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   Jeff Jacoby
Copyright Boston Globe

A CAPITAL-GAINS DOUBLE-CROSS

July 7, 2002

Deadlines were made for mere mortals like you and me, not for the demigods of the Massachusetts Legislature. You and I have to make our mortgage payment when it's due, file our tax returns by April 15, and get to the polls before 8 p.m. on Election Day if we want to vote.

But things are different on Beacon Hill. In the Massachusetts House and Senate, deadlines are puny things, easily brushed aside or trodden underfoot. So it is no surprise that, once again, the Legislature has failed to produce a state budget in time for the new fiscal year.

Apart from passing an annual spending plan before July 1, lawmakers in Massachusetts are not actually required to do very much. They are paid a substantial salary -- $50,000 plus as much as $25,000 more in per diems, office accounts, and "leadership" pay -- for what amounts to little more than showing up at the State House and sometimes casting a vote. Most state legislators don't draft important bills, shape public policy, undertake research, or think for themselves. They don't even have to campaign for re-election, since the Massachusetts Republican Party courteously allows most Democrats to run for office unopposed.

There is really just that one responsibility: enacting a state budget by July 1. But year in, year out, that proves to be more than the General Court can manage. Last year, it finally got around to finalizing the budget on Thanksgiving Eve. Two years before that, the story was much the same. In the real world, routinely missing important deadlines can have severe consequences. (Try blowing off your Masercard bill for 4-1/2 months, and see what happens to your credit rating.) On Beacon Hill, it has no consequences at all.

It's bad enough that the Legislature is too incompetent -- or too apathetic -- to comply with a clear statutory timetable. But now it is preparing to do something even more obnoxious: It wants to punish citizens who do comply with a clear statutory timetable. How? By not only raising a tax that hundreds of thousands of Massachusetts residents pay, but by making it retroactive to Jan. 1, 2002. The higher tax rate is lousy public policy. The retroactivity is an outrage.

Some background:

Since 1994, Massachusetts has been taxing long term capital gains -- the profit earned from selling assets held for longer than a year -- on a sliding scale. Taxpayers who sell property they have owned for more than one year pay 5 percent of their profit to the state. Those who sell after two years pay 4 percent. And so on down to a rate of zero for assets that have been held for six or more years.

The economic rationale for taxing capital gains in this way is straightforward: It encourages taxpayers to invest for the long haul instead of for short-term speculation. A disappearing tax on capital gains is especially beneficial in a state like Massachusetts, where start-up technology companies often cannot pay high salaries and are apt to reward their most valuable employees with company stock instead.

The list of those who benefit when very long-term capital gains are free of state tax is long, from the small business owner who sells the company she spent years building up, to the elderly couple living off their investment portfolio, to the parents socking away a few dollars every week into a mutual fund for Junior's college education. The popular myth is that only fat cats have to worry about capital gains taxes, but the reality is very different. According to the Internal Revenue Service, 40 percent of Massachusetts taxpayers who reported capital gains (or losses) in 2000 had an income of $50,000 or less. Only 29.8 percent had an income of $100,000 or more. It isn't just Easy Street that pays capital gains taxes; Main Street pays them too.

Taking the law at its word, thousands of taxpayers held onto an asset until this year in order to reap the benefit of selling it tax-free. But the Legislature is now poised to hike the tax rate on all capital gains to 5.3 percent regardless of how long the asset was held. Worse, it wants to make the increase retroactive to the start of this year. In other words, it plans to penalize taxpayers who arranged their financial affairs to comply with timetable established by law. Instead of paying no tax (or a tax of 1 percent, 2 percent, etc.), they will be slammed with a tax of 5.3 percent -- a tax they could not have anticipated because it didn't exist at the time of their sale.

This is rotten tax policy. And, like the other tax hikes in the overdue budget, not only rotten but unnecessary: Taxes are going up only because Beacon Hill refuses to bring spending down. (The new budget will be hundreds of millions of dollars higher than the last one.) But there is an added detail that makes this tax even more offensive.

In 1994, the House and Senate leadership struck a deal with then-Governor William Weld: They would pass the capital-gains tax phaseout he wanted if he would sign a bill hiking legislators' pay by 55 percent. When the public found out, it was appalled, but the deal held: Lawmakers pocketed their raise and taxpayers got a break. If the Legislature now intends to take back the tax cut, it goes without saying that it must give up the pay raise.

Will the members do the right thing? We won't know the answer until the final budget appears. That could happen any time between now and -- oh, Thanksgiving.


Jeff Jacoby is a columnist for The Boston Globe.
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