericanEconomics Association, New York, NY, December 29, 1985.

Chernick, Howard, and And~ew Reschovsky, 1985. "The Taxation ofSocial Security", National Tax Journal, June.

Commonwealth of Massachusetts, 1985. Economic Strength. FiscalStability, House NO.1, Volume 4: Tax Expenditure Budget forFiscal Year 1986, Boston: January 23.

curtin, T. and S. Newbig, 1979. "Asset Ownership", Working Paper,Monitoring Economic Change Program, Ann Arbor, Michigan:Institute for Social Research.

Feenberg, Daniel R. and Harvey S. Rosen, 1985. "state PersonalIncome and Sales Taxes: 1977-1983", Working Paper No. 1631,Cambridge, Massachusetts: National Bureau of Economic Research.

Newman, Sandra and James Reschovsky, 1985. "Federal Policy andMobility of Older Homeowners: The Effects of the One TimeCapital Gains Exclusion", Research Report, Ann Arbor, Michigan:Institute for Social Research.

Noto, Nonna A., 1980. "Tax Expenditures: The Link Between EconomicIntent and the Distribution of Benefits among High, Middle, andLow Income Groups", Report No. 80-99 E, Congressional ResearchService, Washington, DC: Library of Congress.

Pechman, Joseph A., 1985. Who Paid the Taxes. 1966-85?, Washington,DC: The Brookings Institution.

Phares, Donald, 1980. Who Pays State and Local Taxes?, Cambridge,Massachusetts: Oe1gesch1ager, Gunn and Hain, Publishers, Inc.

The President's Tax Proposals to the Congress for Fairness. Growth.and Simplicity, 1985. Washington, DC: Government PrintingOffice, May.

Rubinfeld, Daniel L. and Robert W. Vishny, 1982. "Property TaxReduction in Michigan", in Michigan's Fiscal and Economicstructure, edited by Harvey E. Brazer, Ann Arbor, Michigan: TheUniversity of Michigan Press.

Tresch, Richard, 1986. "The Massachusetts Personal Income Tax",_.Report to the Special Commission on Tax Reform.

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