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Dayton's budget undermines both job growth and economic growth

Gov. Mark Dayton offered "the first word" on the budget and released his FY 2014
MinnPost photo by James Nord
Gov. Mark Dayton offered "the first word" on the budget and released his FY 2014-2015 budget proposal.

On Wednesday, Gov. Mark Dayton offered "the first word" on the budget and released his FY 2014-2015 budget proposal. In short, he proposed to increase revenues by $2.976 billion (8.5 percent) as compared to the current budget. The extra revenue pays for $1.64 billion of built-in spending increases and $1.031 billion in new spending and, in the process, erases the $1.09 billion shortfall.    

Peter Nelson
Peter Nelson

Here are the top-line takeaways:

  • The budget undermines both job growth and economic growth.
  • The budget is weighted entirely toward new revenue.
  • Dayton's "comprehensive tax reform" violates basic tax reform principles at nearly every step.
  • Instead of reforming the sales tax to fit the new economy, the proposed sales tax primarily raises taxes on families and their employers.
  • The budget ignored long-term risks pensions pose on the state budget.

For those interested in more details, here's a summary of the budget and more in-depth explanation of the above takeaways.

What's in the budget?

On the revenue side, the governor offered what he called comprehensive tax reform. Major revenue raisers include: 1) a new tax bracket for the top 2 percent of earners ($1.1 billion); 2) a snowbird tax on people who live in the state less than six months, but more than 60 days ($30 million); 3) an expansion in the sales tax base to include more products and services ($4.2 billion); 4) a motor vehicle rental tax ($15 million); 5) corporate tax base expansion ($323 million); and 6) an increase in the cigarette tax ($370 million. 

These new revenues are, in part, offset by a tax rebate and a few rate reductions.  All homeowners (assuming they pay income taxes) would receive a $500 income tax rebate, which would reduce revenues by $1.4 billion. In addition, the sales tax rate is lowered to 5.5 percent, reducing revenue by $2.1 billion, and the corporate tax rate is reduced to 8.4 percent, reducing revenue by $319 million. 

Looking to new spending, the proposed budget adds $344 million to K-12 education, $250 million to higher education, $117 million to local aids and credits, $128 million to health and human services, $86 million to public safety and $70 million to economic development. 

Notably, the high-level budget presentation fails to highlight any specific new expenditure reductions. However, it does cite $225 million in reductions and reallocations, as well as $890 million in cost inflation absorbed by state agencies.  On closer inspection, there do not appear to be any substantial expenditure reductions.

First impressions

Dayton admitted that a lot of people won't like this budget and predicted we'll hear people calling this budget a disaster. How prescient. After reading a few news reports on the governor's position on comprehensive tax reform, it seemed the governor might propose a budget that included at least a handful of positives to counter the negatives. Regrettably, that does not appear to be the case. Here are some of the major problems.

The budget undermines both job growth and economic growth. Very little in the budget says Minnesota is open for business. Yes, the corporate income tax rate and business property taxes are reduced a notch, but it's just a notch. Other tax changes are far more damaging. Adding another income tax tier to the top earners will raise taxes on small businesses and create yet another barrier for all business in attracting top talent. More damaging, broadening the sales tax base to business to business sales will only increase their taxes. Notably, these taxes are passed on to consumers in higher prices and employees through lower wages. Dayton's own revenue department recognizes this fact. Thus, contrary to Dayton's claims, the average Minnesotan is indeed impacted by these tax increases.   

Dayton pooh-poohed the idea that high taxes and high spending impede economic opportunity. Now it's true that Minnesota gets high marks in some business climate indexes and very low marks in others. However, recent research demonstrates that those indexes that give Minnesota low marks — the indexes that stress the importance of lower taxes and lower spending — are the ones that can actually predict economic growth. Fortunately for Minnesota, low taxes and low spending aren't the only factors that influence economic growth, but that doesn't mean we can ignore them.

The budget is weighted entirely toward new revenue. Dayton claimed to offer a "balanced" approach, but, as already noted, the budget does not include any substantial spending reductions to help balance out the projected $1.09 billion shortfall. There's a bit of irony here. On Monday, a news release from the governor's office decried "the slash, burn and borrow budgeting approach of the past." Yet the budget presentation boasted of "$5.1 billion in cost savings and reductions over 4 years," which were largely due to the demands of a Republican-controlled Legislature. The governor called this better government for a better Minnesota, but then failed to offer any specifics on how government would do things better and more efficiently through his budget.  

