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Raising Rates on Unearned Income: An Equitable Way to Avoid Cuts and Support a Robust and Just Recovery

For each one percentage point increase in the state tax rates applied to unearned income, the Commonwealth could raise roughly $465 million a year to help fund a more economically just, robust, and racially equitable recovery. As is now clear, low-income communities and communities of color have been hurt far more deeply by the COVID-19 pandemic than wealthier and whiter communities—both in terms of health impacts and the growing economic fallout.

Snapshot of Findings

  • Each percentage point increase in the rates applied to most unearned income could raise about $465 million a year during periods of strong economic and/or stock market performance.
  • Because unearned income flows overwhelmingly to high-income, white households, raising additional revenue from unearned income would support economic and racial justice.
  • The best path forward for Massachusetts is to avoid budget cuts and instead make needed investments to speed recovery, funded with tax increases on high-income households and profitable corporations.
  • A rate increase can be coupled to an exemption for seniors/disabled persons. This would reduce net revenue gains but increase the overall progressivity.
  • Revenue from unearned income taxes can fluctuate significantly, related to economic and stock market performance.

As a Commonwealth, we must respond to these intertwined health and economic crises in ways that acknowledge and correct for these deep-seated and longstanding inequities. Raising additional revenue through rate increases on unearned income would help the Commonwealth address the immediate harms of the pandemic, as well as make the investments that will speed us toward a just and robust recovery.

What is “unearned income”?

Broadly speaking, the income people receive can be divided into two categories, “earned income” and “unearned income.” Earned income typically comes in the form of wages and/or salaries directly connected to the daily work that people perform. Unearned income comes from the ownership and/or sale of various assets. For example, unearned income includes bank interest; dividends paid by corporations to their shareholders; rental income from real estate holdings; and “capital gains,” the profit realized from the sale of stocks, real estate, artwork and other assets. (Capital gains are further divided into two categories: 1) long-term capital gains, which come from the sale of assets held for more than one year, and 2) short-term capital gains, which come from the sale of assets held for one year or less.)

How much revenue would the Commonwealth generate by raising tax rates on unearned income?

Currently, most unearned income is taxed at the same rate as wage and salary income (i.e., earned income): 5.0 percent.1 This 5.0 percent rate is applied to long-term capital gains, as well as to interest and dividend income. As recently as the late 1990s, however, dividend income was taxed at a rate of 12 percent, twice the rate applied to earned income at that time. And still today, short-term capital gains (from assets held less than one year) are taxed at 12 percent.

Raising the 5.0 percent rate applied to most unearned income could generate significant amounts of additional revenue for the Commonwealth. Each one percentage point increase in the rate applied to long-term capital gains would generate approximately $365 million a year during periods of strong economic and/or stock market performance.2 Each one percentage point increase in the rate applied to dividend and interest income would generate a combined total of approximately $100 million a year in additional revenue during periods of strong economic and/or stock market performance.3

Economic downturns or periods of weak stock market performance likely would decrease the amount of unearned income collected by Massachusetts residents and hence the amount of tax revenue collected by the Commonwealth from this source. (The volatility of revenues derived from taxing unearned income is discussed in more detail, below.)

Raising tax rates on unearned income would support economic and racial justice in the Commonwealth

Generating additional revenue by increasing the tax rates applied to unearned income is a highly progressive policy option, one that supports both economic and racial equity. Additional revenue would come overwhelmingly from high-income, white households. Taken as a whole, Massachusetts’ state and local tax system is regressive: low- and middle-income households pay a much larger share of their income in state and local taxes than high-income households do. While the effects would be modest, raising rates on unearned income would help turn this upside-down tax system right-side up.

Were unearned income taxed at a 9 percent rate, for example, it would be only those households with the highest one percent of incomes (i.e., those households with incomes above $776,000 a year and which, as a group, average over $3.0 million a year) that would see any substantial increase in their effective tax rate (i.e., the share of their household income paid toward state and local taxes). The highest-income households would see an increase in their effective tax rate of 1.3 percentage points. Even with this increase, however, the effective tax rate on these highest-income households still would be well below the effective rates paid by other Massachusetts households.


There is a straightforward reason why tax increases on unearned income primarily affect the highest-income households. Unearned income comes from accumulated wealth. Wealth in the U.S. is distributed extremely unequally – even more unequally than income. The richest 1 percent of U.S. households own over 30 percent of total national wealth, while the richest 10 percent own almost 70 percent of total national wealth. More than half of all corporate stock and mutual fund shares are held by the nation’s wealthiest 1 percent; the bottom 90 percent of the population holds less than 12 percent of this total.

