Lawmakers look to capital gains tax to bolster savings

PLANNING AHEAD 'We need to make sure the state has a [savings] fund for the next downturn,' said Leslie Kirwan, state secretary of administration and finance. PLANNING AHEAD
"We need to make sure the state has a [savings] fund for the next downturn," said Leslie Kirwan, state secretary of administration and finance.
By Casey Ross
Globe Staff / June 17, 2009
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The economic downturn has produced a record decline in the taxes Massachusetts collects from taxpayers on their investment profits, a $1.6 billion drop-off that is largely responsible for the worst fiscal crisis to hit state government in decades.

The 75 percent decline in capital gains tax payments for the fiscal year that ends June 30 is also producing an unusual consensus on Beacon Hill, where Governor Deval Patrick’s administration and lawmakers are moving to protect the state against wild swings in income by diverting more of the tax proceeds into savings.

In boom years, that would mean spending hundreds of millions of dollars less on priorities such as education reform and transportation upgrades. Instead, that money would be put away to serve as a cushion in bad times, such as now.

“We have to discipline ourselves not to build the budget on capital gains, and instead put some of that money in reserves,’’ said Leslie Kirwan, the state’s secretary of administration and finance.

Kirwan and legislative leaders are considering a mechanism that would require the state to set aside an agreed-upon portion of additional capital gains collections for use in lean years. The amount the state has in its rainy day fund is down to around $750 million, its lowest level since 1997.

Currently, the state budgets to spend nearly all the capital gains money it collects during a fiscal year, meaning the services it finances are vulnerable to swings in the economy. When investments in securities and real estate lose value, the state loses funding to pay for those services and falls into a deficit.

Massachusetts is especially reliant on capital gains collections because of its high concentration of financial firms, wealthy taxpayers, and white-collar workers who receive stock as compensation.

A study last winter by the research organization MassINC found Massachusetts ranks third in its dependence on capital gains, behind Oregon and Connecticut.

The Patrick administration was repeatedly forced during the fiscal year to revise downward tax collections as the economic decline accelerated. So far, overall tax collections, which also include sales, income, and business taxes, are down about $3 billion, to about $18.4 billion from an initial projection of $21.4 billion, according to the state Department of Revenue. Nearly half of that is because of losses in capital gains.

This is not a new problem: The state faced similar capital gains declines during economic downturns in 1987 and again in 2001, and each time it was forced to impose years’ worth of spending cuts and tax increases.

“It has a narcotic effect on spending in the good years,’’ Gregory Torres, president of MassINC, said of capital gains. “But one faces the equivalent of withdrawal in the bad years.’’

In 1987, Torres was working for the Senate Ways and Means committee, led by former chairwoman Patricia McGovern, when collections plummeted by more than 60 percent, triggering a financial crisis.

“No one saw it coming,’’ Torres said. “We thought we might have a problem, but we didn’t think we’d lead the country into a recession. . . . We didn’t know about bank failures and real estate crashing. And we had no [savings] fund to deal with it. All of our options were unpalatable.’’

That year, state government raised taxes by $1 billion, cut another $1 billion from public services, and borrowed $1 billion just to keep the lights on. “Now, I scratch my head when I hear someone say, ‘They didn’t see it coming,’ ’’ Torres said. “This is a similar pattern to what we saw in the late ’80s and early ’90s, and again in 2001.’’

Today, state officials who typically battle over tax policy have reached a consensus to address the over-reliance on capital gains immediately. House and Senate budget are trying to iron out differences between their respective proposals.

The main difference is over how fast the state should respond to unexpected changes in capital gains collections: The House says to monitor collections quarterly, while Patrick and the Senate recommend monthly monitoring.

“Making the transfers on a monthly basis allows us to keep a better grip on things,’’ said state Senator Steve Panagiotakos, a Lowell Democrat and chairman of the Senate Ways and Means Committee. “Capital gains collections can change very quickly from one extreme to the other.’’

Also, the House would put 50 percent of excess collections into the rainy day fund, with the rest available for the budget. The Senate and Patrick suggest using a holding account that would be used to smooth out month-to-month fluctuations in revenue. When collections rise above a monthly forecast, the excess would be put into the holding account. When they fall below the forecast, money would be automatically removed to fill the gap. Any excess left at the end of the year would be diverted to the rainy day fund.

The provisions are not likely to have much of an impact on spending over the next few years because the state is not expecting additional capital gains collections.

In years when collections are flat, what does come in will be used simply to pay for budgeted expenses. It is only at times when collections rise significantly - as they did between 2002 and 2006, when capital gains rose to $1.6 billion from $450 million - that large amounts will be put aside for savings.

Some lawmakers contend the proposals do not go far enough to protect taxpayers from overspending.

House Republican leader Brad Jones, a North Reading Republican, said the proposals rely too much on budget projections that can be manipulated. For example, Jones said, if officials decide they want to spend more on programs, they could simply adjust the capital gains forecast upward, so less money goes to savings and more is used for current spending.

“This proposal needs to look at actual numbers instead of estimates,’’ said Jones, who favors the state using an average of capital gains collections over several years as the barometer for determining how much to set aside.

Kirwan, Patrick’s secretary of administration and finance, said that model is under consideration and that only minor differences in the proposals are left to be worked out.

“There is a consensus that now is the time to tackle this,’’ she said. “We need to make sure the state has a [savings] fund for the next downturn.’’

Casey Ross can be reached at