Last month, economists estimated state revenues for fiscal 2021 will fall short of projections by $5 billion to $6 billion — a drop of nearly 20 percent. But the shortfall may be larger, since recent reports indicate that GDP has slowed more than expected, and more than one-fifth of the labor force is currently unemployed, working reduced hours, or had given up looking for work. Worse, revenues have plummeted exactly when more public spending is desperately needed to cover escalating public health costs and the greater demands on safety-net programs due to the coronavirus pandemic.
Help may be on the way from the federal government, but when and how much remains uncertain. Fortunately, the state has amassed a $3.5 billion rainy day fund to buffer budget shortfalls during recessions. It’s hard to imagine a rainier day than the sharp economic contraction that has occurred since March: State tax revenues in April were $2.34 billion lower compared with the same month last year, partly due to the delay in income tax payments until July. Yet even if these deferred income taxes are paid and federal aid to states and localities materializes, this will likely not be enough to fill the gap. Given the balanced budget mandate, how can the Commonwealth avoid painful cuts to essential social services, local aid to cities and towns, and investments in K-12 and higher education?
History shows that spending cuts are more harmful than tax increases during recessions — especially in a downturn expected to be sharp but short like this one. Why? Shrinking safety-net programs like food pantries, housing, and health care remove spending from the economy when it is most needed and from the people who need it the most. Cutting local aid to cities and towns for police and fire protection, parks, and public works erodes the infrastructure that makes communities vibrant places to live and work. Reducing funding for K-12 and higher education reverses longstanding investment in human capital — including recent new commitments, such as the Student Opportunity Act enacted last November that provides more than $2 billion in additional school funding through 2027 — with long-term consequences for worker productivity and economic growth. Moreover, all of these spending cuts serve to exacerbate the already high level of inequality that exists in the Commonwealth.
Although raising taxes can reduce consumer spending and slow economic growth, it turns out to be less damaging than the alternative. Both the Great Depression of the 1930s and, more recently, the Great Recession of 2008-09 demonstrated that raising taxes to fund public spending could stimulate a depressed economy. This is because the rise in public spending more than offsets the fall in private spending, since some of the increase in taxes that households and businesses pay comes out of savings. In contrast, all of the tax revenue collected by the government is spent — much of it by purchasing goods and services from the private sector — and so total spending increases, driving job creation and income growth.
How big would the tax increase need to be and how can we ensure that the burden on taxpayers is distributed equitably? The Commonwealth’s income tax is directly tied to ability to pay and is mildly progressive due to the personal exemption. Increasing the income tax from 5 to 6 percent would raise approximately $2.5 billion per year and could be combined with a phase-back provision to 5 percent as the economy recovers. Moreover, unemployment insurance benefits could be exempt from being taxed by the state to ease the burden on those most impacted by job loss due to the pandemic.
Ultimately, policy makers need to consider the trade-offs involved in any of these options for balancing the budget. It’s likely that some combination of federal funds, rainy day funds, and tax increases would be needed to prevent deep spending cuts. More spending on public goods, services, and investments means less spending on private goods, services, and investments. In other words, households and business owners will have to make financial sacrifices. Ultimately, the question for taxpayers and policy makers is: Are these sacrifices worth it? Given the existential threat confronting the residents, cities and towns, businesses, and major institutions, we believe the answer is a resounding yes.
Alan Clayton-Matthews is professor emeritus at the School of Public Policy and Urban Affairs at Northeastern University. Michael Goodman is a professor of public policy and executive director of the Public Policy Center at UMass Dartmouth. Alicia Sasser-Modestino is an associate professor at the School of Public Policy and Urban Affairs at Northeastern University.