Close to 85 percent of U.S. national wealth likewise is held by white households. Due to centuries of systemic racism, people of color have been excluded from economic opportunities, including opportunities to grow their incomes and to build wealth. As a result, today U.S. median white household wealth is 41 times that of median Black household wealth and 22 times that of median Latinx household wealth.4


Given that the sources of unearned income are so concentrated in the hands of a few, very rich, mostly white households, it is not surprising that a tax increase on unearned income would fall primarily on these same households. Such an increase would produce greater tax fairness among income and racial groups, helping correct the current imbalances in our tax system and our society more broadly.

How would seniors be affected by a rate increase on unearned income?

Some seniors and people with disabilities may rely more heavily on investment income than most other taxpayers and, in many cases, may have fewer options for balancing their household budgets in order to offset any tax increase (for example, by increasing wage or salary income, or reducing living expenses). Given this, lawmakers could include an exemption for low- and moderate-income seniors and persons with disabilities when raising tax rates on unearned income. Such an exemption could prevent most low- and moderate-income seniors and disabled persons from seeing any meaningful increase in their tax bill – and in fact could deliver a tax reduction to many such taxpayers.5

A senior/disabled exemption on unearned income, however, would reduce the amount of revenue the Commonwealth would gain from any rate increases on unearned income. Setting income limits on eligibility for these exemptions (i.e., means-testing) would reduce significantly the amount of revenue lost to the exemption. For example, if only those seniors or disabled persons with annual incomes below $40,000 ($80,000 for those who are married and filing jointly), from all income sources, were eligible for the exemption on unearned income, this would reduce the total exemption costs by roughly 75-80 percent. Such income limits also would improve the overall progressivity of the exemption, focusing the tax benefits on low- and moderate-income households. The following are examples of the approximate revenue reductions that could be expected at different exemption levels:6

Revenue Loss with Senior/Disabled Exemption

Exemption Amount 6% Rate7% Rate8% Rate9% Rate
$10,000 ($20,000 for joint filers) exemptionAll$106M$108M$111M$113M
$20,000 ($40,000 for joint filers) exemptionAll$172M$178M$183M$189M
$30,000 ($60,000 for joint filers) exemptionAll$213M$220M$226M$233M

Does the volatility of unearned income make it a poor revenue source?

Unearned income is a “volatile” revenue source, meaning that income from stocks and other capital assets, as well as dividend and interest income, can fluctuate significantly within a very short time frame. These fluctuations typically follow the ups and downs of the economy. When the economy and stock markets are booming, a large amount of unearned income will flow to a subset of Massachusetts residents. During economic downturns (i.e., recessions), that flow typically will slow significantly and will take several years to return to prior highs. This pattern has not held during the current, pandemic-induced recession – while the real economy, by many measures, has been in worse shape than at any time since the Great Depression, stock markets are hovering at near-record highs.

Looking at the recession of 2001, Massachusetts residents’ income from interest fell by about 40 percent, ordinary dividend income fell by roughly 20 percent, and capital gains income fell by about 40 percent. With the exception of interest income, each of these types of unearned income returned to its earlier, inflation-adjusted high-water mark within two or three years.7 (Interest income took five years to do so.) The Great Recession is a more recent and more extreme example of unearned income volatility. Massachusetts residents’ income from ordinary dividends fell by over one-third, income from interest fell by more than 70 percent, and capital gains income fell by more than 75 percent.8 In this case, the return to former, inflation-adjusted highs for dividends and capital gains income took much longer: a full 10 years.9 (Interest income has yet to return to anything like its earlier highs.)


This volatility does not make unearned income a poor source from which to draw state tax revenue. Instead, it simply means that lawmakers must factor this volatility into their revenue expectations and budgeting practices. For taxes on capital gains – the largest source of tax revenue collected from unearned income by the Commonwealth – there already is a mechanism in place to help manage this volatility. Each year, capital gains collections that exceed a pre-determined threshold amount (currently about $1.3 billion) must be deposited into the state’s “rainy day fund.”10 These dollars then can be used to fill budget gaps during future lean years (i.e., recessions), when revenues from capital gains and other tax sources fall short of expectations.

How would an increase in the tax rate on unearned income affect Massachusetts’ tax ranking relative to other states?

