and the
Citizens Economic Research Foundation

Barbara's Column
May #2

Small wonder smart businesses choose
to invest their money elsewhere
by Barbara Anderson

The Salem News
Thursday, May 14, 2005

So glad the Commonwealth of Massachusetts is looking at a billion-dollar surplus this year. That will be enough not only for the voters' income tax rollback, but also to deal with the recent Supreme Judicial Court decision on the capital gains tax.

If you, like me, depend on the wages you make rather than investment income, you may think that capital gains isn't an interesting topic for a column. But I assure you, if you get this issue, you "get" what is wrong with Massachusetts government in general, Beacon Hill in particular, and the low-job-growth state economy.

First, some history. For years the rate paid by taxpayers on their capital gains (investment income) was higher than the rate paid on earned income. This made no sense, since government should encourage investment, which carries some risk and is optional. We have to work for wages/salary or we starve; but we do not have to invest our extra money we can spend it or keep it in a nice, safe savings account.

For years the investment community tried to get the state to lower the capital gains tax rate to equal the wage rate. But nothing happened until 1994 when the Legislature wanted a 55 percent pay raise.

What, you might ask, does investment income have to do with a legislative pay raise? Pay attention.

In order for then-Gov. Bill Weld to get the capital gains rate cut, he had to "invest" in some goodwill from the legislative leadership. So he said nothing when legislative liberals were told that a vote on a capital gains tax rate cut for "the rich," was actually a "tax cut for low-income taxpayers." There was a giant surplus that year too, so the liberals were willing to swallow their general dislike of tax cuts to allow one for poorer taxpayers.

Not only did this deceptive vote lower the capital gains tax rate to equal the earned income tax rate, it abolished the capital gains tax altogether for investments held for at least six years! In return for this, Weld agreed not to veto the pay raise. Everyone was happy.

Well, not everyone.

Liberal legislators were furious when they found they had been duped. And "good government" types like me, while all in favor of investment, warned the celebrating business community that what the government did sneakily to liberals, it could do sneakily to them in the future.

"You won't think it's so funny," I said, "when the Legislature increases the capital gains tax again after you've made your investment decisions."

In 2002, in the same tax package that "froze" the voters' income tax rollback, the Legislature repealed the capital gains tax repeal. And it did this in the middle of the year, after investment decisions had been made based on the higher rate of return.

Hah! And by the way, it kept the legislative pay raise part of the old deal. Hah hah!

Well, the state Constitution requires that all income earned in the same year be taxed at the same rate, so the Legislature had to know it couldn't tax money made from investments in September at a higher rate than money made from investments in March. But the state "needed" the money, so legislators figured they could worry about the Constitution later.

The Supreme Judicial Court worried about it last month, and ruled that either the state must go back and tax early-2002 investors at the higher rate too; or refund the higher amount paid by later-in-2002 investors if it can find any of these people who, had they any sense, have likely left Massachusetts for saner tax-policy pastures, taking their risks and jobs with them. They were cheated out of some of their rightful gains, and so far the commonwealth has neither apologized nor moved to reimburse them.

People sometimes wonder why Gov. Mitt Romney hasn't been able to persuade more businesses to bring their capital here. Of the 50 states in the union, I know of no other in which you don't know what your capital gains tax rate will be from one hour to the next.

Why invest here when you could live someplace where politicians have a clue about the entrepreneurial mindset? Our legislators can have a fine old debate about stem cell research on moral grounds, without having any idea of what it really takes to convince someone to risk his money on new technologies.

Oh, what a tangled web we weave when we draft tax policy based on a total lack of understanding of economic reality, a self-serving cuteness, and impulsive need. But that's the Massachusetts modus operandi.

Get it? I thought you might.

Barbara Anderson is executive director of Citizens for Limited Taxation. Her syndicated columns appear weekly in the Salem News and Lowell Sun; bi-weekly in the Tinytown Gazette; and occasionally in the Providence Journal and other newspapers.