- Governor's Message
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- Budget Narrative
- Issues in Brief
- Education Investment
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- Massachusetts Geographic Information Systems
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- Line Item Consolidation
- Capital to Operating Transfer
- Information Technology Consolidation
- Capital Gains Revenue in the Budget
- Long-Term Retirement Liabilities
- Limiting Certain Tax Expenditures
- Health Care Reform
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- Local Aid - Section 3
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Capital Gains Revenue in the Budget
[ index ]
FY2011 House 2 Budget Recommendation:
Issues in Brief
Deval L. Patrick, Governor
Timothy P. Murray, Lt. Governor
Commonwealth’s Reliance on Capital Gains
By nature of their reliance on tax revenue, state budgets are subject to the ups and downs of the economic cycle. Massachusetts is no exception. The current economic crisis demonstrates that the volatility of the Commonwealth’s budget is exacerbated by its reliance on capital gains tax revenue to support spending. To address this problem, House 2 includes a proposal to reform the way the state budgets for capital gains tax revenues to promote fiscally sound budgeting practices and curb the problem of recurring structural deficits.
Tax receipts from capital gain income are the state’s most volatile source of revenue. These tax revenues nearly doubled from fiscal year (“FY”) 2004 to 2008, from $869 million to $2.2 billion, but fell by over $1.6 billion to $554 million in fiscal year 2009. While some of the revenue during the 2004-2008 period was used to replenish the state’s Stabilization Fund, there was no formal policy guiding the use of these revenues. Without such a policy, fluctuations in tax revenue can contribute to structural budget deficits when the state makes spending commitments during strong years that cannot be fully sustained when the economy declines.
Figures included in Chart are on a Tax Year Basis. Figures will differ slightly from Fiscal Year Amounts cited in this Policy Brief.
The Governor’s Recommendation
To address this problem, Section 13 of House 2 establishes a new mechanism for budgeting for capital gains revenues. This proposal provides that any capital gains revenues that exceed $1 billion in the fiscal year will be transferred to the Commonwealth Stabilization Fund, sometimes called the “rainy day fund.” But 5 percent of that excess will instead be transferred to the State Retiree Benefits Trust Fund, where it will be used to address the Commonwealth’s liability for its retirees’ health insurance and other non-pension retirement benefits.
How was the $1B threshold established?
Long-term historical averages are largely in the range of $0.9 - $1.2 billion, depending on the time period and inflation assumptions. The Administration proposes to use a conservative figure to ensure discipline and in light of the recent steep decline in the stock market. This decline has resulted in a significant amount of unrealized losses and capital loss carryovers that will likely dampen growth in revenue from capital gains income over the next several years.
|All figures in 2009 dollars.|
* Includes estimated for 2008 and projected for 2009-10.
The deposit of excess capital gains tax revenues to the state’s Stabilization Fund during periods of economic prosperity would serve as a “cushion” in years when markets decline and capital gains revenues fall. This will help ensure that the state does not build recurring spending on a foundation of unsustainable levels of revenue and help mitigate the fiscal impact of economic downturns.
|Fiscal Year||Forecast Cap
into Stab **
|* Adjusted for change in capital gains tax rate effective May 1, 2002.|
** For Historical Results, this is based on Net deposits for years where this was positive.
Will the threshold change?
The methodology above describes a rational basis that can be further developed as more information becomes available. Future developments might include adding an automatic inflation adjustment factor, developing an agreed upon methodology that is forward looking, adjusting the threshold, and/or broadening the approach to include other volatile sources of tax revenue.
This policy incorporates elements of earlier proposals made by both the legislature and the Governor. It includes a clearly identified threshold as suggested by the conference proposal in an amount that is informed, in part, by longer-term trends. The $1 billion threshold, moreover, is expected to retain spending flexibility during the current economic downturn, while establishing a plan to set aside rainy day funds when the economy recovers. In this manner, the policy takes and important step towards establishing a sustainable, structurally balanced budget.
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