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Who bears the biggest tax burden in Minnesota?

protest sign that reads "Kiss my Tax"

CC/Flickr/Fibonacci Blue

Rep. Kurt Zellers speaks to the 2011 Tax Cut Rally at the Minnesota state Capitol building.

It’s tax time again, and everyone is abuzz with stories of how difficult it was to prepare their taxes and how much money they are getting back from the government (or how much they owe). But let’s take a look at Minnesota’s tax system from an economist’s perspective because it will tell us who bears the burden of a tax.

Economists use tax incidence analysis to answer that question. In particular, the Minnesota Department of Revenue examines both “how the total state and local tax burden on Minnesota households varies by income range” as well as “how the burden of each component of the overall state and local tax system is distributed across Minnesota households.” (The reports are done every two years and are available here.)

On Tuesday, MinnPost's Sharon Schmickle presented data from the 2011 tax incidence study. She wrote: “Pull together every state and local tax Minnesotans pay and you clearly can see that the households with the highest incomes pay the lowest effective tax rates.” That is, our state and local tax systems, when taken together, are regressive. 

Minnesota is not unusual in this regard; only one state, according to the Department of Revenue, had a progressive state/local tax system and Minnesota was about average in terms of regressivity. Unfortunately, the regressivity of Minnesota’s state and local taxes increased between 1990 and today, with our system being roughly neutral (neither progressive nor regressive) in 1990 and becoming more regressive over time.

The tax incidence studies conducted over the past 20 years allow us to study how tax burdens changed over time.  The chart below shows the effective tax rate paid by each population decile from 1990 to 2008 along with an estimate for 2013.

chart of tax incidences by decileSource: Minnesota Tax Incidence Study 2011, Table 1–8OK, that’s a lot to absorb. What does it tell us? First, “population deciles” means that we rank Minnesota households by their income; the 10 percent of households with the lowest incomes are in the first decile, the next 10 percent of households are in the second, and so on. 

Second, the first decile pays the highest tax rate and the 10th decile pays the lowest rate, meaning that the system is regressive. However, as Schmickle wrote, “That stat is accurate as far as it goes, but analysts caution that it [the first decile] includes a lot of Minnesotans who draw from resources other than taxable income – for example, seniors who rely on savings supplemented by relatively small earned incomes.”

This is true, but it brings up a question for public policy: Do we want a system that has effectively doubled the tax rate on the lowest income households over the past 20 years? My answer is no.

The next chart on taxes goes to the other end of the spectrum and shows the evolution of tax incidence for the top decile along with the top 5 percent and top 1 percent of income earners. It’s almost the reverse of the previous chart.

chart of tax incidence for top decileSource: Minnesota Tax Incidence Study 2011, Table 1–8Top effective tax rates were around 12 percent in the 1990s and are around 10 percent today. The rationale for this was, in part, that tax cuts for the top income earners would spur economic growth. Did this happen?  Nope. The chart below shows that income growth actually slowed in the 2000s relative to the U.S. average.

chart of state per capita income relative to national averageSource:Bureau of Economic Analysis

The final chart shows the middle of the income distribution, which consists of the fourth, fifth and sixth deciles, along with the top decile. Middle-income households saw their tax rates fall in the early 2000s, but then they rose over the course of the decade. The top tax rate dropped and did not rise.

tax incidences for middle and lower decilesSource: Minnesota Tax Incidence Study 2011, Table 1–8Minnesotans deserve a better tax system than they have now. We can raise the same amount of revenue in a way that spreads the burden more equally across income groups and that makes the tax code simpler.

Susan Riley and I pointed out in an earlier column that we don’t need to do another study to show us what to do. Gov. Tim Pawlenty appointed a tax-reform commission and ignored its findings, but the Legislature and the governor could pick it up and use it as a roadmap for tax reform. The commission recommended, in particular, a broader sales tax (with a consequently lower rate), a simplified income tax system, and reform to both household and business property taxes.  The commission's report is a starting point to achieve a better tax system for Minnesotans.

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Comments (5)

To the author

You mention in various spots above that you will derive your opinion from an economists perspective, but you fail to mention an economists definition of income. I would think this would be critical to this analysis as it does represent the denominator in all above data. The tax incidence studies only use income reported on a tax form specifically excluding most benefits received. So from an economic perspective shouldn't non-cash benefits need to be included in the definition of income; any non-cash aid, premium value of state issued insurance, subsidized rents?

What is it going to take?

Will their ever be enough data for your type?Sometimes I wonder if their is a automatic doubting thomas super computer meant to grab on like a pride of lions attacking a water buffalo!Eventually it can't drag them along anymore and gives up.

A big part of the problem is

A big part of the problem is that we can't seem to agree on whether tax deductions and credits count as spending. I think our differences boil down to a few incompatible assumptions about what taxation is. You may feel very differently about tax deductions, government handouts and mandates backed by penalties. As far as economics is concerned, a tax credit and a government check of the same amount are indistinguishable. Nevertheless, I cannot help but see the home-mortgage interest deduction as a subsidy, as an implicit form of spending, just as economists say.

I'm all for taking an axe to the tax deductions.

Aside from being a hidden subsidy, they finance a large industry devoted to finding, keeping or gaining tax deductions. That doesn't add much in terms of driving economic growth and productivity IMO.

Further evidence of this can

Further evidence of this can be seen in the fact that from 2003 to today, Minnesota has been rolling from deficit to deficit and in spite of warnings from Moody’s concerning the folly of short-term fixes.

Some of the short term fixes that have been applied thus far:

Leveraging the tobacco settlement – money designated for health care.
Taking over $2 billion from the federal stimulus funds.
Borrowing billions from K-12 education funding.
Borrowing over $400 million from the Healthcare Access Fund for low-income families.
Accelerating tax payments.
Delaying bill payments.
Engaging in accounting shifts.

Some folks might call this a form of cash management.
Personally I would prefer the 21st Century Tax Reform recommendations.
Although that would require political courage from both sides of the aisle.

Broader Sales Tax

While I recognize that the scope of this article was concerned with the numbers from the tax incidence studies, which are very well-presented and persuasive on their own right, but you mentioned the recommendation to institute a "broader sales tax," and its relevant to question what is meant by this and how it would better distribute the tax burden. Consumption taxes are by nature regressive and the logic of "spreading the load" is not self-evident in calls to "broaden the sales tax," and seem to only make sense under the presumption that consumption is uniform across income ranges.

Presumably you are referring to efforts to expand sales taxes to services (such as massage parlors, barber shops, etc.) , food, and clothing. There have been studies (though I don't have any in particular to cite here) that indicate that consumption of these products progressively increases with income, but with certain limitations -- there is a floor and a ceiling. The floor is the minimum necessary consumption, the cost of which would rise if sales taxes were expanded. The ceiling is the point at which greater income ceases to produce greater consumption in these areas. Food, haircuts, and clothes can only get so fancy.

Furthermore, think of the small businesses in your neighborhood. In mine, the small businesses are almost exclusively in the sectors targeted by the expanded sales tax. There is one knick-knack shop that I suppose wouldn't be covered, and a couple of art galleries. The rest are services, food, and clothing. Chain groceries, hair salons, and clothing stores drive these small businesses out precisely by off-setting the costs of lowering prices to sub-market levels across the entire organization. Adding sales tax adds an additional sum to the prices which small businesses cannot avoid but giant businesses can mitigate.

While expanding the sales tax to these areas may seem like a good way to lower the across-the-board sales tax rate, it does not bear out that it would make the tax incidence any less regressive or help even out income. In fact, it risks enticing greater income inequality between the wealthy and working people.