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Minnesota's tax loopholes on automatic pilot

The Minnesota Legislature routinely directs state agencies to produce reports on important public policy issues, and just as routinely leaves them on the shelf gathering dust.

Before the 2012 session, there's a 47–page report [PDF] from the state Revenue Department that lawmakers should take the time to read and ponder. It examines the topic of "tax expenditures" — the nearly 300 tax exemptions, deductions and credits (some say "loopholes") — written into state law.

These expenditures total $24.3 billion, or 42 percent of the two-year budgetary pie. However, unlike state appropriations for each biennium, they aren't reviewed or voted upon. They're on automatic pilot.

The Revenue Department report, completed in February with the help of six economists and fiscal experts, did not propose repealing any specific tax breaks. But it suggested that the current number of tax expenditures is excessive and recommended that they be subjected to greater scrutiny.


Whether lawmakers will pay any attention is open to doubt. Many of these tax breaks are incorporated into state law to conform to the federal tax code — to simplify tax administration and enforcement. But legislators love adding to the list to encourage certain desired behaviors.

"We call them 'Fiscal Fritos,'" says Mark Haveman, executive director of the Minnesota Taxpayers Association. "Everyone knows they're not good for you, but they're irresistible."

The problem
So what's wrong with these tax breaks?

The Revenue Department report said they collide with three guiding tax principles — efficiency, simplicity and equal treatment of equals. Giving one group of taxpayers a break from a given tax complicates the system and shifts tax burden onto the remaining taxpayers.

Narrowing the base subjected to a given tax also can increase its volatility. For years, policy experts have argued that broadening the state's sales tax to clothing and services would make it less vulnerable to fluctuations in the economy.

Worst of all, tax expenditures largely escape legislative and public scrutiny. Unlike direct appropriations, they don't appear in the governor's proposed budget or budget bills, aren't subject to legislative hearings and aren't reauthorized every biennium.

In May, the Citizens League issued a paper [PDF] strongly encouraging the Gov. Mark Dayton and the Legislature to make a reduction in tax expenditures "a part of any budget solution." But that did not happen.

Instead, the 2011 Legislature bestowed another generous tax benefit upon a favored group of taxpayers. It increased the estate tax exemption from $1 million to $5 million — for the stated purpose of allowing farms and small businesses to stay in the family.

Jay Kiedrowski
Jay Kiedrowski

Still, former state Finance Commissioner Jay Kiedrowski, a member of the Revenue Department panel of experts, is hopeful that the report will not be forgotten. "We got a pretty good reception in the Senate Tax Committee," he said. "Members were really interested."

The subject of tax expenditures admittedly is a political minefield. What career-minded politician is going to propose eliminating the income tax deductions for mortgage interest, charitable giving or employer-provided health benefits, for example?

Still, there might be room for changes. Along with the feds, Minnesota law allows income tax payers to deduct mortgage interest on second homes. So the state is spending $30 million a year helping affluent Minnesotans buy that lake home while some 13,000 Minnesota adults and children are homeless on any given day. Misplaced priorities?

Another example: Minnesota law allows state and local governments to issue tax-exempt bonds to finance public projects. A 2009 report by the House Research Department concluded that the interest savings of governmental units are exceeded by the loss of tax revenues on the interest earned by purchasers of these bonds.

Beyond that, 81 percent of the $70 million in annual benefits from this tax break flow to the upper 10 percent of household incomes. The state could both save money and improve tax fairness by eliminating the tax exemption on government bonds.

Some solutions
Short of targeting any specific tax expenditure, lawmakers could heed the report's call to establish a system for their systematic review. Specifically, the report proposed:

• Establishing an eight-year cycle during which every tax expenditure would be reviewed to determine whether it is accomplishing its intended purpose and whether this purpose could be achieved through more cost-effective means.

• Creating a commission to oversee the evaluation process and make recommendations to the governor and Legislature.

• Setting a "revenue-neutral" sunset date at the completion of each evaluation. Unless a tax expenditure was extended by lawmakers, it would expire and the tax rate for the affected tax would be adjusted downward to hold state revenue constant.

• Fully integrating tax expenditures into the biennial budget process to show their impact on gross tax revenues.

"Minnesota is considered a leader in tracking tax expenditures," the report said. "However, we — like other states — have historically struggled to provide firm oversight once these provisions have been enacted."

Steven Dornfeld is a former newspaper reporter and editor and former public affairs director of the Metropolitan Council.

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Comments (21)

Thanks for a great piece of journalism.

The state loves to produce reports like this, but the problem is that the legislature doesn't want to hear the results. By and large, they're focused on towing the line for their corporate benefactors.

Hear no evil, see no evil, do nothing.

