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How does Minnesota stack up in business taxation? Pretty well, it turns out

Tax Facts

If you could collect $100 for every claim a political candidate slings your way about Minnesota's business taxes, you probably could start a respectable small business.

The political points are simple: Minnesota's business taxes are so onerous they drive companies and jobs to other states. Or, from another view, companies use loopholes to avoid paying their fair share of the costs of state and local services.

Of course, the issue is not at all simple. More than any other, it offers proof that statistics can be manipulated to support almost any point.

So it is with both humility and trepidation that I take up business taxes for this installment of MinnPost's occasional series on taxes. You can read the first article in the series here.


Look beyond the income tax
Politics aside, reasonable people could and do conclude that Minnesota's business-tax climate compares favorably with other states — even with South Dakota.

If you haven't slept through the political debates of the past few decades, you know that South Dakota has no corporate income tax. Minnesota does.

But corporate income taxes are not even close to being the biggest tax burden on businesses.

That distinction goes to property taxes. They accounted for 36.2 percent of all the state and local taxes that businesses paid in Minnesota during fiscal year 2009, according to a recent report by the Council on State Taxation, a nonprofit trade association that grew out of the Council of State Chambers of Commerce.

Next was the sales taxes businesses pay for the stuff they buy for their operations — some 19.2 percent of the total burden. The ranking goes on through items like unemployment insurance, excise taxes on motor fuel and other items before it comes to corporate income taxes — 7.8 percent of the total burden.

You still have to say that's a significant share, one worth debating. But you also have to keep it in perspective.

The council's study, done by analysts at Ernst & Young LLP, provides some useful ideas for comparing overall business taxes state by state.

It also serves up some surprises.

What's a fair return?
The basic rationale for taxing businesses is to pay for government services benefiting businesses, the report says. If a business gets a dollar's worth of direct services for every dollar it pays in taxes, then it gets a fair deal.

Measuring the services part of that equation isn't easy, but the Federal Reserve Bank of Chicago has developed methods for calculating estimates. It counts items like police and fire protection, water and sewer infrastructure, transportation amenities, etc.

The trickiest item to count is education. There is no doubt that companies benefit from the millions that states spend on everything from specific vocational training — in, say, factory robotics — to general improvement of reading and math skills.

If you operate a chain of drug stores, you look to universities to train pharmacists and the K-12 system to turn out workers who can run a checkout counter. If you're in the business of keeping pets healthy, you need highly trained veterinarians, lab technicians, bookkeepers and receptionists. Your modern auto-repair shop couldn't operate without trained specialists in electronics.

You get the idea.

Because the business value of all of this training is difficult to gauge, the Ernst & Young analysts offered different ways of looking at each state's tax-benefit ratio.

If you count absolutely no benefit from education, Minnesota businesses paid about $3.80 in state and local taxes for every dollar's worth of benefits they received. That's close to the national rate of $3.50 and comparable with other states in the Upper Midwest.

But the ratio changes if you assume that half of the money spent for education benefits businesses. Seen that way, Minnesota businesses pay about $1.10 in taxes for every $1 in government benefits. That compares with $1.50 for North Dakota, $1.40 for South Dakota and $1.00 each for Wisconsin and Iowa. And it's better than the national rate of $1.20.


How much businesses pay in state and local taxes for every dollar’s worth of government services they receive

How much businesses pay in state and local taxes for every dollar’s worth of government services they receive
Source: Council on State Taxation

Measure against economic activity
Another way of looking at a state's competitiveness is to measure state and local business taxes that actually were collected against economic output. The report calls such output private-sector gross state product.

This isn't a perfect measure because competitiveness depends on where the economic activity took place. A tax on a local service — say, a restaurant meal in St. Cloud — probably doesn't take away from the state's overall competitiveness. But certain taxes on a company that sells lawnmowers nationwide could be a different story.

Still, economists do compare states by this measure because it reflects the actual taxes paid after businesses took advantage of various deductions and opportunities to pass expenses along to customers. The Ernst & Young report calls it the "total effective business tax rate."

Here too, Minnesota stacks up favorably. Its total effective business tax rate for 2009 was 4.3 percent. That compares with 8.2 percent for North Dakota, 4.9 percent for South Dakota and 4.6 percent each for Iowa and Wisconsin. The national rate was 4.7 percent.

