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

Doing nothing could result in a very complicated tax season next year. But simply conforming the state’s code to that of the feds could mean big tax increase for many Minnesotans. 

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.”
MinnPost file photo by Bill Kelley

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.”

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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.”