The Fiscal Impact of Potential Local-Option Taxes in Massachusetts

Abstract

Municipal governments in Massachusetts have experienced difficulties raising adequate revenues to meet their expenditure needs. Responding to these challenges, policymakers have been investigating additional revenue sources for municipalities, such as new local-option taxes. Using a Representative Tax System approach and new data, this paper examines the impact of local-option taxes on meals, general sales, income, and payroll on revenue-raising capacity of Massachusetts municipalities.This paper shows that new local-option taxes would help municipalities generate considerable additional revenues from untapped sources. However, revenue capacity from new local-option taxes is not evenly distributed across municipalities. Local-option tax capacity is concentrated in Boston suburbs and resort areas in eastern Massachusetts. On average, large cities would benefit more from local sales, meals, and payroll taxes than smaller towns. High-income, property-rich municipalities would gain more local-option tax capacity than low-income, property-poor municipalities. Local-option taxes also do not compensate municipalities in proportion to their loss of state aid dollars in FY 2009.Local-option taxes are likely to exacerbate fiscal disparities, because municipalities with low existing revenue-raising capacity often lack the tax bases for new local-option taxes. Policymakers could consider increasing equalizing state aid to offset these fiscal disparities. If more aid is not forthcoming, this paper proposes that the state change aid formulas to reflect differences across municipalities in local-option tax capacity, and to better target fiscally distressed communities. These strategies - explored in the Massachusetts context - could also be useful in other states.