Like Gov. Mark Dayton’s proposal and the House tax bill, the Senate’s a tax bill — Senate File (SF) 552 — contains a significant income tax increase. The Senate tax bill extends further down the income ladder than the House’s and governor’s proposals, but stops well short of affecting middle-class families.
Minnesota’s current income tax has three tiers:
- The first tier consists of taxable income up to $35,840 and is taxed at a rate of 5.35 percent.
- The second tier consists of taxable income from $35,840 to $140,960 and is taxed at the rate of 7.05 percent.
- The third tier consists of taxable income in excess of $140,960 and is taxed at a rate of 7.85 percent.
For ease of comparison, this analysis will focus on the tier breakpoints (or brackets) for married joint filers; the corresponding breakpoints for single filers and heads of households are lower than those of married joint filers.
In order to target only high-income households, the governor and House proposals each create a new fourth tier. Under the governor’s tax proposal, the new fourth tier will include taxable income above $250,000 and will be taxed at a rate of 9.85 percent. This impacts the wealthiest two percent of Minnesota households.
Under House File (HF) 677 — the House omnibus tax bill — the fourth tier will begin at taxable income of $400,000 and be taxed at a rate of 8.49 percent. Approximately the wealthiest 1.1 percent of all Minnesota households will be affected by the House’s new fourth tier rate. (The House proposal also imposes a temporary four percent surcharge on taxable income over $500,000 for tax years 2014 and 2015.)
The Senate tax proposal takes a somewhat different approach. Given that the current third tier includes only the top 7 percent of all full-year resident filers, Senate leadership decided that there was no need to create another tier to target high-income households. Instead, the Senate opted to increase the tax rate on the existing third tier to 9.4 percent.
While the Senate’s rate increase would begin at a lower income level than the governor’s proposal or the House proposal, it would not be far beyond the range of other proposals considered by the Legislature in recent years. For example, in his February 2011 budget, Gov. Dayton proposed increasing the tax rate on taxable income in excess of $150,000.
Immediately the clamor arose from the right that the Senate was taxing the middle class. It is indeed a bizarre definition of “middle” that includes the top 7 percent of all households.
An annual income of $140,960 — the beginning of the third tier and the threshold above which the proposed Senate rate increase would apply — may not seem extraordinarily high by today’s standards. However, keep in mind that the $140,960 refers to taxable income, which is after subtraction of deductions, exemptions and other adjustments. According to Minnesota Revenue Department data cited by Senate Tax Committee Chair Rod Skoe, the typical total income (before subtractions) associated with a taxable income of $140,960 is $194,000 — which is well beyond the range of what most reasonable people would consider to be middle class.
One of the justifications for increasing the tax rate on high-income households is that state and local taxes per dollar of income for these households is far below what is paid by middle-income households. For example, the top two percent of all households — those that would be affected by Governor Dayton’s proposed fourth tier income tax increase — pay approximately 9.8 cents in state and local taxes for each dollar of income, which is 20 percent less than the 12.2 cents on the dollar paid by middle-income families.* (For purposes of this analysis, “middle-income” is defined as the middle 20 percent of all households by income.)
So what about the top 7 percent of all households — those affected by the Senate’s proposed income tax increase? These households pay approximately 10.2 cents in state and local taxes for each dollar of income.* This is still 16 percent less than what is paid by middle-income families.
Furthermore, those taxpayers at the lower end of the third tier would see only a small income tax increase under the Senate proposal. For example, a household with taxable income of $150,000 (corresponding to a typical gross income in excess of $200,000) would see an annual tax increase of $140 under the Senate proposal — hardly excessive for a household with annual income that is over three times greater than the statewide median.
The standard conservative attack upon any income tax increase is that it would be a “job killer.” However, recent studies from U.C. Berkeley (Zidar) and theCongressional Research Service (Hungerford) find no significant relationship between state income tax increases and job losses or lower economic growth. Using data extending from 1950 to 2013, Minnesota 2020 found that periods following a state income tax rate increase generally coincided with above average job and income growth.
The new conservative critique of an income tax increase — that it is hurting the “middle class” — does not fare any better. The Senate income tax proposal is not impacting “middle-income” households by any reasonable definition of the term “middle.” Furthermore, those households that are affected — the top 7 percent — currently have a state and local effective tax rate well below that paid by the average Minnesota family.
Conventional economic theory holds that the smart way to balance a state budget during a recession or a weak economic recovery is through a tax increase targeted to high-income households. This is precisely what the governor’s, House, and Senate tax proposals do. All three approaches deserve serious consideration as the state struggles to recover from its most recent deficit and a decade of disinvestment in education, infrastructure and other critical public assets.
*These estimates are based on data for 2010 from the 2013 Minnesota Tax Incidence Study (MTIS). The effective tax rates for the top 2 percent and the top 7 percent are not reported in the 2013 MTIS. However, it is possible to get reasonably accurate estimates of the effective tax rates for both groups by interpolating data from the population decile and income decile tables. The estimates sited here were calculated by Minnesota 2020 using this approach.
Jeff Van Wychen is a Fellow and Director of Tax Policy & Analysis at Minnesota 2020, a nonpartisan think tank based in St. Paul. This article originally appeared on its website.
