A sinkhole has opened beneath the state budget, thanks to a $240 million shortfall in April tax payments. Something will have to be done — and quickly — if lawmakers want to balance the books before the current fiscal year ends in July.
Don’t be too quick to blame the usual suspects, however. This time, it’s not about weak economic growth, swelling health care costs, or the long-term imbalance between spending and revenue that has left the state facing budget deficits for the past decade.
In fact, the root cause doesn’t lie in Massachusetts at all. Our current budget shortfall is driven by the changing of the guard in Washington and the alluring promise of what President Trump’s team has called “the biggest individual and business tax cut in American history.”
The mere prospect of falling tax rates has already started changing people’s behavior, encouraging them to hold stocks a bit longer or claim their income a bit later. And that’s wreaking havoc across state budgets, including in Ohio, Connecticut, and Pennsylvania.
A few examples, before we get to the evidence.
Say you have a lot of money in the stock market. You don’t pay taxes on those investments until you sell your shares and pocket the gains. So if you believe that the tax rate on investment income is going to fall — as it would under Trump’s plan, at least for high-income families — then it makes sense to refrain from selling until the tax plan is enacted.
Alternatively, imagine you’re an independent contractor or a small business owner. Then your incentive to defer income is even stronger. That’s because Trump’s plan would cut the top tax rate for closely held businesses from a maximum 39.6 percent to just 15 percent. So rather than send out invoices in December 2016, maybe you wait until 2017 on the unlikely-but-potentially-transformative possibility that his tax changes kick in this year.
These are oversimplified examples. But there are good reasons to think that taxpayers really are seeking creative ways to defer their tax bills, and draining state coffers in the process.
One way to see this is by looking at the difference between automatically paid and self-reported taxes.
The automatic sort, such as the withholdings from your paycheck for Medicare, Social Security, and state taxes, don’t allow much opportunity for gamesmanship of tax deferral. The same is true for the sales tax, which is applied to your purchases and collected on the spot.
Right now, automatic taxes are going up more or less as you’d expect in our middling economy. Total withholding for January through April 2017 was about 3.2 percent above the same period last year. Sales tax receipts grew at a slightly more sluggish 1.5 percent, but that’s still more or less in line with current economic conditions — especially once you account for the fact that we’re spending more online, where sales tax collections are uneven.
The very fact that receipts for these kinds of automatic taxes are relatively healthy suggests that there is no problem with the state economy. The April shortfall must have some other cause. And you can spot it once you turn to the kind of taxes people have to calculate themselves and then share with the state.
Consider estimated taxes. Business owners and those with large investment portfolios are often required to report taxable income on a quarterly basis and pay as appropriate. And guess what? These estimated payments to the state are down 8 percent compared with January-April 2016.
Or look at the just-filed state income tax returns from April. Payments were down 12 percent from last year, a huge drop. And we know it’s not because people in Massachusetts are earning less money. Remember, withholding is up, a sure sign that incomes are doing just fine.
So blame the big April shortfall on investors, business owners, independent contractors, and others whose earnings aren’t covered by withholding.
If those sorts of taxpayers sent in lots of unexpectedly low checks, that can’t really be because they’re struggling — after all, the economy and stock market are both humming along. Deliberate deferral is a far more likely explanation.
This is a perfectly sensible strategy, when the president and congressional leaders are all promising a substantial rewrite of the tax code. And in the years ahead, the state may reap a kind of compensatory windfall, when all this deferred income shows up on future tax returns.
For now, though, it’s having a destabilizing effect on the state budget, forcing lawmakers to make last-minute changes and hunt for unused funds in every budgetary corner. Think of it as the latest reminder that even deep-blue Massachusetts is extremely vulnerable to policy changes — even mere proposals — emanating from red-dominated Washington.