By this measure, Minnesota is 15th from the bottom state in business taxation.


Business taxes as a share of private-sector gross state product

Business taxes as a share of private-sector gross state product
Source: Council on State Taxation

Changing direction
Finally, the report looked at the direction states have taken in terms of spreading any increase in their tax burdens. Nationwide, businesses paid 46.7 percent of the increases in state and local taxes from 2005 to 2009. In Minnesota, they paid 36 percent. That compares with 73.5 percent in North Dakota, 61.6 percent in South Dakota, 55.7 percent in Wisconsin and 50.5 percent in Iowa.

I'm not sure what to make of that last measure. One explanation for the high rate in North Dakota, for example, could be that business thrived in the state during the five years and thus there was more to tax. Comment from readers on this point would be great.

The poor pay more
One point to keep in mind is that businesses pass a good share of their taxes to consumers in the form of higher prices. These shifted business taxes fall most heavily on low-income families, reflected in everything from rent to medical bills.

Minnesota has taken care to shield less-fortunate families from the brunt of the sales tax by exempting essentials like groceries and clothing. But, because businesses can pass along their tax expenses for everything from utilities to software to property, the poor still end up paying a hefty share of taxes. 

Business taxes also squeeze workers. When tax bills cut into profits, layoff notices or pay cuts often follow. 

So, if you think these business tax issues are all about business owners, think again.

Not far apart
That regressive shift in business taxes is one reason the political sides aren't as far apart on these issues as campaign rhetoric makes it seem. Republicans and DFLers alike have been concerned that workers and the poor end up paying dearly for high business taxes.

The big political differences begin with claims that taxes on the higher brackets of personal income hurt businesses too. That's a good subject for a future installment of this series.

For now, though, I'll say it helps explain the gap you almost surely will encounter between the analysis presented above and the claims you will hear from candidates for your local legislative seats and statewide offices.

One example is often-cited data from the Tax Foundation, a conservative think tank in Washington, D.C. Its most recent ranking of states [PDF] counts Minnesota among the 10 states with the worst business tax climates. One factor in the foundation's decision to rank Minnesota 43rd among states was the state's individual income tax.

Keep an eye on property taxes
A key factor to watch in the political debates is the property tax. That was one area where Minnesota scored favorably in the Tax Foundation's business-tax-climate report, ranking 16th best in the nation.

But by every indication, property taxes are climbing in Minnesota as the state government balances its budget by pulling back support for local government services. The debate, of course, is whether cities and counties should and can further slash spending rather than raise property taxes.  

Meanwhile, here's an excellent guide [PDF] to business taxation in Minnesota. It's from the Center for Public Finance Research, an arm of the Minnesota Taxpayers Association.

Sharon Schmickle writes about the economy, science, international affairs and other topics. She can be reached at sschmickle [at] minnpost [dot] com.

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Comments (11)

So let's see....
Which candidates are talking about raising sales taxes and other 'fees' (27% of tax burden) and which are talking about raising corporate income taxes (~10%).
And of course property taxes on businesses (36.2%) have been going up as incomce taxes are reduced.

Interesting numbers!

The North Dakota increase falling most heavily on businesses is likely because much of their tax revenues are derived from oil production.

The fact that such a low portion of Minnesota revenue increases have fallen on businesses reflects in part the shift of the state's fiscal problems onto local governments and property taxes, via cuts to state aid to counties and local government aid, as well as accounting shifts and cuts to schools who then go for property tax levies, and increases in the cost of unfunded mandates to local governments and schools. State officials can say they are not raising taxes, but local governments are left holding the bag. City property tax revenues have increased 102% over 10 years as LGA has been cut, but their total spending after inflation has fallen by 7%. So they are cutting, significantly when you consider skyrocketing health care, pension, energy, and other major cost drivers. The State Auditor's recent city finances report goes into this in greater detail. http://www.osa.state.mn.us

I'd venture that the energy economy in North Dakota accounts for the higher ... oh, Shawn Otto beat me to it.

Oil production went up in the state during that period, and energy states love to "export" their tax burden to the oil and mining companies.

