Policy Documents

The Enterprise Value Tax: What it Means for the Massachusetts Economy

David G. Tuerck, Paul Bachman, Frank Conte –
December 9, 2011

President Obama’s Plan for Economic Growth and Deficit Reduction contains a provision that would tax, as ordinary income rather than capital gains, the net proceeds from the sale of what is deemed an “investment services partnership interest”(ISPI). An ISPI is any interest in an investment partnership that is acquired by a person as a result of activities involving the purchase and sale of certain “specified assets,” defined to include partnership interests, securities and real estate holdings. This provision, which is labeled as the “Enterprise Value Tax” (EVT), would force certain partnerships to pay ordinary income tax on the sale of any part of their business.

Although publicly touted as a tax on financial firms, the EVT will have broad sweeping impact on other industries such as natural resources, real estate, and many other businesses. The EVT represents an important departure from current law. Under current law, most of the profits from the sale of investment partnerships are taxed at the capital gains rate, consistent with the long-standing general rule that business interests should be treated as capital assets. The tax rate on long-term capital gains is 15%.

The EVT would treat these same profits as ordinary income, for which the top statutory tax rate is 35%. The purpose of this study is to assess the effects of this change on the Massachusetts economy. The implications for Massachusetts are potentially severe, considering that the state is a center for venture capital and the incubation of high-technology businesses. The plan would be particularly punishing toward the financial, insurance and real estate (FIRE) sector, which comprises 25% of the state’s economy. We predict that persons who reside in Massachusetts will pay $611 million annually in new federal taxes under the plan. Using our State Tax Analysis Modeling Program, (STAMP), we also find that, as a result:

  • The state will lose 5,400 jobs.
  • Annual capital spending will fall by $9.5 million.
  • Residents’ real disposable income, or income available for spending and saving, will fall by $673.2 million.

These results are consistent with the argument from economics that a tax on capital income discriminates against saving and risk taking. By reducing saving, the tax reduces investment and employment, thus also reducing income and that part of income (i.e., disposable income) that is available to finance consumption. By reducing risk taking, the tax discourages innovation and, with it, technical progress, with further negative effects on investment, productivity, employment and income. These effects are likely to be especially severe for states like Massachusetts whose economies are centered on financial services and high technology.