The volatility of taxing the rich

Massachusetts was surprised by its tax revenue windfall, while Washington’s capital gains tax fell short of expectations.
Lauren Sanchez, left, and Jeff Bezos arrive at the Vanity Fair Oscar Party on Sunday, March 10, 2024, at the Wallis Annenberg Center for the Performing Arts in Beverly Hills, Calif. (Photo by Evan Agostini/Invision/AP)

State leaders in Massachusetts and Washington are learning it’s hard to predict how much money their taxes on millionaires and billionaires will rake in.

Massachusetts’s brand-new 4% tax on income above $1 million has stunned budget writers by raising $1.8 billion so far this fiscal year, 80% more than lawmakers planned to spend. The cash will be set aside to fund education and transportation projects.

Meanwhile, Washington’s 7% tax on the sale of long-term capital gains over $250,000 has raised a disappointing $433 million this year, 36% less than lawmakers expected. Money raised by the tax funds education services and school construction.

States that impose higher taxes on their highest earners must prepare for revenue swings, fiscal policy experts say, because much of the income earned by the wealthiest Americans can fluctuate with equity markets — such as income from bonuses or selling shares in a company.

“Progressive tax systems, while they aim for fairness, can also inject volatility into state budgets,” said Justin Theal, an officer with the state fiscal health project at the Pew Charitable Trusts, a nonpartisan nonprofit based in Washington, D.C.

The Massachusetts and Washington taxes are also relatively new — this is the first year for Massachusetts’s tax and second year for Washington’s — which creates an additional challenge for budget writers.

“Predicting the revenue from a new tax in its first year is notoriously tricky, because forecasters are working, basically, from a blank slate,” Theal said.

While analysts on the right say volatility is a reason not to tax the rich, left-wing supporters of the strategy say the benefits outweigh the drawbacks.

“The bottom line here is that forecasting is difficult,” Aidan Davis, state policy director for the Institute on Taxation and Economic Policy, a left-leaning think tank based in Washington, D.C., said in an email to Pluribus News. “But it’s nothing that can’t be handled through good budgeting practices.”

State leaders can manage volatile revenue sources by figuring out how much money they can expect to raise each year and setting aside surplus collections in a savings account, Theal and other fiscal and tax policy experts say.

Both the Massachusetts and Washington taxes are “raising needed revenue for each states’ key priorities,” Davis said.

Washington’s capital gains tax brought in $786 million last fiscal year, which ended June 30, 2023. It’s unclear why collections have fallen this year, said Dave Reich, executive director and chief economist for the Economic and Revenue Forecast Council, which provides economic and revenue forecasts to Washington state leaders and the public.

“We don’t know, really, other than to say: For us, it’s a really difficult thing to forecast, because capital gains, even at the national level, are just notoriously volatile from year to year,” Reich said.

Taxpayers may be changing their gains realization strategies in response to the tax, he said. Some may be waiting to sell assets until after the November election, for instance, when Washington voters will decide whether to repeal the capital gains tax.

It’s also possible some high earners have moved out of state, as Amazon founder Jeff Bezos did last year.

Bezos’s move likely does not explain the drop in capital gains collections. While he typically sells billions of dollars worth of Amazon shares each year, he sold no Amazon stock in 2022 or 2023, after Washington’s new tax went into effect, according to CNBC. He gifted $200 million worth of shares at the end of 2023.

Once in income-tax-free Florida, he moved to sell $8.7 billion worth of shares, CNBC reported.

Some states that rely on taxing top-earning residents have structured their budgets to handle inevitable revenue swings.

Connecticut lawmakers, for instance, since 2017 have capped the amount of money from estimated income and pass-through entity tax payments that can be used to balance the budget. Any extra revenue from those sources moves to the state rainy-day fund.

Massachusetts lawmakers created something similar after voters passed the “millionaire’s tax” in 2022.

Money raised by the 4% surtax flows to an account for funding education and transportation, rather than the state’s main spending account. Spending from the education and transportation fund is capped at $1 billion this fiscal year, which ends June 30, and $1.03 billion next year.

That structure gives lawmakers less flexibility to spend money raised by the new tax, said Doug Howgate, president of the Massachusetts Taxpayers Foundation, a nonpartisan research group. But it helps the state manage revenue swings.

“We know that these revenues are going to be volatile,” he said. “So part of the point of the cap is creating this ability to withstand future volatility.”