Study: Ending Income Tax Would Stress Capital Spending in Massachusetts

Massachusetts may have to postpone capital spending for seven years and cut most programs by more than 70% if a referendum to gradually eliminate the state's personal income tax passes, according to a report released yesterday.

At the same time, the state's Treasury Department confirmed that it has been in discussions over the past week with the U.S. Treasury regarding the state potentially borrowing money from the federal government as a "policy option," and is not connected to recent attempts to access the short-term market. Officials still plan on pricing $750 million of short-term notes today after postponing the deal last week due to market conditions, an issue that Massachusetts Treasurer Timothy Cahill called "a full-blown crisis."

"The Massachusetts state treasury and the U.S. Treasury are in talks to explore whether, if necessary, the U.S. Treasury or the Federal Reserve would be a lender of last resort," said Treasury spokeswoman Francy Ronayne.

In looking at yesterday's report of the proposed income tax elimination, the Bay State received $12.5 billion of income tax revenue in fiscal 2008, which ended June 30. That funding stream accounts for 60% of total tax revenue and 40% of state spending, according to the Massachusetts Taxpayers Foundation, which compiled the report, titled The Enormous Consequences of Question 1.

That ballot question will ask voters next month if they favor cutting the state's income tax in half to 2.65% from 5.3% starting on Jan. 1 and ending the tax completely on Jan. 1, 2010. If passed, lawmakers would have the capability to draft new legislation to repeal the initiative or to amend it in some way.

The referendum does have support. In 2002, 45% of voters approved a previous attempt to terminate the 5.3% state-income tax in Massachusetts.

If it becomes law, the state would have to cut spending by 71.1% to offset the drop in revenue and would be forced to abstain from capital spending over the next seven years to keep the state's debt service costs at a level 8% of budgeted revenues, the commonwealth's ceiling.

In addition, the report claims that debt service costs would jump to 12.2% of the state's budget in fiscal 2009 if officials proceed with authorized plans to borrow $1.6 billion of debt for the current fiscal year. That ratio would still sit above the 8% maximum until fiscal 2016, if the state were to maintain its current capital spending program, according to MTF president Michael Widmer.

"So it's really, to say the least, a dramatic conclusion that essentially all capital spending would dry up for seven years," Widmer said. "And we already have a capital funding crisis in this state, particularly with transportation in which we're under-investing by a lot in our capital needs."

Widmer said that eliminating the income tax could prompt a downgrade in the state's credit rating. Standard & Poor's and Fitch Ratings assign their AA rating to the commonwealth's roughly $29 billion of outstanding debt. Moody's Investors Service rates the credit Aa2. On Oct. 3, Standard & Poor's announced in a report that if the referendum passes, it will put the state on credit watch with negative implications.

Moody's analyst Nicole Johnson said that her team will be evaluating how the commonwealth adjusts to a change in the state's largest revenue stream, if voters approve ending the tax.

"It's not impossible to live without an income tax ... but to eliminate close to half of your operating budget and have it not affect localities and schools is hard to imagine," Johnson said. "So I think we're still waiting to see if it passes and then what the commonwealth chooses to do, to either cut spending or raise revenues to offset what they would lose."

Yet proponents of the referendum say that ending the income tax will force the state to run more effectively.

"Our goal is to yield smaller government in Massachusetts, which we believe will be better," said Kamal Jain, spokesman for the Committee For Small Government. "It'll be more efficient, it will be forced to be more efficient .... By cutting a major source of revenue they're going to be forced to open the books to the people, which is something they've refused to do."

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