Were Massachusetts, for example, to raise the tax rate on unearned income by four percentage points, this would create a top marginal tax rates of 9.0 percent. This would place Massachusetts in the company of eight other states with similar or higher top rates. (Notably, however, in these other states, the top marginal rates apply to all forms of taxable personal income, not just to unearned income.) These states include New York (which has an additional local income tax that raises the top rate by another 3.876 percentage points in New York City), New Jersey, Vermont, Minnesota, Iowa, Hawaii, California, Oregon and the District of Columbia. Several of these states have rates close to 10 or 11 percent, and one (California) has a top rate above 13 percent. Applying relatively high, top tax rates to high-income households would put Massachusetts in good company: a recent study comparing states’ economic performance over the last decade found that states with high top rates fared considerably better than those with no income tax at all.


Other studies meanwhile continue to debunk the persistent myth of “tax flight” by high-income households as an inevitable response to higher state tax levels. Instead, several notably high-tax states saw a disproportionate share of growth of the total U.S. millionaire and half-millionaire populations from 2017 to 2018. As one researcher summarizes, “Top earners have already found success and typically choose where to live based off family and business connections and quality of life, not differences in tax rates that have no direct bearing on their standard of living.”11


Today, Massachusetts families are confronted with profound health and economic challenges. These near-term challenges compound the challenges created by decades of underinvestment in our public systems, our communities and our people. This is especially true for many communities of color, which have suffered disproportionately both from the COVID pandemic and from centuries of economic exclusion driven by deep-rooted, systemic racism. Raising the tax rates on unearned income is one good option for generating the additional revenue the state needs now – and will continue to need in the future if we are to build a prosperous and just Commonwealth.

Appendix A – It makes good sense to generate new revenue from a tax increase on unearned income, especially during a recession.


As some 90 Massachusetts economists made clear in a letter they delivered to state lawmakers in May, the most harmful approach lawmakers could take at present is one of state budget cuts and under-investment. While the economists note that a failure to properly care for hard-hit communities would be morally unacceptable, their letter’s focus is the underlying economic logic for avoiding budget cuts.

As the economists explain, an austerity approach is precisely the wrong medicine to apply during a recession. When consumers are losing jobs and spending less – thus causing further job losses and setting in motion a downward economic spiral – the federal and state governments must short-circuit this spiral by shoring up economic activity.

How does government do this? By spending more, not less, to keep people employed, consumers buying goods and services, and the economy moving. And how do we pay for this necessary investment in our state’s economic health? As the economists make clear, the best state source for the required revenue is increased taxes on profitable corporations and high-income households. For the households and businesses that have prospered over the last decade and more – and which continue to thrive even during the pandemic – the necessary tax increases represent a relatively small share of their total income. This – along with their ability to draw on savings – allows them to maintain much of their own, pre-pandemic spending, while also supporting state efforts to preserve the health of the overall economy.

This same economic logic has been presented by many others, including Nobel laureate economists Joseph Stiglitz, in a recent op-ed to the New York Times, and Paul Krugman in a separate New York Times op-ed from 2019.

Moreover, the alternative to generating additional taxes is not simply maintaining a satisfactory status quo. Instead, the alternative is to underfund crucial services in the midst of a global pandemic and thereafter to continue a decades-long practice of under-investing in the systems – our education and transportation systems being prime examples – upon which a robust and just recovery will be built. Progressive tax increases will prevent suffering in the near-term and unlock our Commonwealth’s potential over the long-term.


Appendix B – Why should the Commonwealth apply higher tax rates to unearned income?


There are many compelling reasons for applying higher tax rates to the forms of income that flow overwhelmingly to the highest-income households.

At a gut-level, most Americans share a sort of reverence for hard work, believing it should be respected and rewarded in ways that wealth – particularly inherited wealth – should not be. There is the further, commonsense argument that those who have profited most from our social and economic systems have a special interest in and responsibility to pay for the maintenance and growth of these systems – especially during periods of crisis, when much of the population is hard-pressed to make ends meet.

Less philosophically, there is the practical challenge that, as a group, the wealthy substantially under-report their taxable income from unearned sources, and as a result under-pay the taxes they owe on their unearned income.12 Exacerbating the problems of revenue loss from unearned income, federal tax laws provide numerous tax breaks for these forms of income, which further reduces collections at both the federal and state levels.