Reducing spending might sound draconian on the heels of the budget cuts made to balance out those ugly shortfalls of $6.4 billion and $5.2 billion in the past two biennial budgets. However, the state actually survived the so-called Great Recession without needing to make extreme sacrifices. Thanks to an assortment of budget gimmicks and federal funding, the state was able to increase total spending by 5.9 percent in the 2010-11 budget and by 7.2% in the 2012-13 budget. Because the state found ways to increase spending, there remains room to make reasonable spending reductions to balance the current shortfall.

Dayton's "comprehensive tax reform" violates basic tax reform principles at nearly every step. Tax reform principles like simplicity, accountability, efficiency and certainty do not fare well under Dayton's budget. Our tax system is repeatedly lampooned for violating nearly all of the most basic principles of a sound tax system. Complexity is the most serious and common charge. Yet, Dayton's budget proposal adds new layers of complexity.   Some new wrinkles to the tax code include a 4th rate tier for the income tax, a new income tax rebate added to an already long list of income tax adjustments, and a requirement on clothing retailers to account for items sold priced higher than $100. Efficiency also suffers. The state tax system should minimize any distortions on private and local government activity. People will find new and innovative ways to avoid snowbird taxes and cigarette taxes (e.g., tribal retailers selling cigarettes will be more popular than ever). In addition, the proposed $500 rebate on property taxes gives local governments an opportunity to adjust taxes upward and, thereby, reducing their accountability to tax payers. 

Instead of reforming the sales tax to fit the new economy, the proposed sales tax primarily raises taxes on families and their employers. Dayton attempted to heed the nearly universal call from tax policy experts to broaden the tax base and to lower rates, but his proposal fell far afield from what nearly every tax policy expert would advise. To the extent Minnesota consumers have shifted more of their spending to services, broadening the sales tax base to include these services makes sense, assuming any expansion is coupled with a reduction in the sales tax rate on all products and services. Doing so should create a more stable revenue source and reduce distortions on how households spend money. But Dayton's proposal depends much more on expanding the sales tax to sales between businesses.  This leads to what tax experts call tax pyramiding where the final cost of a consumer product can include a pyramid of sales taxes on all the inputs that went into creating the product. And in the end, it's the consumer who ends up paying the price.  

The budget ignored long-term risks pensions pose on the state budget. It's not surprising that the governor didn't mention the unfunded liabilities in state and local pensions. After all, pensions are supposed to be an off-budget item. But Dayton was keen to point out how his budget solved long-term structural problems with the budget. The fact is, pensions pose a long-term problem to the state's budget. And any resolution requires taking on the public employee unions, which this governor simply will not do. 

Now the budget debate turns to the DFL-controlled Legislature. The governor shrewdly left the tough choices to them. Clearly, the sales tax base expansion is going to need to be trimmed back if it is going to be implemented at all. It's up to the Legislature to now pick the winners and losers.

Dayton also made no effort to trim spending, which legislative leaders have suggested may be necessary. And spending cuts will be necessary if Dayton's revenue proposal proves unworkable, which is quite likely.     

A majority of Minnesotans gave complete control of state government to Dayton and the new DFL Legislature. It will be interesting to watch the Legislature react to the governor's budget.   Will legislators pay more attention to advancing sound tax policy principles, reducing spending and promoting economic opportunity? I'm not holding my breath. 

Peter Nelson is the director of public policy at Center of the American Experiment.

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Comments (20)

I particularly liked this

I particularly liked this comment:

"Instead of reforming the sales tax to fit the new economy, the proposed sales tax primarily raises taxes on families and their employers."

Who else is there? Martians?

Grain of salt recommended

Just in case folks haven't noticed, the author of this piece is the director of public policy at Center of the American Experiment.

The usual large grain of salt while reading is recommended.

Value-added tax

In response to the criticism that business-to-business taxing would 'pyramid' price increases on to the consumer, perhaps a value-added tax, such as is popular in Europe, could be a viable alternative. It has the simplicity argument going for it, since the tax is only levied at the final point of sale. I imagine that such a fundamental change to the state's consumption tax would require a great deal of discussion and fine-tuning; perhaps this is beyond the scope of a single legislative session.

VAT on Wikipedia

Thomas, when you say at the "final point of sale", in terms of the VAT the final point-of-sale would include every transaction in the production process producers, processors, manufactures, wholesalers That is actually how Minnesota's system work currently, in general, where there is no sales tax paid on production inputs and so forth and refunds are provided for production equipment and upfront exemptions for farm and ag. It is only the end-user or consumer who pays the sales tax to the retailer (or self-accrues use tax). This is my understanding and I claim no expertise.