I used to think that public campaign financing would help cure the problem of tax expenditures, which is directly related to campaign contributions. It works like this: you donate so many dollars to my campaign, and I'll help pass legislation that gives you thousands of times that amount in return. The highest ROI available anywhere in this world is investment in (actually, purchase of) political influence.

Tax expenditures are a primary way public officials pay off political debt, and reward political influence.

For the elected official, another boon is that once out of office, there is often a well-paid position waiting for you with your new friends, acquired through the process described above. There are many examples of this locally.

But since the Supreme Court's decision confirming there are hardly any limits to the equation of money with speech in the political sphere, there is no mitigating the influence of money through public financing.

The amount of public financing available is dwarfed by what can be raised through traditional campaign financing. This is substantially due, I believe, to the high profits available to donors through tax expenditures.

A very timely article!

The goal should be to eliminate as much distortion in the tax system as possible.

Tax revenues can be increased substantially by limiting the deductions, credits and exclusions that are essentially government spending by another name. The state of MN may as well be sending checks out.

If a policy gives you a subsidy to the tune of $1 culled from 100 taxpayers, a penny at a time, ending the subsidy will cost you a dollar and earn each taxpayer a penny. That penny's not enough to worry about, but the dollar's worth fighting for.

One such solution could be to limit the total tax saving for any individual to a maximum percentage of his total income.

A plan to pare back a subsidy won't induce as much resistance as a plan to end it altogether. And a limit on the total benefit from all tax expenditures, but not any particular deduction or credit, seems even less likely to incite powerful resistance. But it can be tough reducing so-called "tax expenditures" for all the familiar reasons.

It seems to me that, hidden in these unexamined "tax expenditures" are many that are the very definition of "waste, fraud, and abuse." Why did our Republican-dominated legislature ignore this report?

It would almost seem as if their definition of "waste, fraud, and abuse" only includes a particular group of people: the poor, the elderly, the sick and the disabled and those who care for them.

When our politicians say the rising cost of health care in Minnesota is "unsustainable," they mean that, if they get their way, retiring Baby Boomers and unemployed people in Minnesota will NOT have anything close to the same access to health care their parents' generation has had.

I guess their idea of caring for the sick and elderly amounts to giving away free tickets to Point Barrow, Alaska, where those folks can climb onto ice floes and drift away into the Arctic Sea to quietly freeze to death, invisible and unmourned, as the Eskimos were reputed to have done in ancient times.

Of course the government contract for those Point Barrow trips would be VERY profitable for a very few, well-connected, wealthy conservatives (and likely cost the taxpayers just as much as providing health care to those folks would have cost).

// Whether lawmakers will pay any attention is open to doubt.

Open to doubt? Not when Norquist and Sutton have declared that ending tax breaks is the same as raising taxes... and is therefore forbidden by the Republican canon. There's no doubt when half the Republicans now elected or running for office have signed no new tax pledges. Open to doubt? you're kidding right? Law makers won't consider these tax breaks until the Republicans taken out of power and Democrats willing to do so replace them.

This may be an opportunity for Governor Dayton to capture revenue and drop his unpopular "tax the rich" proposal. This should become a major part of his tax reform policies. At the same time it takes the "raising the income tax" issue away from the GOP.

Dayton should learn a lesson from his previous negotiations about revenue. It's hard to argue against good policy but then again it's all in how you frame it.

To me, the real problem here is that we, as a society, have left reality in the dust. Most of the legislative leaders this session were never working with real numbers or facts -- and that's what this report is; more facts. What Koch and Zellers want is sound bites, simple-sounding accomplishments, campaign slogans and short-term fixes.

For a report like this to be taken seriously we need politicians who take their jobs seriously.

Good article. I hope people read the report and e-mail their legislator with their preferred list of tax exemptions to end.

You can watch the Tax Expenditure Review Report hearing in the Senate Tax Committee on Feb. 23, 2011 from these links:

http://www.senate.leg.state.mn.us/media/media_video_popup.php?flv=cmte_t...

or

mms://stream2.video.state.mn.us/Senate/cmte_taxes_022311.wmv

Nice article.
However, the likelihood of change is further reduced by the Republican's efforts to eliminate public campaign financing and discourage voting through voter ID etc.

Excellent piece, Steve, and it's sad that I have to integrate--by gender-- this comment sectopm. Why don't more women pay attention to taxes? Probably too busy taking care of house and children and bringing home bacon too.

My suggestion is that people talk to their friends and relatives about this article and about taxes generally. Ask your legislators about it. Somehow give this report more publicity.

Again thanks to both Steve and MinnPost for educating us. Keep doing that.

From report: "imputed value of ownership of homes and durable consumer goods".

When President, Jimmy Carter proposed this but there was such a backlash that it was never proposed again. Basically, if I pay off the mortgage on my house I will get "cheap rent". This is a basic retirement strategy. Just yesterday a neighbor mentioned that their mortgage will be paid off when they are 66 and 64.

