As the 2013 legislative session nears an end, it is almost certain that the DFL House and Senate will agree to raise taxes paid by many Minnesotans. One unanswered question is whether these tax increases will be accompanied by much in the way of tax reform.
Most of the focus has been on proposals to increase taxes on the wealthy, as DFL Gov. Mark Dayton has urged. Both houses have passed tax bills to do just that, although both depart significantly from the governor’s plan. The differences will have to be worked out in conference committee before lawmakers go home.
Income tax increases, of course, are not the only tax hikes under consideration.
Others under discussion include expanding the sales tax to clothing and consumer services, increasing the sales tax dedicated to transit, imposing new gasoline taxes at the wholesale level, and raising taxes on alcohol and tobacco.
Depending on how many of these proposals become law, the new DFL majorities could be vulnerable to charges of political “over-reaching,” which they began the session vowing to avoid. Such over-reaching appeared to cost Republicans control of both houses in the last election.
Income taxes: new top rates
In his budget, Dayton proposed raising income taxes on the upper 2 percent of Minnesotans. He would create a new fourth-tier tax rate of 9.85 percent, raising taxes on single filers with taxable income of more than $150,000 and couples with more than $250,000.
The House bill would establish a lower fourth-tier rate of 8.49 per cent, raising taxes on single filers with more than $226,000 in taxable income and couples with more than $400,000. It also would impose a temporary 4 percent surcharge on those with income of more than $500,000, sending Minnesota’s state tax on upper-income residents to among the highest in the country.
The Senate’s approach would go beyond “taxing the rich” and affect what many would regard as the middle class. It would increase the existing third-tier tax rate from 7.85 percent to 9.4 percent, raising taxes on single filers with more than $80,000 in taxable income and couples with more than $141,000. That’s a police officer and a teacher, or a Metro Transit driver and a nurse.
Whether any of these proposals constitutes “reform” probably depends on your political perspective.
Comparing the tax plans
|Dayton plan||House plan||Senate plan|
|Net tax increase||$1.8 B||$2.6 B||$1.8 B|
|Income tax||New 4th tier||New 4th tier*||Raises 3rd tier rate|
|Top rate kicks in at:|
|Property taxes||Increases state aid to local governments||Increases state aid to local governments; expands Property Tax Refund program||Increases state aid to local governments; buys down voter-approved school levies|
|Tobacco tax increase||$0.94 per pack||$1.60 per pack||$0.94 per pack|
|Liquor tax increase||None||$.07 per drink||None|
The Minnesota Department of Revenue’s latest tax incidence study shows that the state’s income tax already is “very progressive” — that is, it imposes taxes at progressively higher rates as a taxpayer’s income rises.
However, the same study shows that Minnesota’s overall tax system is regressive when you also include property, sales and business taxes, which consumers pay indirectly through their purchases.
The governor and DFL legislators argue their income tax proposals would reduce the regressivity of the system as a whole. Business leaders counter that these proposals would make Minnesota less competitive and would be particularly onerous for 21,000 small business owners who pay individual income taxes on their business income.
Sales tax: broadening the base
Apart from income taxes, the most controversial element of the Senate bill is the one that constitutes the biggest tax reform. It would broaden the state’s sales tax to clothing and certain consumer services — such as haircuts and auto repairs — while lowering the overall rate from 6.875 percent to 6 percent.
Owing to its narrow sales tax base, Minnesota currently ranks 21st among all states in sales tax collections per capita. However, just six states have a higher tax rate than Minnesota.
Most tax experts agree that the Senate’s proposed change would modernize the sales tax, stabilize revenues and reduce tax inequities and marketplace distortions. Contrary to Dayton’s assertions, the change also would make the current sales tax less regressive, as tax studies going back to the Perpich administration have found.
Of the 45 states and the District Columbia that have a sales tax, all but five states now impose the levy on the purchase of clothing. Many states also tax services.
Minnesota’s current sales tax is a relic of earlier times and consumer spending patterns. In 1950, consumer goods accounted for 61 percent of retail sales and services for 39 percent. Today, the figures are reversed, with services accounting for 67 percent of retail sales and consumer goods for just 33 percent.
Property tax relief
The most significant reform element of the House tax bill is its proposed method for delivering additional property tax relief. The House would expand the current Property Tax Refund (PTR) program, providing homeowners an additional $157 million in tax relief based on their income and the size of their property tax bill.
The House proposal is a more equitable, direct and efficient approach than the flat $500 property tax rebates that Dayton proposed. It also is vastly superior to simply increasing aid to local governments as a method of delivering property tax relief. Over the past four decades, such increases have done more to fuel local spending increases than to reduce property taxes.
Both the Senate and House would increase Local Government Aid (LGA), too. Both would provide an additional $80 million a year in aid to cities; the House would provide an additional $30 million for counties, while the Senate would allocate $40 million more for counties.
Both measures also would overhaul the formula for aiding cities, which in recent years has been heavily tilted toward Greater Minnesota.
Over the last decade, the Legislature has slashed LGA by $179 million, according to Patricia Nauman, executive director of Metro Cities, an organization of 86 cities located in the seven-county area. Of that total, she says, $119 million was cut from aid to cities in the metro area.
While many cities in Greater Minnesota receive 50 percent or more of their annual operating budget from the state, 90 of the 140 communities in the metro area receive no LGA whatsoever.
Nauman says the new formula, negotiated by representatives from cities around the state, would provide a fairer shake for older communities in the metro area. Under the new formula, she says, an additional 32 metro area communities would receive aid. They include Bloomington, Brooklyn Park, Coon Rapids, Golden Valley, Hastings, Maplewood, New Brighton, St. Anthony and St. Louis Park.
The new formula also would provide substantial increases in aid for the core cities — $11.9 million for Minneapolis and $10.1 million for St. Paul.
Tobacco taxes: risky business?
One potential pitfall for both the House and Senate bills: Both would rely heavily on tobacco tax increases to generate new revenue. The House is counting on increased tobacco taxes to produce $434 million in new revenue, and the Senate is hoping for $736 million in new revenue.
The Minnesota Center for Fiscal Excellence (formerly the Minnesota Taxpayers Association) warns that the revenue estimates for the proposed tobacco tax increases could prove to be as unreliable as those for electronic pulltabs, a key funding source for the new Vikings stadium that has fallen far short of projections.
With major increases in cigarette taxes – 94 cents a pack under the Senate bill and $1.60 under the House bill – the loss of sales to border states and other illegal trade is likely to escalate.
“Of the 21 states that increased excise taxes on cigarettes since 2008, 18 realized less revenue than projected, and the average shortfall among these 18 states was a rather remarkable 48.7 percent,” the center says.