Wikipedia (Value Added Tax):

"....A VAT is like a sales tax in that ultimately only the end consumer is taxed. It differs from the sales tax in that, with the latter, the tax is collected and remitted to the government only once, at the point of purchase by the end consumer. With the VAT, collections, remittances to the government, and credits for taxes already paid occur each time a business in the supply chain purchases products..."

In my opinion, I would say that the more transactions that need to be taxed, in theory, would increase compliance cost for business and administration and enforcement costs for government. But there are a lot of other moving parts and that's only given an increase in the current scheme (though cost per transaction would decrease marginally).

~Bob

Well said...

I have to agree with Bob on this one...

As mentioned if increases were made at the final POS, and the other aspects of such a change were put in place on the government's side... I think it would be a win/win for everyone and we wouldn't even need to have this discussion.

Sure as consumers we are never happy to pay more taxes when we hear the news of an increase, but at the same time, once we get to the register (http://www.gilbarco.com/us/products/point-sale/passport-c-store-pos-display), watch the screen as our items are scanned, and are ready to check out... we almost never are looking at the amount of tax that is charged but it's usually the cost of each individual item. So making the change at the final point of sale as mentioned might not be a bad idea. I know there are other things that would need to be addressed as well, but in theory... it seems like a good solution.

And you propose what

in the alternative, more tax cuts, perhaps?

Of course

Tax cuts! This time more jobs will result - we promise - for sure - trickle down. LOL

A note on Mr. Nelson's credentials.

Peter J. Nelson
Peter.Nelson@AmericanExperiment.org

Peter Nelson is our Director of Public Policy. As such, he spends most of his time researching and writing on issues related to health care and energy. On health care, Peter primarily focuses on issues involving insurance regulation, Medicaid, and long-term care. He regularly consults with state policy makers on these issues and contributes commentaries to the Star Tribune, Pioneer Press, and other local newspapers across Minnesota. Peter received his B.A. in economics from Wheaton College and a law degree from the University of Minnesota Law School where he was a member of the Minnesota Law Review.

I am so sick of the same tired talking points

from these "conservative" think tanks I could scream. The non-partisan CBO study shows NO correlation between lower taxes and higher growth -- if anything it shows the converse. What low taxes do do is increase income inequality -- which is a drag on growth for the oh-so-simple fact that an extra forty thousand in the pocket of a millionaire is more likely to be stuck in a bank or gambled on Wall Street, while an extra four thousand in the pocket of a "poor" or middle class worker is more likely to be spent.

Agreed.

"...I could scream..."

Agreed, Lora, and I've commented to that effect below. Just want to let you know I hear you. These are really backward and un-American thoughts and an alternative conversation is needed.

~Bob

Perhaps it should be called the Center for the American Hysteria

I don't know what Mr. Nelson's credentials are but apparently reading comprehension isn't one of them. The article he linked to from the San Francisco Federal Reserve would have to be read in some other language to reach the same conclusions he did.

I have yet to work with a business that considered taxes a big issue it is just part of the rhetoric that they supply politicians with to get them out of there hair. I would call it the "yeah I would like lower taxes now go away approach". In fact most businesses would do most anything to keep politicians away.

As for more tribal cigarette sales with a new sales tax - perhaps Mr. Nelson could do a bit of research on that topic as well because he is misinformed.

Must Not Have Actually Read His Citation

Mr. Nelson must have misread/not read the Federal Reserve article he cited as evidence that tax-and-cost indexes are a better predictor of economic growth than quality of life indexes. While it may be true that tax-and-cost indexes are better predictors, the authors state:
"Although we found that policies associated with a higher ranking on the tax-and-cost indexes—lower taxes and costs of doing business—lead to faster economic growth, the role of these policies should not be overstated. Figure 1 shows that some nonpolicy factors appear to have much stronger relationships with economic growth than the policies captured in the tax-and-cost indexes."

These non-policy factors include: climate, population density, geographic features, and most important for GSP growth is Industry Mix. The authors state: "Several states, mostly in the South, such as Tennessee and Alabama, have favorable business climates, but unfavorable non-policy factors."