If such a "loophole" is closed I could, in theory have one-thousand dollars per month "imputed income" because my house was paid off before the crash. I definitely have cheap housing but let's look at the "imputed income' more closely. You would need to deduct costs. I have never filed an insurance claim so my insurance is relatively low. Obviously with no mortgage the chance of foreclosure is relatively low. (basically not paying property taxes for four or five years.)

Foreclosures are "toxic" to a neighborhoods housing values. Insurance seems a legitimate expense. Last week someone told me that my twenty-five year old roof (which still looks solid to me) could be replaced with insurance at little cost to me as "storm damage". If I wanted to "game" the system I could file a lot of insurance claims and use the higher premiums as an expense. If I had a mortgage that would logically also be an expense. If I wanted to "game"the system I would keep the debt on the house high by refinance and take-out. Minnesota is not a mortgage "strategic default" state but if I had continuously refinanced I could potentially have a high principle and interest payment.

This increases the risk of defaulting and foreclosure even with Minnesota not being a "strategic default" state for mortgages. Again, defaults in a neighborhood decrease property values.

I haven't done it but with a five or ten year plan you can hide assets. Gold is one example and if you had slowly diverted assets to physical gold you would be "sitting pretty" right now.

Next is the commercial depreciation of property. The tax code says 40 years so that would be almost half of the "imputed income". If we do a "real time" value since the crash the government stated value of my house has decreased 10% to 15% from peak. I live in a very slow turnover neighborhood so this isn't much but if that was deducted from on a "real time" basis that would eliminate most of my "imputed income".

The point is that if you tax the "cake eaters" the law of unintended consequences might occur "big time" and it could "backfire" big time.

I am not against helping the truly needy but from my vantage point Minnesota has become the "welfare magnet of the USA and the world". We can't save the world so this "do-gooderism" can backfire big time especially as other states cut welfare and "do gooder" agencies seek the path of least resistance.

Try googling "Minnesota Welfare" and the third entry is http://www.winonadailynews.com/news/local/article_d949dfaa-ad74-11de-99c...

There is an old saying "Minnesota has a terminal case of compassion."

Excellent article...with solutions! If we could achieve nothing else, a formal cyclical review and affirmation by the legislature would begin to establish some shred of accountability. Other than sending a copy of the report to our local legislator, what can "we the people" do?

Mark @#2, you make a good point about such reports being ignored, but remember this tactic is classic Pawlenty--sweeping an issue under the rug by forming a group to study it, and then ignoring the findings.

Case in point, Pawlenty's health care commission to which he appointed Sen. Dave Durenberger and other knowledgeable people. Created with much fanfare at a time when Minnesotans were loudly demanding action, the group was asked to recommend ways to reform health care in MN. The commission dutifully completed its work, announced its findings, and Pawlenty promptly mothballed it.

This approach bought Pawlenty time to continue to avoid a touchy issue, while appearing to be committed to the cause. Durenberger was understandably chafed, and said publically that Pawlenty had wasted his (Durenberger's) time, or something to that effect. Just so.

It's about time that tax expenditures were discussed.

It is the other side of the revenue coin that needs to be looked at.

I have no idea what Greg Lang is trying to say but he does apparently have a lot of time on his hands.

Hey Jody, I do have a lot of time on my hands, to research! As an example, when the CBS 60 Minutes had a segment on mortgage "strategic default" I did online research to see if Minnesota was a strategic default state. It took a lot of digging but I found the answer. Basically in Minnesota a mortgage debt can only be relieved via bankruptcy. Bet you didn't know that! I looked that up!

excellent and timely article. Something that the "raise tax to balance budget" politician has always had a choice to tackle, for many many years, regardless the party in power.
Those who want to blame one party over the other have to face reality and talk to all politicians, their political representatives, state and federal, about complete overhaul of the MN tax code as well as the federal tax code, and getting rid of loopholes is a good place to start.

Well actually Greg I do know that, it is dinner conversation at my house, my hubby was a banker and is familiar with mortgages. As dinner conversation that puts it somewhere above "how about those Twins" and "we need to paint the steps this weekend" and below "hey did you hear that program on MPR" or "I read an article in ...".

I think the point of your comment is that anyone can find some way to reduce their tax liability or increase their net worth. One of the least admirable ways however is getting special treatment.

Why don't the taxpayers insist that the legislature read and act on the state agencies'reports to the Department of Revenue? It would certainly be a good place to start a relatively accurate "recitation" of the loopholes that allow for tax exemptions, etc. This suggestion would not even require that taxpayers know what they are, but that they exist. This of course would require that the legislators show some courage and actully close some/all of the loopholes and make it clear that the taxpayers are demanding their actions. This would be a risk worth taking and assuming.

So Jody, you agree that my "Minnesota is not a strategic default state" is basically correct! How many people reading this know that?