Is Minnesota’s tax system unfair?

It has been central to the political pitch made by Gov. Tim Walz, DFL legislators and their allies: Wealthy state residents and big corporations did well during the pandemic recession — but they didn’t pay their fair share of taxes.

It’s become a common refrain. “The rich and big corporations are getting richer while working families are struggling the most,” House Majority Leader Ryan Winkler said on the opening day of the 2021 session. 

House Speaker Melissa Hortman agreed: “There are people who are not paying their fair share. … there are people and industries who are doing better in the pandemic and it is important that everyone is paying their fair share as we go through these tough times.”

It’s not just Minnesota. Democrats in states across the country are looking to make tax changes that increase assessments on high earners and cut tax burdens on lower-income families, including expanding child care tax credits and the earned-income tax credit.

But Republicans and business leaders are pushing back against claims that the state tax system lets some escape their fair share. As Minnesota Senate Taxes Committee Chair Carla Nelson, R-Rochester, said at a hearing on the Walz tax plan: “You almost have to discount this statement — ‘pay their fair share’ — as a rationale for increasing taxes by over a billion dollars. The fact of the matter is, in Minnesota, a highly progressively taxed state, people do pay their fair share. In fact, they pay more.”

Minnesota’s tax system does score highly for progressivity from both left- and right-leaning analysts. That, however, might not matter. The fair share strategy is a national one, applied to states regardless of whether their tax systems are progressive or regressive. 

Part of a national push

The blueprint for the strategy was described in an article published in December by the progressive Center on Budget and Policy Priorities, which argued that — due to the disparate effects of the pandemic and its economic consequences — “states would be well-advised to raise taxes on wealthy families to preserve funding for crucial priorities that can promote an equitable recovery.”

Walz’s plan fits into the national story. His proposed fifth income tax tier — for couples earning $1 million or more — will hit about 0.7 percent of taxpayers, allowing Walz to define those being taxed as the “1 percent on the 1 percent.” It would also create a higher tax rate on capital gains, the profits people make from the sale of assets like stocks or property: 1 percent if profits on the sale was between $500,000 and $1 million; 4 percent if more than $1 million. Finally, the proposal would also increase the state’s corporate income tax, known as the corporation franchise tax, for profitable corporations.

Taken together, the three measures would raise $1.3 billion of the $1.66 billion total tax hike proposed by Walz.

Thursday, Walz will present a new plan that takes into account two significant changes since his budget blueprint was first released: the February forecast, which projected a $1.6 billion surplus in lieu of a previously projected budget shortfall for the next budget period; and the federal American Rescue Plan, which will send $2.7 billion to Minnesota, with $2.1 billion going directly to local governments and nearly $1.4 billion going to the state’s school districts.

“As we set the budget and as we set obligations going forward, we need to think about that and take it into account,” Schowalter said. “Understanding the nature of the money, that more of it is one time instead of structural is a really important consideration.”

How does Minnesota’s compare?

Is Minnesota’s tax system unfair? Most analyses and state-by-state comparisons conclude that Minnesota already has one of the nation’s most progressive tax systems, defined as one that collects more tax revenue from the wealthy than from the poor or even the middle class.

The state Department of Revenue’s Tax Incidence Report, which was updated on March 4, says the system is regressive, but only slightly. Using a statistical analysis known as the Suits Index, Minnesota’s system is just 0.013 percent below proportional. But if income taxes are separated from business taxes, the system becomes very progressive. That is: regressive business taxes drag down the state’s overall progressivity score.

Carl Davis, the research director at the Washington, D.C.-based Institute, said Minnesota does better than most states. But he also says “that’s a very low bar.”

“Most states have steeply regressive tax systems where you’re asking the most of those who have the least. It runs counter to most people’s perception of fairness,” he said. “If you stack up Minnesota next to most states, it looks better than most — no doubt. But you have to keep in mind what most states look like, and it is definitely not the case that Minnesota has a robust, progressive tax score.”

