If passed, a constitutional amendment to impose a graduated income tax would raid the retirement plans of Massachusetts residents by pushing their owners into higher tax brackets on the sales of homes and businesses, according to a new study published by Pioneer Institute.
The study, “The Graduated Income Tax Trap: A retirement tax on small business owners,” aims to help the public fully understand the impact of the proposed new tax.
In June 2019, Massachusetts legislators proposed and provided initial approval to an amendment to the state constitution that would eliminate a century-old requirement that Massachusetts impose taxes at a uniform rate. The proposed amendment would impose one of the highest state income tax rates in the country and make Massachusetts the only state in the nation to permanently enshrine such a tax in its state constitution where it cannot be quickly adjusted in the face of changed circumstances in the future.
Advocates claim the proposed 4% surtax on annual household income greater than $1 million (about 20,000 individuals) would raise nearly $2 billion per year for education and transportation, while opponents say it would hurt small business owners, prompt wealthy residents to move to more tax-friendly states and encourage employers to steer clear of Massachusetts.
The amendment (H 86) must win at least 101 votes of support among the 200 state legislators at a Constitutional Convention in the current legislative session in order to go before voters on the November 2022 ballot. Senate President Karen Spilka has until May 12 to convene a new Constitutional Convention.
A “raid on retirement nest eggs”
National data from the U.S. Treasury Department show that the majority of taxpayers earning more than $1 million in a year did so only once over a nine-year period. Data Pioneer Institute recently obtained from the Massachusetts Department of Revenue make it clear that this phenomenon hits close to home as well.
“A graduated income tax would be more of a raid on retirement nest eggs than a tax on super wealthy millionaires,” said Andrew Mikula, who co-authored the study with Greg Sullivan. “In Massachusetts, 46% of the people who would be affected by the tax—those with incomes over $1 million—did so only once in 10 years. Sixty percent did so only once or twice in the 10-year period that ended in 2017. These are likely people selling a business or a home.”
Evidence from other states heightens the concern that older adults are willing to move to protect their retirement nest eggs. After California passed an income tax hike in 2012 that had a similar impact on seniors, it witnessed a wave of out-migration among its more senior population the following year.
In 2012, California lost about $87 million in taxable income from net out-migration of people aged 65 and older. That number exploded to $1.26 billion in 2013. Meanwhile, other amenity-rich Sunbelt states, notably Florida, have thrived by attracting wealthy retirees and other migrants with low taxes and a friendly business climate.
Data also show that nearly half of the capital gains earned in the U.S. from 2007-2012 were from pass-through businesses, another common source of retirement funding. Pass-through entities are usually small businesses that pay taxes via the personal income returns of their owners.
Over the period 2007-2012, capital gains from U.S. pass-through businesses totaled more than double those from stocks, bonds, and mutual funds combined. Owners that sell these businesses to pay for their retirement could see their tax bills on those capital gains rise by 80% under the surtax.
The surtax could similarly affect long-time homeowners in areas with sharply rising home prices. In some communities in Massachusetts, such as Cambridge, the median single family home price rose by more than $1 million between 1995 and 2020. While a tax exclusion of up to $500,000 for joint filers would apply to sales of these homes, a graduated income tax could blindside elderly people relying on accrued real estate value to fund their retirement.
“This surtax would devastate the retirement plans of many Massachusetts residents,” said Pioneer Institute Executive Director Jim Stergios. “Proponents of the tax haven’t thought about the incentive it creates to change one’s domicile to low- or no-tax states as Massachusetts residents approach retirement, nor the deterrent it would create to investment.”
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• ‘Millionaire Tax’ Coming to N.J.—Will Other States Follow Suit?
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.