The Neutrality of Massachusetts' Taxation of Financial Institutions

By Tannenwald, Robert | New England Economic Review, May 2000 | Go to article overview

The Neutrality of Massachusetts' Taxation of Financial Institutions


Tannenwald, Robert, New England Economic Review


The provision of financial services has changed dramatically over the past two decades. Technological innovation and deregulation have extended providers' geographic range and broadened the array of products they are capable of delivering. Constraints on bank branching across state lines have been all but eliminated. A single holding company can now offer a full array of financial services, from insurance and banking to securities underwriting and investment management.

These changes have intensified competition among financial service institutions. As their competitive interface has expanded, so have the potential inefficiencies and inequities created by tax regimes favoring some types of institutions over others. Consequently, in recent years Massachusetts, like other states, has passed legislation designed to narrow disparities among the tax burdens of insurance companies, banks, credit agencies, and mutual fund service corporations (MFSCs) doing business within the Commonwealth. At the same time, the Commonwealth has passed tax cuts, designed to enhance the competitiveness of Massachusetts-based financial institutions, which have widened tax disparities among financial service providers. Consequently, the degree to which the Commonwealth has actually leveled the tax playing field for financial services is unclear. This article attempts to resolve the issue. Have tax disparities within Massachusetts' financial services sector narrowed or widened? Has the identity of the "winners" and "losers" changed? Are the financial institutions that used to be tax-preferred now the disadvantaged?

By way of background, Section I briefly describes the percentage of Massachusetts employment and payroll comprising the financial services sector and its components. Section II explains why policymakers should care about disparities in the tax treatment of competing financial service industries and discusses difficulties in evaluating them. Section III explains the Commonwealth's tax treatment of financial institutions and how it has changed in recent years. Section IV attempts to estimate the extent to which these changes have narrowed or widened disparities in tax burdens among Massachusetts-based financial service providers. The final section summarizes the article and discusses policy implications.

The article concludes that tax changes enacted in recent years have widened some disparities in tax treatment of Massachusetts-based financial institutions while narrowing others. Currently, life insurance companies with a geographically dispersed nationwide clientele and managers of mutual funds enjoy the lowest effective rates of taxation. By contrast, as recently as six years ago, credit agencies were taxed lightly relative to Massachusetts-based banks, life insurers, and mutual fund managers. Life insurers whose policyholders were concentrated in the Commonwealth bore especially high effective rates of taxation. Nevertheless, tax burdens on most Massachusetts-based financial institutions have been reduced, enhancing their competitive standing vis-a-vis their out-of-state rivals.

I. Financial Services' Shares of Massachusetts Employment and Payroll

Between 1991 and 1998, consolidation and the substitution of capital for labor shrank financial services' share of Massachusetts employment from 6.2 percent to 5.9 percent (Table 1). Within this sector, employment shifted away from depositories, insurance carriers, and insurance agents to nondepository credit institutions; [1] security and commodity brokers, dealers, exchanges, and services; and holding and other investment offices.

While growth in employment within the sector lagged, growth in wages outpaced the statewide norm. Employees in the financial services sector accounted for 9.9 percent of the Commonwealth's total nonfarm wages in 1998, up from 8.0 percent in 1991. By 1998, the average annual wage of the Commonwealth's financial service employees, $63,391, was 68 percent higher than the statewide average. …

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