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Dayton would use federal tax conformity to achieve ‘middle-class tax cuts’

Aligning the state with federal tax-code changes, such as eliminating the “marriage penalty,” would cost the state about $205 million.

Gov. Mark Dayton is eyeing a slew of less-talked-about "middle-class tax cuts" at a cost of about $205 million to the state.

Gov. Mark Dayton predicted that news of an unexpected $1 billion budget surplus in Minnesota next year will set off a “blizzard” of proposals for tax cuts and new spending.

It’s been years since legislators have had so much potential money on the bottom line — $825 million in all after the school shift and an airport fund are repaid — and ideas about how to spend the surplus are already making the rounds in St. Paul.

Consider Dayton the most eager — the Democratic governor was the first lawmaker to propose ways to spend the surplus if it holds until the February budget forecast, surprising some Republicans when he said he wants to repeal three controversial taxes on business services that he and DFL lawmakers passed last session. That proposal will cost about $231 million next year, he said.

But Dayton is also eyeing a slew of less-talked-about “middle-class tax cuts” — at a cost of about $205 million to the state — that would result by conforming state tax code with federal tax breaks and write-offs passed by Congress earlier this year.

Federal tax conformity is not a new idea in St. Paul. Each year Congress votes to extend many tax breaks, and it’s up to the states to line up their tax code with the federal government. Earlier this year, the state House passed a bill to conform with the tax changes, but the proposal failed to pass out of the Senate.

So who gets hit when the state doesn’t line up with federal tax breaks?

Many married couples, for starters. At the federal level, lawmakers eliminated the so-called “marriage penalty,” which can bump married couples with similar earnings into a higher tax bracket. The penalty hits 640,000 Minnesotans, Dayton said.

Lining up state and federal tax codes would also mean increasing the working family credit, which aims to help low- to moderate-income working individuals and families. It was originally created to help offset the regressive nature of Social Security payroll taxes. Congress increased the eligibility range for the credit, but in Minnesota, those filing as a married couple with three or more children may no longer qualify for the credit. By Dayton’s count, increasing that credit will help about 53,000 Minnesotans.

There’s a laundry list of other, smaller tax breaks wrapped into federal conformity. For instance, federal lawmakers extended tax breaks for parents who got help from their employer to pay for adoption and education costs, but Minnesota did not.

The same goes for teacher expenses, student loans and mortgage insurance premiums — Minnesotans will face state taxes on those things. If you’ve recently gone through a foreclosure, the state can tax you on the “income” you earn when a lender sells the house for less than the mortgage. The federal government does not count that as income.

The mechanics of how such a tax change would affect Minnesotans in the middle of tax-filing season haven’t been addressed yet.

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Dayton said the idea has already been vetted by the Legislature and has strong support from the House tax committee chairwoman, Rep. Ann Lenczewski, DFL-Bloomington.

“It does focus its relief on middle-income taxpayers. It has that advantage. I’m not wedded to that as the solution, but I think it’s a very good one,” Dayton said this week. “It’s got some very good features to it and it simplifies the tax system, and it fits within the spirit of the unsession. It’s simpler for people if they can basically just make the federal deductions and credits and use those for the state as well.”

Some Republicans support federal tax conformity, too.

Sen. Julianne Ortman, R-Chanhassen, chaired the tax committee two years ago and worked with Dayton to pass federal conformity. Next year, she says Dayton should be more “cautious” and wait to see the economic impact of more than $2 billion in new taxes Democrats passed last session.

“The state has had roller-coaster projections over the last 12 years,” Ortman said. “Every time there is a surplus Democrats insist on spending it, and that has contributed to the unpredictability in the budget.”