Minnesota has favorable non-policy factors in population density (i.e. room to grow), geographic features (rivers, great lake, centrally located), and Industry Mix, even with a not so mild climate. Our Industry Clusters in information technology, medical devices, education, business services, financial services, transportation and logistics, analytical instruments, and production technology, all provide Minnesota's economy with a diverse base for employment and growth. Minnesota Dept of Economic Development is intently focused on a cluster-based strategy for enhancing the state's competitiveness, and according to this research that kind of strategy will be more successful than cutting taxes and eliminating regulations.

Our advantages in these areas allow us to offset some of the disadvantages of our tax-and-cost index rankings. As the authors state: "These findings shouldn’t be taken to mean that progrowth policies are always good public policy." In fact, the paper seems to offer up a solid rebuttal of Mr. Nelson's "Capital is the ONLY THING" argument. Our unique situation allows us to devote more public funding to pursuits like early childhood and higher education, research and development, the arts, conservation, social safety nets, and public services.

Those sorts of investments matter to me as a citizen, far more than whether we have a favorable business climate. This is partly because the benefits of economic growth (GDP, GSP, etc) largely accrue to the wealthiest individuals and not to middle-class and lower-class earners. For instance, in 2010 GDP grew by roughly 3%: the top 1% of earners saw their incomes increase by 11.6%, while the bottom 99% saw their earnings grow by 0.2%. Conversely, the benefits of public investment in education, arts, culture, and the environment accrue to all citizens, not just the wealthy.

cite: http://elsa.berkeley.edu/~saez/saez-UStopincomes-2010.pdf

Summary

Let me see if I can sum up this opinion piece: Doom! Gloom! If we follow Dayton's budget cats will sleep with dogs, it'll snow in July, and the earth will spin backwards.

Seriously though. We've tried the whole budget cut business and while it's helped in some areas, it's been a disaster in others. Our roads are full of potholes because we have 1/3 the number of crews out there fixing them, bridges are falling down, homeless veterans are sleeping out in the cold, and we're kicking kids off of aid they need to stay fed and healthy.

This is not what Minnesota is about. If that's what conservatives want, then I suggest they move to one of the southern states like Mississippi where that sort of thing is normal in society. Here in Minnesota though we like to work towards a higher order, one where we help our fellow citizens rather than push them down in the mud with a gruff "get a job, loser!"

The Govs proposal

I find a lot to like in the proposal. Walk down any main street of any city- how many are retail shops, how many are service offices? Share the tax but at a lower level. We will see restaurant business go up, by the time you add city taxes on a restaurant bill, it gets pricey. If I can afford a $100 blouse, I can afford the tax on it. The vast majority of us don't buy expensive clothing to start with. We still will get our haircut on the same schedule, and many of the services like taxes are only once a year, many are once a life-time. I prefer this over the high/lows we now have in state revenues. The very businesses that want better and updated infrastructure and an educated workforce will have to help pay for it. And property tax relief- who doesn't want that? I believe that will help the middle class more than the new sales tax will hurt. And who is concerned about the middle class all of a sudden?

Mr. Nelson

…knows not whereof he speaks.

“Adding another income tax tier to the top earners will raise taxes on small businesses and create yet another barrier for all business in attracting top talent.” Wow! The top 2% of income earners in Minnesota own all the small businesses in the state? Amazing! Name five businesses that are offering incomes in that top 2% to new hires, and then provide some documentation, Mr. Nelson, to show how a somewhat higher tax rate kept those amazing and talented people from coming to work and live in Minnesota.

“However, recent research demonstrates that those indexes that give Minnesota low marks — the indexes that stress the importance of lower taxes and lower spending — are the ones that can actually predict economic growth.” Why quote the San Francisco Federal Reserve? What does the Minneapolis Federal Reserve have to say?

“However, the state actually survived the so-called Great Recession without needing to make extreme sacrifices.” School districts are still more than a billion dollars in the hole. Why are school children bearing the burden of demonstrated Republican ineptitude at government?

“Dayton's "comprehensive tax reform" violates basic tax reform principles at nearly every step.” Lots of assertions here, no support for them.

“Instead of reforming the sales tax to fit the new economy, the proposed sales tax primarily raises taxes on families and their employers.” As Rob Levine pointed out, who else IS there? More to the point, if the “new economy” is to be service and internet-based, as many have asserted, Dayton’s tax proposals seem right in line with what’s happening.

And I’m not holding my breath, waiting for Mr. Nelson to defend the interests of the bulk of Americans, as opposed to the interests of those in the top few percent in terms of income. This piece is mostly right wing / chamber of commerce boilerplate.

