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What you need to know about the coming debate over Minnesota's tax code

State Rep. Greg Davids
MinnPost file photo by Bill Kelley
State Rep. Greg Davids: “There are going to be some people who will pay a tax increase, but it is my goal to have as few in that category as possible.”

State Rep. Greg Davids had a request at the start of his first committee meeting of the 2018 legislative session: Keep your opinions about the recently passed federal tax bill to yourself.

It may have seemed like a strange request coming from Davids, the chair of the Minnesota House Taxes Committee, as lawmakers embark on a session-long endeavor to figure out what the massive federal tax overhaul means for the state of Minnesota.

But as Davids noted to committee members on the first day of session, the tax bill is a reality, passed by Republican-controlled Congress and signed by President Donald Trump in December. At this point, people’s political opinions about whether it’s bad or good are moot. Or as Davids told his colleagues: “Tell it to the postmaster.”

Minnesota officials already have a big enough job in trying to figure out how (and how much) to make Minnesota’s tax code align with all of the changes made at the national level — a task known as federal tax conformity. And the stakes are high: Doing nothing could result in a very complicated tax season for Minnesotans next year, but simply matching the state’s code to that of the federal government could actually mean a huge tax increase for many of the state’s taxpayers.

For now, addressing those issues is a bipartisan effort: “We’ll have to work with a scalpel, not a sledgehammer,” DFL Gov. Mark Dayton said this week.

It's also a confusing one. So here’s a primer on the debate that's likely to take up a lot of the 2018 session — from how the federal law differs from state provisions to how Capitol politics could complicate the whole process:

Okay, what — exactly— did the federal tax bill do?
The Tax Cuts and Jobs Act is the biggest overhaul of federal tax policy since the 1980s, and it affects just about everyone. For big businesses, it represents the largest single reduction in the corporate tax rate in U.S. history, bringing it down from 35 percent to 21 percent. For everyone else, the bill lowered the tax rates for each income level and nearly doubled the standard deduction. As a result, the vast majority of people will see lower tax bills next year, though how much lower will depend greatly on each individual’s circumstances. The new federal bill also eliminates the personal and dependent exemptions, which is a standard sum people got for themselves and their children taken off of their taxable income.

So what does the Tax Cuts and Jobs Act mean for Minnesota tax filers?
Minnesota has its own tax provisions, of course, but it relies on the federal tax system as its starting point. Minnesota is one of six states that starts with the “federal taxable income” figure and calculates each resident’s taxable income from there — by adding Minnesota-specific deductions, exemptions and rates. The elimination of personal and dependent exemptions in the new federal law has complicated that process, and for some Minnesota families who claim dependents, it means their taxable income number could go up.

What’s more, the standard deduction for federal and state income taxes have historically been the the same number. Under the new federal changes, however, the standard deduction nearly doubled to $24,000 for a married couple filing jointly; $12,000 for single filers. But in Minnesota, where a large majority of taxpayers take the standard deduction, the current standard deduction still sits at $12,700 for married joint filers and $6,350 for single filers.

“The result is a Minnesota taxable income that is $11,000 higher than the federal taxable income for taxpayers that elect to take the standard deduction,” said Cynthia Rowley of the Minnesota Department of Revenue.

If lawmakers do nothing this year, what happens?
For starters, tax season would get a whole lot more complicated for the 2.9 million Minnesotans who file returns every year, according to the Department of Revenue. Without making some changes to make the state tax code conform to the federal tax changes, officials say they would have to create all new tax forms and schedules next year.

Already, more than half of people who file tax returns use professional services to help prepare their taxes. That number would likely go up. With new software needed to calculate forms, Minnesotans will also have to pay more to get their taxes prepared, and they could have to wait longer for a refund, with inadvertent errors more likely as the state and federal government adjust to the changes.

“If there is no law to respond to the federal changes, there will be complexities that the department cannot limit,” said Department of Revenue Commissioner Cynthia Bauerly. “How we conform is really the question we will be answering together this session.”

Why doesn't Minnesota just get its tax policy in line with the federal government to make filing easy next year?
Because a move to simply mimic the federal changes in state policy would mean tax hikes for many Minnesotans, in large part because of the changes to what will be considered federal taxable income. The most recent estimate from the Department of Revenue shows the state would collect $464 million more in taxes from Minnesotans for the current two-year budgeting period if the state completely conforms to the federal law, and about $1.168 billion over the next two-year biennium. That number could change in the February budget forecast, which is due to lawmakers on Wednesday.

As a result, one of the biggest challenges for lawmakers is figuring out the state's response to the federal bill is how to adjust taxable income for families, who would have typically been able to claim a number of dependents. Lawmakers don’t want a family family of five, for example, to pay the same amount as a single filer who makes the same taxable income. The federal government did include a new $2,000 child tax credit for some families, but they must qualify first, and Minnesota doesn't have an equivalent to the new credit in current law.

Lawmakers are still in the early phases of figuring out their options, but they hope to provide some tax relief for those hit with increases while conforming to as many federal provisions as possible.

“I don't see us getting to a point where we hold everyone harmless,” Davids said. “There are going to be some people who will pay a tax increase, but it is my goal to have as few in that category as possible.”

How would the state pay for any tax cuts?
The federal tax bill could cost $3 to $7 trillion over the next several decades, which will add to the national debt. But unlike the federal government, the state of Minnesota must have a balanced budget every two years, so they need to find a way to pay for any potential tax cuts right away.

Most lawmakers expect there to be a budget surplus when the February forecast is released, and Republicans in control of the Legislature are already eying it as a potential way to offset costs associated with federal tax conformity. Democrats are open to the idea, but some are wary of committing too much in state funds toward tax cuts now and blowing a hole in future state budgets. Democrats could recommend using some of the tax base generated by the major cuts for businesses in the federal bill toward cutting individual taxes, but Republicans are likely to push back on that idea.