Other ways to measure system

Mark Haveman, the executive director of the business-oriented Minnesota Center for Fiscal Excellence, said the state’s Tax Incidence Study “tells a very compelling story about Minnesota’s tax system, that we are fair, and frankly we have been fair for a very long time.”

Haveman said that what are actually tax adequacy debates — whether there is enough money to buy things people want — are often “marketed as tax fairness problems.” He said it is a compelling political message to frame the issue as someone not “doing their fair share of the lifting.”

“But it distorts the public perception and does a disservice to Minnesota’s long and significantly successful efforts to address progressivity and ability to pay,” Haveman said, who produces a regular state-by-state tax comparison called “How Does Minnesota Compare?”

“Our highly progressive individual income tax, with a tiny assist from the estate tax and the property tax refund program, offsets the regressivity of every other tax imposed on every other tax on individuals and households, including the regressive vice taxes and gas taxes and provider taxes,” he said. “That’s something really worth reflecting on.”

But progressivity shouldn’t be the only measure of a good tax system. It should also be stable and relatively easy to collect and administer, and over-reliance on wealth taxes has its own dangers, since that too can be volatile. The 2008 recession, for example, caused a deep deficit for Minnesota because it hit capital gains and high-earners harder than others.

Washington state has among the nation’s most regressive tax systems, with no income tax, heavy reliance on sales taxes, and business taxes on gross revenue instead of profits. The Institute on Taxation & Economic Policy places it on its list of “The Terrible 10.” At the same time, Oxfam put Washington at the top of its list of states that treated its workers best during the COVID recession. Minnesota was 17th.

As Haveman notes: “What you do with your tax money is just as important as how you raise it.”

Taxes Committee Chair Nelson said she worries that Minnesota will become what she called a “tax island” in the region, with much higher tax rates than surrounding states and with rates among the highest in the U.S. “We do not want that capital, those revenue producers, leaving our state,” she said. “Is there any level of tax increase that would make us uncompetitive?”

COVID-19’s disparate impact

Minnesota’s state economist, Laura Kalambokidis, has shown that the recession caused by the pandemic had different impacts on different groups of people and businesses in Minnesota. The businesses that weren’t closed — and the jobs that could be done from home — didn’t suffer much economic loss, said Kalambokidis.

House Taxes Committee Chair Paul Marquart, DFL-Dilworth — the person charged with shepherding the Walz plan through the House — has been in the House for two decades, and has watched the changes in the tax code that have made the system more progressive, especially the addition of a 4th income tax tier in 2013.

He said refundable tax credits for working families, property tax refunds and renters credits have helped to make the system fairer. Minnesota has the country’s most generous “zero bracket” — the income level beneath which no taxes are owed — at $34,000 for a family of four. 

“We’ve done a number of things that are progressive, and you can see that in the data,” Marquart said.

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But he said he is concerned about the disproportionate impact of the COVID recession. “The lower-income you were before COVID-19, the harder you were hit by COVID-19,” he said. “That income inequality has to be factored in.”

Marquart said the federal tax reform of 2017 was also more generous to higher-income earners and businesses.

“We’d spend more than half of the surplus just on that,” he said.

And like Schowalter, he argues that the money from the surplus and the federal American Rescue Plan is one-time money and can’t be used to pay for the new spending on school and economic development that Walz wants. If you want to fund any of the things Walz wants to do, he said,  “there’s gonna be revenue needed, in my mind.”

Adequate or inadequate, progressive or regressive are the terms of the tax debate in 2021. But another term might be more apt: academic. Senate Republicans who control that body were opposed to tax increases before the session began and have only become more given the $1.6 billion surplus and the federal money from the American Rescue Plan.

“The $4.7 billion, with the $1.6 billion in surplus that we already had, is why I stood up and said we do not need a tax increase,” said Senate Majority Leader Paul Gazelka, R-East Gull Lake. “I’m asking the governor to drop his plans for any tax increase because we have so much money coming into the state, now is not the time for a tax increase.”