To balance our revenue system, start with a balanced discussion

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There has been a lot of talk about tax reform and balance at the Capitol.  Minnesota’s revenue system has become less balanced in the last dozen or so years. And our state budget has too often followed suit. We have had state budget deficits in eight of the last 11 years, with a net deficit of $16.4 billion over that period.

People from both sides of the aisle – including Gov. Mark Dayton and legislative leaders, among others – agree that we need to restore some of that balance and end the fiscal uncertainty we have experienced. As a longtime tax economist and former revenue commissioner, I agree.

It requires fiscal discipline to monitor and maintain balance in the face of competing political agendas. Consensus on taxes and other fiscal issues has been hard to come by in recent legislative sessions. Perhaps we can start with a policy-based discussion about our revenue system and how it could be properly balanced.

Balance matters

A balanced tax system provides a reliable source of funding for important state and local services that all Minnesotans rely on – such as public safety, roads and highways, health care, education and our social safety net for those in need.

These services are funded by three major sources of state and local revenue:  income tax, sales tax, and property tax (often referred to as a “three-legged stool”). Each of these used to provide about the same share of state and local tax revenue in Minnesota. (Other taxes, user fees – such as fishing licenses and vehicle registrations – and federal funding also make up part of our state budget.)

But in the last dozen years, the share of sales tax revenue has dropped sharply, while income tax revenue has been unsteady. And, since 2009, property taxes have been the biggest source of funding for state and local government services.

The revenue system should be predictable and adequate – in a word, it should be reliable. Taxes should raise enough to cover spending commitments while allowing for future growth. At the same time, we must maintain budget reserves that are sufficient to smooth out economic fluctuations that occur from time to time.

A balanced revenue system – built on a solid three-legged stool – helps meet these goals. Diversifying among income, sales and property taxes helps even things out, since each is affected differently by the business cycle. But right now, the three legs of Minnesota’s revenue stool are woefully out of balance.

How can we get there?

First, any changes we make should aim for long-term balance, not quick fixes that focus only on the current budget. And we should aim for broad tax bases and minimize special provisions – or “tax expenditures” – that benefit only a few taxpayers while passing the burden on to others.

We lean too heavily on property taxes right now and need to find a way to reduce them. That means taking a fresh look at how state aid to local governments and schools fits into the picture. It also means considering the appropriate level of that aid and how it can most fairly be distributed. 

This aid is a crucial tool to ensure that all communities in Minnesota can provide basic services like education and public safety at a reasonable cost for their residents and businesses. But our historic state-local funding partnership has frayed in recent years. Several rounds of funding cuts and shifts have contributed to higher local property taxes and supplemental K-12 education levies in many communities.

May need to update sales tax

It also may be necessary to update the state sales tax – currently the smallest leg on our revenue stool. For example, Minnesota’s sales tax does not apply to most consumer services. Yet services now make up more than two-thirds of our consumption. 

Furthermore, when people do buy goods, they are far more likely to purchase them online than in the past (when their first stop was more likely to be a local store). Yet many Internet retailers are not required to collect taxes on sales made into Minnesota, unless they have other business activity in our state.  Minnesota loses millions of dollars, $400 million in 2011 alone, because we can’t enforce the sales tax on Internet sales.

Make no mistake: It’s easier to say “revenue balance” than to achieve it.  State revenue and spending targets are continually on the move. Federal tax changes often trickle down to state taxes, which can affect revenues and add more complexity for those who pay and collect taxes in Minnesota. And every tax expenditure has its own, often vocal, supporters.

Reform requires broad input and involvement

A tax system that works must provide adequate funding for services and programs that meet the needs and values of the wider community. For that reason, it’s crucial that any changes we make are built on the ideas – and involvement – of people from all along the political spectrum.

A proper revenue balance will provide a more dependable funding stream for government services in Minnesota, while maintaining the quality of life we all expect from our great state.

Dan Salomone is a retired state tax commissioner and long-time observer of the Minnesota tax scene.

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