Could partisan differences affect a deal?
Absolutely. A fight over a tax package was one of the major debates of the 2017 session. Republicans sent Dayton a $650 million package of tax cuts, including cuts to taxes on business property and Social Security benefits; and credits for college students and families with child care expenses. Dayton signed the bill, but he objected to a number of provisions in it, including the cuts to business property taxes and the tobacco tax, so he vetoed funding for House and Senate operations in an attempt to compel legislative leaders back to the table to negotiate the tax cuts. That never happened. Instead, there was a legal fight over the governor's veto, but there are still plenty of lingering disagreements over tax policy between the two parties.

This sounds extremely complicated. Can they get this done this year?
That remains to be seen, but everyone is stressing the importance of finding an agreement before the tax season starts next year. Senate DFL Minority Leader Tom Bakk has already raised the possibility that lawmakers could come back for a summer special session to finish tax conformity work, but Davids thinks that is a dangerous prospect, especially in an election year. “We go from legislative mode into campaign mode when we go sine die [adjourn]. I don't see how you can put a bipartisan bill together in the summer,” Davids said. “We have to do it now.”

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Comments (14)

Dependents

"Lawmakers don’t want a family family of five, for example, to pay the same amount as a single filer who makes the same taxable income."

And why not? Why should people pay less tax when they have more children? Why shouldn't they pay more, commensurate with their added social burden?

Dependents

An interesting argument – or argument-starter. I wonder if it will come up in the legislative debate. There are arguments both ways, of course, but it's not often I see the "added social burden" of children phrased quite that way, though I think it has merit. The other side, of course, is that the family of 5 has far greater expenses for basics (food, clothing, shelter) than does the single person (assuming that single person is not disabled or otherwise incurring unusually-high expenses of necessity), so, in theory at least, the single person has more discretionary income than does the family of 5. Like most financial conundrums, there are pluses and minuses for each side.

Others who are more knowledgeable about the rationale for various parts of the tax code, including how it treats dependents, might have something worthwhile to add here.

Growing Tax Base

A family of five will in about 20 years most likely add three new taxpayers to the tax base so economic expansion and government can grow. A family of one won't.

Social Burden

In about 60 years those families will likely add 3 more seniors to the system who will be increasingly expensive burdens to our social safety net. Personally i don’t think we should be subsidizing population growth.

Population

Assuming they are completely average citizens, those people will be massive net contributors to society, even if they have increased expenses in their old age. They will work needed jobs, create jobs for others, pay taxes, buy stuff from other people, etc. Economic growth and population growth have a positive correlation.

SALT deduction

The other potentially substantial change curiously omitted from this article is the federal limitation of SALT deductibility. This too will boost federal taxable income for some Minnesotans who itemize. Other high tax states line New York California New Jersey etc... have been looking at ways to protect their taxpayers from some of these targeted increases- what will Minnesota do?

"Do nothing" actually represents a state revenue windfall

Of course the MN House & MN Senate must "Do something" for the simple reason that a "Do nothing" will represent a MN tax increase. However, I suspect Governor Dayton sees this windfall as more taxpayer money to spend.
My simple solution is to join the other states that have eliminated the double taxation of SS in MN.

Mike: You may be mistaken.

What source may I find to understand your premise of increased state taxes resulting from the tax cut law?

Sources

Read & re-read the 1040 instructions and M-1 instructions. Limiting SALT deductions increases adjusted taxable income in high tax states. CA, MA, NO, MN, etc. will have higher state taxes unless the states act in 2018.
Talk to members of the House & Senate Tax Committees.

Tax season already started

Re: "before the tax season starts next year", it's important to remember that employers are already withholding 2018 taxes. We need clarity ASAP.

One partial solution

One of the Fed Tax Law changes that drives a large piece of State extra tax liability is the repeal of the personal exemptions, $4050 per person. The Legislature could put those exemptions back in. There are other 'drivers' but not being a tax expert I need to stop here. Maybe orhers can point to other tax 'drivers.'

The state tax return process

The state tax return process is already complicated for do-it-yourselfers. I can't believe how many different forms you are directed to fill out and then find out it doesn't apply. Please simplify the filing process.

When are the postcards being mailed out?

"We're making it so simple that almost nine out of 10 taxpayers can do their taxes on a postcard. This, instead of the 1040 form. Wouldn't that be nice?" -- Paul "Better Way" Ryan

"'Over 90 percent of Americans are going to fill out taxes on that postcard or a virtual electronic postcard. This is about simplifying taxes and simplifying the business system" -- Secretary of Money, Steve "Private Jets" Mnuchin

And remember when the president was caught on video kissing a postcard-sized tax form to, it was explained, "express his commitment" to simplification of the "hideously complex Internal Revenue Code"?

Remember when G Bush, Dick Cheney, Condalisa Rice, Don Rumsfeld and everyone else in the White House was on the tube every Sunday for months talking about mushroom clouds, our troops being greeted by wild happy people throwing flowers and candy, how it wouldn't cost all that much and how we wouldn't be there long because, Dick Cheney kept saying (every 10 minutes), "As we stand them up, we'll stand down. As we stand them up, we'll stand down. As we stand them up, we'll stand down"?

Wouldn't it be great, fantastic, wonderful, beautiful and ultra-amazing to do your taxes on a postcard (in five minutes or less!) instead of another unbelievably complicated, frustrating and depressing 1040 form?

CALL NOW!

Doing nothing would probably be the best thing

The state will probably need the extra $464 million in the next couple of years (we'll see Wednesday) and the blame falls squarely on the federal government which is controlled by the Republicans who will then get the blame for the tax increase. Win-win.