Thanks, Sharon, for an interesting analysis. I'll have to hear more campaign rhetoric, unfortunately, before I can decide which gubernatorial candidate is massaging (i.e., distorting) the numbers the most, but I already have my suspicions.

I look forward to an installment on the effects on business of higher income taxes on those in the upper brackets. Having moved here only 15 months ago, I can vouch for the fact that my own modest income as a retiree is taxed at an effective rate that’s very nearly 3 times as high as the effective rate in my former home of Colorado. The property tax on my home is also significantly higher than in Colorado, though the rate doesn’t approach the increase in my income tax.

You come at it somewhat sideways, but there's also a philosophical point that public policy could (but usually doesn't) address. That is, when considering the benefit to business of an educated workforce, a question arises (at least in my own mind) as to the overall purpose of K-12 education. I’m retired, but I’ll phrase it as if I were still in the classroom: Is it my job as a teacher to train workers for business and industry, or should the emphasis be more on training the next generation's citizens? Those are not mutually exclusive, literacy and thoughtfulness are important to both, but they ARE significantly different goals.

Training for a specific job via public schools, it seems to me, provides a significant benefit to business at taxpayer expense – more accurately, it’s a public subsidy of the operation of that business. I have no idea if this is what Ernst & Young are trying to measure, but as you’ve suggested, it strikes me as something rather difficult to measure. Among the problems with this area is that job-specific training routinely becomes obsolete and/or irrelevant. What proportion of jobs available now didn’t exist a generation ago, or require extensive retraining for existing workers?

"And of course property taxes on business (36.2%) have been going up as income taxes are reduced.

I don't know the figure offhand, but I'd guess property taxes on residential properties have risen by at least as large a percentage as that on business property.

Sharon S.: This is a very interesting article. Thanks for digging out all the pertinent information and writing about it so well.

The following was sent to the Star Tribune in May (a portion of which was printed). It should help your readers some context around the COST study.

Business taxes still too high

TO THE EDITOR:

Much has been made about the Council on State Taxation's (COST) recent report on business tax burdens. One statistic grabbing the attention of some legislators and pundits is that Minnesota ranks 35th highest by one measure: state and local business taxes as a percent of gross state product (GSP). Those who quote that statistic should have read the entire report. COST specifically says it does not provide "sufficient information to fully evaluate a state's competitiveness."

Furthermore, there is a quirk with the measure used in the COST study. A state with high labor costs, such as Minnesota, will typically rank low even though its business taxes are above average or even high. That's because higher labor costs lead to higher GSP – both good things – but it also lowers the ratio of business taxes to GSP.

A closer look at the state's business tax structure is necessary to reveal a far different – and more factual – picture. The Minnesota Taxpayers Association reports that in 2007 – the most recent data available – Minnesota had the 14th highest corporate income tax per $1,000 of income, ninth highest personal income tax per $1,000 of income and 36th highest sales tax per $1,000 of income (businesses pay 45 percent of the state's sales tax). In addition, in 2009, the state ranked 11th highest for a $1 million commercial property in the largest urban city.

Many economists believe the only rationale for taxing business is to recoup the cost of the government services from which businesses benefit. The report also calculates the ratio of business taxes to benefits received. Using COST's midpoint estimate, Minnesota businesses are overtaxed – not undertaxed - by approximately 80 percent.

So before everyone concludes that Minnesota has no business tax problems, read the entire report. Doing so should convince you that Minnesota has more work to do.

Tom Hesse
St. Paul

Tom Hesse is vice president of government affairs at the Minnesota Chamber of Commerce.

"State officials can say they are not raising taxes, but local governments are left holding the bag."

So the T-Paw Presidential slogan is "We're charging you the same price, we're just giving you less"? Guess that explains the 1% in Iowa.

By every measure taxes were significantly higher 10 years ago, but there were no tea parties. George W. Bush and a Republican Congress vastly expanded spending for pork barrel projects and enacted an unfunded, multi-trillion-dollar Medicare give-away to the elderly to buy re-election in 2004. But there were no tea parties. Why should I treat with respect people who have only suddenly noticed problems that have been around for many years that they turned a blind eye to? I suppose some will say better late than never, but not me. I want to see some consistency from people before I grant them credibility.