Dayton's idea

Of having the tax base be roughly 1/3rd property, 1/3rd sales and 1/3rd income is a good one in terms of more fairly sharing the burden. My partner will be happy to know that sales taxes will likely be lower on the goods & services she sells, but we'll see.

Peter Nelson is indeed a very

Peter Nelson is indeed a very bright fellow, let there be no debate about that. But, he writes for the Center of the American Experiment which must, given its mission and funding, cheer for any and all Republican tax/spending cuts no matter how foolish or misguided. And in concert, any tax/spending increases offered by DFL'ers must be branded as bad ideas no matter how well conceived or necessary.

I know I'm just piling on but I can't resist

I second the comment regarding fatigue. I'm just so tired of these predictable and intellectually bankrupt responses from the so called intellectuals on the right. Dayton's plan contains no magic tax or budget cuts... guess what, there's no such thing as magic, that's why Republican magic plans never worked. Instead of an age of prosperity and unlimited freedom we chronic budget crises and massive recession. The value in providing this article on Minnpost is that it tells us the folks at the American Propaganda Experiment (sic) still believe in magic, and still cannot connect with reality on a meaningful level.

Phoning it in

Mr. Nelson just repeats the old, old conservative incantations. His only solution to the state's budget problems are to cut spending and taxes. He even throws in a little union bashing for good measure, just to show he's hip to all the current right-wing talking points.

Minnesota tried the Republican approach to budgeting: It didn't work. We are in our present situation after eight years of Pawlentynomics, and after two years of Republican control of both houses of the Legislature (the short term shows how popular they were). A relentless focus on tax cutting does not promote economic growth, and it does not promote fiscal stability.

The Center for the American Experiment long ago lost whatever credibility it may have had, thanks to the fantasies spun by deep thinkers like Mr. Nelson. Perhaps they should consider changing their name to Get Rid Of Slimy liberalS, and make a permanent move to their treehouse.

Where will "growth" come from?

"...undermine both job growth and economic growth..."

Where does Mr. Nelson believe job growth comes from, or from whom? I think he is borrowing a conversation that others have had for a quarter-century since Reagan. Get over it, move on; you are tone-deaf with young people and these bogus conservative principles are toxic and your parties have no futures without a complete metamorphosis.

In the 21st Century, in Minnesota, as part of a 21st Century Economy with a 21st Century Tax System, I am pretty certain that a majority of economic "growth" will come from people under thirty-five. Young people have taken more time in college and been cushioned by their parents and need to do more, and more quickly, to add spark and momentum to economic revitalization. I think they have the technology, desire and access to capital in a way probably never so much as before.

My peers need to find a way to be more successful. That's my plan at onemantaxplan@gmail.com. By doing that they will generate more (a) business income, more (b) sales and sales tax revenues, and (c) more acquisitions an improvements to the property market place raising tax base and local revenue. It is a three-pronged attack on lagging income, property and sales tax revenues in need of a jolt. This will also create jobs for their unemployed peers and all cohorts and make people more happy generally.

I would support the Dayton plan over the status quo, but I find much to be desired and in particularly the disregard for the people I speak of, which I guess would undermine economic and job growth in my mind (disregarding the other effects of his budget, like education, health, transportation):

(1) The homeowners' rebate ($500) disregards the fact that most people under thirty-five are renters so this would offer no benefit and would likely incentive or "cushion" local government increases in property taxes which would fall on renters disproportionately.

(2) The sales tax increases and their effect on consumer groups, I have to believe in my humble opinion, are rather deceptive. These will absolutely burden young, non-business people the poor and middle class. Things like 7-county metro taxes on top of 5-county metro taxes (special districts) on top of Hennepin County, Minneapolis, St. Paul sales taxes burden the compliance costs for new business (and education costs) and are deleterious to business-friendly climate.

(3) As for income taxes, know that young people don't care what their taxes are as long as for the next dollar they make they get a cut. That's the bottom line. In my understanding that is what the 2% increase would do. It would not retroactively tax income up until the threshold, but would tax income over that so. If you made $50K over the threshold, say $150,000 for a single filer, you would pay an additional $1,000. in MN income taxes, not 2% more on all of your income, including the $150,000, so $200,000 x 0.02 = $4,000.

Is it acceptable to pay $4,000 on $50,001 additional income? No, I don't believe so.
Is it acceptable to pay $1,000 on $50,001 additional income? Yes, I believe so. This must be more than the average single filer FAGI.

So here's "Bob's 21st Century Economic Plan for Minnesota":

~A Message to Young People: Be more successful, dammit!~

(Tough) Love,
~Bob