The most obvious of these many federal tax breaks is the lower tax rates applied to unearned income.13 This preferential, federal tax treatment – while out of step with most Americans’ values and expectations – offers states an opportunity: by raising state-level rates on unearned income, state governments can generate significant amounts of highly progressive revenue, while only nudging the overall, federal-plus-state rates on unearned income toward parity with the rates applied to earned income.

It also is worth noting that the households that would pay significantly more to the Commonwealth if state tax rates on unearned income were raised are the same households that recently received massive tax cuts at the federal level, through the 2017 Tax Cuts and Jobs Act (TCJA). On average, the richest one percent of Massachusetts taxpayers (with average incomes exceeding $3 million per year) will see an annual federal tax cut from the TCJA worth over $60,000 in 2020 alone.14 Those in the next highest-income four percent of households (with average incomes of $475,000 per year) typically will receive a tax cut worth more than $13,000 a year from the TCJA. This is yet another reason why these few, very fortunate households are well-positioned to absorb higher state-level taxes.




1An exception to this is that short-term capital gains (from assets held less than one year) are taxed at a rate of 12 percent.

2Estimate produced by the Institute on Taxation and Economic Policy (ITEP), upon request from MassBudget. Using the most current national IRS Statistics of Income (SOI) data, ITEP assumes that 84 percent of total capital gains income comes from long-term capital gains and that 16 percent comes from short-term capital gains. Incorporating those shares into their model, ITEP estimates that a one percentage point increase in the long-term capital gains rate in Massachusetts would produce a gain in annual revenue of $364 million.

3Estimate produced by the Institute on Taxation and Economic Policy (ITEP), upon request from MassBudget. The combined total revenue gain from raising rates by one percentage point on long-term capital gains and dividend and interest income would be approximately $465 million per year, during periods of strong economic and/or stock market performance.

4Income and wealth disparities are more extreme in the U.S. – and more persistent across generations – than in most developed (OECD – Organization for Economic Co-operation and Development) countries. See, Batchelder & Kamin, “Taxing the Rich: Issues and Options”, Sept. 11, 2019: As the authors summarize (pg. 2), “Thus, to an unusually large extent in the U.S., economic disparities between individuals reflect the luck of one’s birth and systemic discrimination, not hard work.”

For further discussion of income and stock ownership disparities by racial group, see MassBudget’s report, “Supporting Racial Equity and a Robust Recovery with a Corporate Income Tax Rate Increase.”

5Currently, Massachusetts does not provide an exemption for unearned income. As a result, seniors and persons with disabilities – like other filers – are likely to pay tax on some or all of this income. A senior/disabled persons exemption could remove from taxation a significant share of these filers’ overall income, income which currently is subject to state income taxes. As a result, many of these taxpayers could see a decline in their state income tax bill.

6Whenever unearned income declined (for example, during a recession) – and tax collections on unearned income therefore declined as well – there would be a roughly proportional decline in the cost of these exemptions.

7MassBudget analysis of Internal Revenue Service, Statistics of Income (IRS SOI) data. The periods from pre-recession peak to a return to those peak levels was as follows: 2001 to 2003 for dividends, 2001 to 2006 for interest income, and 2001 to 2004 for capital gains. Analysis is based on inflation adjusted income figures. See IRS SOI tables:

8MassBudget analysis of Internal Revenue Service, Statistics of Income (IRS SOI) data. The periods from pre-recession peak to a return to those peak levels was as follows: 2007 thru 2009 for both dividends and capital gains. Income from interest fell sharply and has yet to return to earlier highs. Analysis is based on inflation adjusted income figures. See IRS SOI tables:

9As of 2018 – the most recent data available from the IRS SOI – Massachusetts interest income had yet to return to previous highs reached in 2007.

10The threshold for Fiscal Year 2020 was $1.26 billion. See the Department of Revenue FY21 Revenue Briefing Book, pg. 24:

11Institute on Taxation and Economic Policy, Carl Davis, Just Taxes (blog), September 9th, 2020:

12See also Center on Budget and Policy Priorities report, “Substantial Income of Wealthy Households Escapes Annual Taxation or Enjoys Special Tax Breaks”, November 13, 2019:

13For a discussion of specific rates, see Center on Budget and Policy Priorities report, “Substantial Income of Wealthy Households Escapes Annual Taxation or Enjoys Special Tax Breaks”, November 13, 2019 (pgs. 12-15):

14See Institute on Taxation and Economic Policy, “TCJA by the Numbers, 2020” (refer to interactive map of U.S.):


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