Is there a good way to determine a business "standard of living" for an area? The Ernst and Young analysis seemed to suggest somethng along those lines, but it would be interesting to seem how that standard of livng (ignoring taxes) in Minnesota would compare to other states and regions.

I finally finished reading both the Ernst and Young study referenced by the author Ms. Shmickle,

http://www.cost.org/Page.aspx?id=69654

and the Taxpayers Association article referenced by Mr. Hesse from the Chamber of Commerce.

http://www.mntax.org/cpfr/documents/HDMCFY08FINAL.pdf

There are a couple interesting things to note. First, Mr. Hesse is mistaken, the most recent study by the Taxpayer Association is from 2008, not 2007, and it ranks MN at 17 not 14. The same study projects that in 2009 MN will be 18th. The tax burden for MN businesses is and has been dropping.

The most significant differences between the two studies is complexity and purpose. Ernst and Young actually try to develop a method to evaluate the costs and benefits of business taxes. The Taxpayers association (TA) makes no attempt to do this, it simply assumes that anything greater than zero is not good.

It's important to note that the Taxpayer's Associations assumption that lower tax rates are better for the economy or business environment is an ideological position, not a consensus amongst economists. There's nothing more "factual" about the TA study, it just calculates rank using a different data set. The truth is that the TA rankings have no correlation economic performance. State by state and even nation by nation comparisons of tax rates are never reliable predictors of economic performance. Several observers have pointed out that historically MN has outperformed the nation despite it's higher tax rates.

The Ernst & Young (E&Y) study likewise produces a rank, but it uses a much more comprehensive set of data. That doesn't make a "better" study, but it's important to not compare apples and oranges. Unlike the TA study, E&Y assume that businesses derive benefits from business taxes. I think it's silly to deny that businesses derive such benefits. Profitable commerce depends on reliable and extensive infrastructures that government provides. Commerce also benefits from educated workforces, fire and police protections, reliable and fairly un-corrupt legal systems etc. The idea that taxes are an all cost and no benefit formula simply defies common sense.

Mr. Hess's reference to the E&Y rankings being a "quirk" of GSP is misleading. E&Y rankings aren't a "quirk", they're simple the product of their calculation. The number "4" isn't a quirk of arithmetic, it's simply what you get when add two plus two. Mr. Hesse obviously doesn't like E&Y's ranking, but that doesn't mean it less factual or useful.

The problem with the E&Y study is that it's something of a black box affair. The factors used to calculate services delivered to business in exchange for their taxes are drawn from another study by William H. Oakland and William A. Testa: “State-Local Business Taxation and the Benefits Principle,” Economic Perspectives (January/February 1996)." That study does not appear to be available online. Without knowing what kinds of assumption Oakland and Testa made it's hard to evaluate their cost benefit analysis. I think if anything they probably underestimate the value of services. However, it may a fair calculation if they're simply trying to track business tax dollars and only business tax dollars back to businesses. That would produce a smaller benefit. Consider for instance the stadium we built for the Pohlads, their getting $20 million dollars a years direct subsidy, but the source of that funding is not business taxes. Likewise other indirect business subsidies like Medicare, food stamp programs, and subsidized housing facilitate lower wages for businesses but are not funded by business taxes. If businesses were required to pay actual living wages and provide health care coverage instead letting government programs make up the the difference it would dramatically increase their costs. Likewise, I'm not sure how tax breaks like TIFs can be factored into such an equation. Since I don't know what Oakland and Testa defined as a "service" I don't know how inclusive they're definition was.

I can tell you this, someone can look at this and evaluate the methodology better than I can. And that brings me to a basic complaint about our public policy. Neither of these studies is peer reviewed. Nor do they conform to standard publication formats that would allow a peer review. Increasingly we've making public policy decision and bases public arguments on "studies" or "reports" issues by various institutes, Centers, Foundations, etc. These studies aren't necessarily bad, but it's frequently impossible to evaluate the methodology they use. We end up with consumer driven debates where people shop for studies that support their positions rather than look for studies that reliably produce useful data and analysis.

It's nice to see someone try to do a cost benefit analysis of business taxes, but it would be nicer if such studies were peer reviewable.