Minnesota’s new tax laws decidedly lacking in reform

Minnesota’s DFL legislative leaders say their adopted $38 billion budget for the coming two years represents “progress,” but they haven’t made a lot of claims about it representing “reform.”

The so-called “linchpin” of the budget – the $2.1 billion tax bill approved by the two houses – is decidedly lacking in reform. And Gov. Mark Dayton can share in the blame.

After conducting forums in more than 50 cities around the state and raising expectations, the Dayton administration offered a tax plan that contained surprisingly little reform. Indeed, it included a terrible idea for providing property tax relief – a flat $500 rebate for homeowners regardless of their income or the size of their tax bill.

It’s curious that a DFL governor driven to raising income taxes on the rich also wanted to send them a $500 property tax refund.

The most important reform in Dayton’s tax plan was his proposal to expand the sales tax to clothing and services, and lower the tax rate from 6.875 percent to 5.5 percent. This would have modernized the tax to recognize our transition to a service-oriented economy and made the sales tax a more stable source of state revenue.

But Dayton abruptly yanked that proposal from the table after business leaders convinced many legislators and members of the public that taxing business-to-business services was a bad idea.

Hidden taxes

They argued that it would result in hidden taxes on Minnesota goods and services, make them less competitive with out-of-state businesses and result in higher prices for consumers.  Minnesota Revenue Department studies have shown that business taxes passed along to consumers are the state’s most regressive taxes – that is, the most burdensome for lower income taxpayers.

The Senate DFL leadership sought to retain the expansion of the sales tax to clothing and some consumer services, but Dayton wouldn’t support it in the absence of a tax on business-to-business services.

In the final bill, the two houses did extend the sales tax to three new types of business transactions – the purchase of telecommunications equipment, warehousing and storage, and maintenance of business equipment. These provisions are expected to generate more than $300 million in additional revenue.

Bill Blazar, senior vice president of the Minnesota Chamber of Commerce, says just the tax on telecom equipment will have a huge impact. “Most businesses replace telecom equipment nearly as often as they replace computer equipment,” he says.

Of course, the biggest revenue raiser in the bill is Dayton’s signature proposal to increase income taxes on the upper 2 percent of Minnesotans.  As Dayton proposed, the bill establishes a new top tax rate of 9.85 percent for single filers with taxable income of more than $150,000 and married couples with income of more than $250,000. This will generate more than $1.1 billion in the coming biennium

Under the bill, Minnesota’s income tax ranking will rise from 11th to fourth for single taxpayers with $250,000 of income, from 12th to fifth for married taxpayers with $500,000 of income, from 11th to fourth for married taxpayers with $1 million in income and from seventh to fourth for single seniors with $250,000 in income, according to the Minnesota Center for Fiscal Excellence.

Blazar says he is worried about the impact of the increase on 20,000 small business owners who pay individual income taxes on their business income. He says the chamber proposed an exemption for a portion of this business income, but DFL legislators “chose not to do that.”

Mark Haveman, executive director of the Center for Fiscal Excellence, says his biggest concern is the impact of the increased income tax on Minnesota’s ability to attract new business and jobs.

How many CEOs are “going to look at a 9.85 percent income tax rate and decide this is probably not the best place to expand?” Haveman says. “We think this bill is a very big bet on the irresistibility of Minnesota as a place to do business.”

The other big revenue raiser in the bill is a $1.60-a-pack increase in the cigarette tax, which is projected to bring in another $408 million in the next two years.

Property tax relief

DFL legislative leaders claim their tax bill will provide $400 million in property tax relief over the next two years. This total includes $80 million in additional aid to Minnesota cities and $40 million in aid to counties. In addition, the bill repeals the existing sales tax on purchases by local governments, saving them another $172 million.

Historically, over the last four decades, property tax relief provided in the form of increased aid to local governments has been eroded quickly by increases in local spending.

Haveman says the best study of the impact of local government aid (LGA) was done by the nonpartisan Legislative Auditor’s office in 1990. “It found that cities used 82 percent of the additional aid to finance increased spending and 18 percent to reduce property taxes,” he says.

To ensure that Minnesotans see some property tax relief next year, the bill imposes a one-year limit on local property tax levies. Cities and counties will not be permitted to raise their levies more than 3 percent, minus the additional state aid they receive.

At the insistence of House DFLers, the bill also provides $135 million in additional aid to homeowners and renters through the current Property Tax Refund (PTR) program, which provides refunds based upon the taxpayer’s income and the size of their property tax bill (or, in the case of renters, the amount of rent that is presumed to go for property taxes).

Tax experts generally agree that the PTR program is the most direct, efficient and equitable way of providing property tax relief to the people who need it most.

About three-quarters of currently eligible households will see an average $219 increase in their refund and another 112,000 households will now qualify for a refund, according to the Minnesota Budget Project, an initiative of the Minnesota Council of Nonprofits.

Perhaps the most important reform in the budget is that it erases a projected $627 million shortfall and balances the books without the kind of one-time accounting shifts and other gimmicks that have been used over the last decade.

“We have re-set the clock in Minnesota,” says Senate Majority Leader Tom Bakk, DFL-Cook, and put the state on a “stable budget path.”