With tax cut off the ballot, the battle shifts to making excess revenue refunds more frequent

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A tax cut proposal that seemed all but certain to win voter approval was blocked from the ballot last week by the Supreme Judicial Court. The reason: a sloppy mistake by the state attorney general’s office — and the failure of the measure’s supporters to flag it.

Good.

The initiative, backed by an alliance of business groups, was a bad idea, as I warned in March. It would have cost the state billions in lost revenue each year and forced painful spending cuts, a hit to fiscal stability that would have outweighed any improvement a lower rate would have made in Massachusetts’ competitive climate.

But there’s another tax question, also pushed by the same business groups, that’s still headed for a November vote. This one would revise the method for setting the state’s Chapter 62F annual tax revenue cap — yes, such a thing exists — and most likely lead to more frequent automatic taxpayer refunds.

The revenue loss from the new Chapter 62F cap (named for its spot in the legal code) would be less severe than the income tax cut, and the formula it would replace is itself flawed. But the proposed fix has its own shortcomings. Does swapping one bad revenue cap rule for another make sense? Are more tax refunds a decent consolation prize for those who believe reducing the tax burden will make the state more competitive?

Why it matters: The tax cut initiative would likely have passed despite opposition from Governor Maura Healey and legislative leaders. Two-thirds of respondents to last week’s Suffolk University/Boston Globe poll supported it.

Now, the stakes are higher on the revenue-cap initiative.

Rewind: The tax cut proposal would have lowered the individual income tax rate to 4 percent from 5 percent over three years. When fully implemented, it would have reduced tax revenue by about $5 billion a year, according to an estimate by the Massachusetts Department of Revenue.

But the state’s highest court ruled Thursday that the proposal couldn’t appear on the ballot for a technical reason: The required summary of the proposal by Attorney General Andrea Joy Campbell’s office erroneously stated it would not affect the rate on long-term capital gains. In fact, the long-term rate on most investment gains is tied directly to the income tax rate.

Zoom in: The new Chapter 62F proposal would revise how Massachusetts calculates the tax revenue cap, which was established by a 1986 ballot initiative.

Since enactment, maximum tax revenue has been restricted to the previous year’s limit, plus three-year average wage growth. Exceeding the cap triggers a refund, which has only happened twice, most recently for the fiscal year ended June 2022.

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The new cap would be pegged to the previous year’s actual tax collections, plus wage growth. This would mostly lower the revenue limit — and result in more annual refunds — because the current level of actual tax collections has fallen short of 1986 collections adjusted for wage and salary growth.

What it means: Annual refunds would be three to five times more likely than in the past, according to by the Center for State Policy Analysis at Tufts University. Refunds would be anywhere from five to 15 times larger.

said that if the revenue-cap proposal had been in place over the past 10 years, collections would have topped the limit four times, with refunds totaling $7.9 billion.

Unintended consequences: The big problem with the current cap is that it’s untethered from what the state actually brings in each year. The Chapter 62F initiative would fix that problem but introduce others, according to Mass. Taxpayers and the Center for State Policy Analysis. Most notably:

• It risks creating a herky-jerky cycle of alternating refund years. Payouts for a year in which revenue breached the cap are delivered the next year and, for accounting reasons, depress revenue collections in that following year.
• It would constrict revenue growth just when the state is recovering from a recession, since the cap resets to the recession’s depressed collection levels.
• It could strain the so-called rainy day fund, where most excess revenues are currently deposited.

Final thought: In 2023, the state changed the distribution formula for Chapter 62F refunds, with all taxpayers sharing the returned funds equally; in the past, refunds were proportional to the taxpayer’s tax bill.

That made the refund system more progressive. If the revenue cap formula is updated and refunds become bigger and more frequent, that’s not necessarily a bad thing given the state’s extreme income inequality.

The Chapter 62F proposal’s downsides are messy but manageable. The fiscal damage would be far less than if the income tax cut had become law. But additional refunds would make only a small dent in the state’s high cost of living.

For proponents of lower taxes, approval of the new revenue cap would be a small victory after the big loss delivered by the SJC.

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