State Tax Reform
Options, Challenges & Creativity
The February/March 2013 edition of ABFM’s newsletter, Line Item, features several articles on the pertinent topic of State Tax Reform. Click here to check out the rest of this special issue, and click here for information on a special webinar featuring contributors to this issue, hosted by AABPA on Wednesday, March 13th (1PM Eastern).
By Jay Kiedrowski, University of Minnesota
This January, Governor Mark Dayton and his Revenue Commissioner Myron Franz proposed the most significant tax reform package in decades in Minnesota, impacting all of the state’s main taxes.
The goals of the tax reform were threefold:
- Balance the state and local revenues derived from income, sales and property taxes,
- Broaden the bases of the taxes and lower the rates, and
- Balance the budget with no gimmicks.
Traditionally, the sales tax has lagged income and property taxes in raising revenue. Minnesota is one of the few states that do not apply the sales tax to food, clothing or personal services. As a result the state sales tax rate is currently high at 6.875%. There also are local sales taxes in some communities applied to the same base.
The governor’s sales tax proposal broadens the items covered in the base to include clothing purchases over $100, personal services, and business to business services (such as legal, accounting, specialized design and business support services). E-fairness sales and digital products are also taxed under the proposal. With the broader base, the sales tax rate is proposed to drop to 5.5%. Minnesota would go from having the seventh-highest sales tax rate in the nation to having the 27th-highest.
Part of the rationale for expanding the sales tax base to personal services is that consumer spending has changed. In 1967 when the sales tax was first enacted,two-thirds of purchases were for consumer goods and one-third for consumer services. The reverse is true today with two-thirds of the spending for consumer services and one-third for consumer goods.
An additional $2 billion would be raised from the sales tax changes even at the lower rate.Total state revenue from the revised sales tax would be $12.2 billion for the two year budget period, an increase of 21%.
The sales tax changes are controversial. Governor Dayton is a Democrat and Democrats in Minnesota have traditionally been opposed to sales tax increases. Further, the Minnesota business community is strongly opposed to the business-to-business sales tax. Only five states currently have such a tax.
The governor proposed increasing the income tax rate two percentage points (from 7.85% to 9.85%) for individuals with Minnesota taxable income of at least $150,000 and couples with taxable income of at least $250,000. This change would affect 53,600 Minnesota returns and raise $1.1 billion. Minnesota’s income tax would become the fifth highest in the nation.
The tax reform package also includes a new income tax on part-time residents (so-called snowbirds) that would raise $30 million. Responding to an 86% increase in property taxes since 2002, the governor proposed a $500 tax rebate as part of the income tax system. This rebate plus increased funding for local government aid would lower property taxes by 10%. The rebate is estimated to cost $1.4 billion. All of the income tax changes would bring the total income tax revenue to $17.1 billion for the two year period, a slight decrease from the current biennium.
The Governor’s Office shared a graphic illustrating the impact of the changes to the sales, income, and property taxes. Their argument is their plan balances the state and local methods of taxation with respect to their shares of total tax revenues.
Corporate taxes are reformed as well. The governor proposed lowering the corporate tax rate from 9.8 percent to 8.4 percent by eliminating a number of current tax breaks for particular corporations. As with the sales tax proposals, the corporate tax changes follow the economic policy of expanding the tax base and lowering the rate. The proposal is revenue neutral.
The forecast for the Minnesota state budget completed in November of 2012 indicated a $1.1 billion deficit for the 2013-2015 biennial budget. Governor Dayton’s proposals eliminated the deficit by increasing revenue $1.1 billion. The governor also increased revenue additionally by $1 billion to finance additional spending primarily on K-12 and higher education.
The proposed budget in total for the upcoming two year period is $38 billion, a 8.5% increase over 2010-12. The projection for the 2015-17 biennial budget shows that it is balanced as well meeting one of the governor’s other goals.
Jay Kiedrowski is a Senior Fellow with the Humphrey School of Public Affairs, University of Minnesota.