WANT TO ADD YOUR VOICE?
If you’re interested in joining the discussion, add your voice to the Comment section below, or consider writing a Community Voices commentary. For more information about Community Voices, email Susan Albright at salbright@minnpost.com.
Doesn’t hit the middle class directly
Many small business owners are facing significant tax increases that will force them to lay off workers and or raise their prices, both of which cost the middle class. Nobody completely escapes tax increases. It is not just income taxes, the middle class will be spending more for many things as well as other tax increases that impact everyone is some way.
Bravo!
I’m glad to see another voice calling out the absurdity of considering a six-digit income to be middle-class. People have that perception partially because of the nonstop drone of the Right, but also because the income curve becomes very steep indeed once you get into six-figure territory. Those at the bottom end of this bracket certainly don’t “feel” rich because they’re lumped in with people making millions. But indeed, they are well within the top 10% of households.
Effect on Small Business
As a small business owner, my personal income is not high enough to be affected by these increases on the “rich”, but like most small businesses the tax on my business’s profits are added to my personal income and taxed at that combined rate which is the highest rate possible (both Federal and State) and likely much lower than big corporations who are treated differently in the tax system.
I’m not arguing that small business or the rich shouldn’t be taxed more. I’m arguing that these articles should be clear to say a “tax on the wealthiest Minnesotans AND small businesses” so everyone understands that small businesses are being affected too.
Please don’t argue that if my small business is making this kind of profit I must be rich, too. Yes, it’s true I could take all that money and spend it, but that would be like eating the seed corn so to speak. Until I liquidate or sell the business that profit needs to be used by the business to make repairs, buy new equipment, and if possible hire people.
If That “Profit” is Used As You State
Then it’s not profit, it’s not counted as part of your income; it’s business expense.
If you’re doing your own taxes, counting your gross receipts as profit, and not subtracting your expenses,…
you need to find someone else to help you do your accounting and tax preparation.
Even the small business version of TurboTax or a similar program would save you a ton of money.
Even if you’re running your business as a “sole proprietorship” for tax purposes, you should ONLY be paying taxes on the portion of your income that’s left over after all your business and employee expenses are subtracted.
THAT’S your income, and, just like the rest of us, you should be paying appropriate taxes on it.
Of course, as a “sole proprietor” you’ll get seriously dinged for Federal Self Employment tax (both halves of Social Security), but even that might be considerably lower if you account for your business properly (unless your income places you over the contribution limit).
I’m not an idiot
Greg, I’m not an idiot and of course I’m talking about the profit my small business makes, not its gross receipts. The point is that this profit is not really mine, yet it’s taxed as if it was. This profit belongs to the business for growth and expansion and those expenses will ultimately be tax deduction in the future, but not this year. This year they are taxed by adding them to my personal income tax and this is the combination that is being increased by the state.
I also tried to make the point that if I were to pay myself a higher income and reduce the business profits to zero then paying the rich man’s tax would be fair enough, but that this would be a stupid and short sighted way to run a business. The business needs this cash for the future.
If Your Business is Running in This Way
And your business income is large enough for this to be an issue, I suspect you need to incorporate in order to separate the business’s finances from your own salary.
The only reason most truly small business people don’t do so is because their profits are so small as to have negligible tax impact or they generally run losses which reduce the income from their day jobs.
If you’re running a business which provides you with income high enough to hit by these tax increases, I question your judgment regarding how you’re managing the financial end of your business affairs.
I give up
Greg, you don’t seem to understand the issue. We are an “S-Corp” and there are hundreds of “S-Corps” affected in the same way. We hire a group of seasoned CPA’s to do our taxes and advise us on ways to minimize taxes. I’m confident that we are not missing anything here.
On the other hand, you seem to have a naive understanding of the issues faced by small businesses who get caught in the cross-hairs regardless of which party is involved.
Thank You for the Explanation
Logical, fact filled, straightforward.
I’ll have to forward a link to the legislators who represent me.
(Ingebrigston and Franson),…
although I’m sure it will fall on closed minds and deaf ears,…
violating as it does the “voddoo” economic perspectives in which they are such true believers,…
economic perspectives which hurt each and every employer and employee here in their home districts.
what’s the middle class?
it’s interesting that this author thought it best not to include single taxpayer rates in his presentation, because in the Senate proposal singles would start paying 9.4% tax on income over $79,500 or so–pretty far from six figures, and nothing like the millions per annum earned by the 1% or the hundreds of thousands earned by the 2%.
Can we define the middle class by median income? The median income in Minnesota and the U. S. is not terribly much above the poverty level, and the average income is not far distant. Where is the line of “wealthy”?
Middle class, however, includes a lot of folks who live–precariously in many cases, it’s true–the American Dream of a non-poverty-level income and the comforts of life that come with it.
One can only hope that the House and Governor can convince the Senate to be sensible about “taxing the rich.”
Tax the Rich?
If Dayton signs into law a tax increase (not just the income tax) that will increase taxes on the poor and middle class – and breaks his campaign promise to just “tax the rich” – would that be considered Rude?
Or does the left consider just raising the income tax a true tax – the other taxes are just “fees.?”
Or is “tax the rich” code words meaning that Dayton will tax everyone?