Rare Massachusetts Tax Refund Raises Interesting Question About Surplus Revenue

Massachusetts taxpayers are getting a rare refund thanks to a 1986 law that requires the state government to refund tax revenue that exceeds a maximum threshold. The triggering of section 62F of the Massachusetts tax code raises an interesting question about state budgeting: If there is surplus revenue, what should states do with it? Giving surplus revenue back to taxpayers in some fashion is appropriate in most circumstances, but there are other reasonable uses.

Chapter 62F was enacted by Massachusetts voters via a ballot question in 1986 and was last triggered in 1987. The law stipulates that total annual state tax revenue can only grow by a certain percentage based on total state wage and salary growth. The impetus for the law appears to be a desire to link the growth of taxes to the growth of taxpayers’ ability to pay, which in this case is approximated by wages and salaries. This makes sense as a means of keeping the tax burden relatively constant as a share of economic activity. Other states have laws designed to limit the growth of the tax burden, with the most famous being Colorado’s Taxpayer Bill of Rights (TABOR).

There are some differences between the refund mechanisms of 62F and TABOR, though. The size of each taxpayer’s 62F refund is based entirely on their income tax liability. This year’s refund is projected to be 13% of each eligible taxpayer’s Massachusetts personal income tax liability and it will be paid as a lump sum via direct deposit or check.

Some have argued that calculating the refund this way is unfair to lower-income people who may not have an income tax liability but paid sales or other taxes over the last year that contributed to the surplus the refund is based on. This is a good point.

According to the Urban Institute, state personal income taxes only represent about 35% of all Massachusetts’s state and local tax revenue, and an even smaller share if other government charges and fees are included.

Basing the entire refund on income tax liability ignores that a significant portion of all state taxes come from sources other than income. Taxpayers who pay sales taxes, other fees, or earn lower wages due to corporate income taxes but have no personal income tax liability due to other features of the tax code (deductions, exemptions, etc.) essentially get no credit.

Like 62F, TABOR provides a refund based on income taxes, but unlike 62F there are other refund mechanisms. The last four times TABOR refunds were triggered, Colorado taxpayers got a property tax reimbursement. In 2020 and 2021, they also received an income tax rate reduction, and in 2021 there was a sales tax refund as well. In 2022, the refund included cash payments of $750 to each qualified taxpayer.

So, in contrast to 62F, TABOR provides several different mechanisms for refunding excess tax revenue. Using different mechanisms makes it more likely that each taxpayer who contributes to the excess revenue gets something when it is refunded and alleviates the concern that the rebate mechanism disproportionately benefits higher-income taxpayers.

That said, most people do not keep track of sales taxes paid, which makes it hard for state officials to base a refund on sales taxes. Income and property taxes paid, on the other hand, are easier to verify and trace to specific people or households. A tax rebate more closely tied to actual taxes paid could consist of an income tax portion, a property tax offset, and a lump sum payment linked to average consumption spending in the state across income deciles or quartiles to approximate a sales tax refund. Such a rebate would be more complicated to calculate, but likely more acceptable to people of all income levels.

Taxpayer refunds are a great use of excess revenue since they return resources back to their original owners who can use them as they see fit, such as saving for an emergency, making a new investment, donating to a charity, or buying something new. People know the best way to spend their own money and good tax policy lets people keep as much of it as possible while still enabling government to provide basic public goods and services.

Another way states can use excess tax revenue is to bolster their rainy-day funds. No one likes recessions, but they happen, and when they do state tax revenue falls as economic activity declines. It is a bad idea to raise taxes during a recession since doing so further weakens the economy, so state rainy-day funds can help stabilize revenue until the economy improves.

According to research from The Pew Charitable Trusts, the size of state rainy-day funds varies quite a bit. Wyoming, North Dakota, Alaska, and New Mexico could fund their state governments for over 100 days on savings alone, while Washington, Illinois, Kansas, and Nevada would run out of savings in less than 10 days. Massachusetts has about 46 days’ worth of savings in its rainy-day fund, and according to a recent state stress testing analysis from Moody’s Analytics it is prepared to handle a moderate recession.

Another good use of surplus state revenue is paying down state debt, particularly pension liabilities. According to a recent report from the American Legislative Exchange Council, Massachusetts has over $190 billion of unfunded pension liabilities. Using a slightly different method for calculating unfunded liabilities, Pew estimates that Massachusetts’s liabilities equal 8% of total personal income in the state.

By either measure, Massachusetts has a pension problem.

Given these options, what should Massachusetts do with surplus revenue? 62F is the current law so a tax refund is happening, but in an unconstrained world and given Massachusetts’s relatively strong financial position, decreasing the state’s unfunded pension liabilities would also be an acceptable use of money.

If a state consistently runs a budget surplus while providing basic public goods and services more fundamental tax reforms should be implemented. Rather than regular rebates, states should lower tax rates, especially income and capital gains tax rates to increase the incentives to work and invest. Such pro-growth policies expand the economic pie while still allowing the government to raise adequate revenue. In recent years states such as Nebraska, Idaho, New Hampshire, North Carolina, and Iowa cut tax rates to make their states more attractive places for businesses and families.

Massachusetts’s tax refund is not perfect, but I was happy to learn it has a law on the books that returns money to taxpayers in some instances. There are fairer ways to refund taxes that Massachusetts should consider, and if refunds become more frequent, it should cut tax rates to encourage more work and investment or use the money to fund its state pensions. But for now, I hope Massachusetts taxpayers enjoy the extra money in their pockets.