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Minnesota Governor Drops Reform Parts of Tax Reform Proposal

2 min readBy: Liz Malm

Last month, we analyzed the disappointing taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. plan suggested by Minnesota Governor Mark Dayton (D). The proposal would have added a new top income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. and sharply hiked cigarette taxes, and included a poorly-designed revamp of the state’s sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. system, a sharply-criticized property tax rebate program, and a welcomed corporate income tax rate reduction.

In theory, promising sales tax reform includes base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. and rate reduction. By including more transactions in the base, a state can reduce the overall rate without any negative revenue implications. Unfortunately, this reform is both politically difficult and tough to get right.

Governor Dayton’s first budget attempt would have expanded the sales tax to services, but many of these services would have been classified business inputs. Taxing business inputs is problematic because it causes tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. and leads to associated economic distortions. Although expanding the sales tax to services is generally a good way to broaden the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , care has to be taken to ensure inputs are excluded. Further, service providers don’t often take too kindly to such a measure.

As expected, many service businesses within the state voiced opposition to the proposal. After the Minnesota Management and Budget Office announced that the state’s projected deficit wouldn’t be as high as has been originally predicted, the Governor was able to scrap the unpopular sales tax scheme. He also withdrew his suggestion to lower the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate.

The Governor’s revised plan includes the following (see page 15 of this document for specific tax-related revisions):

  • increased income taxes on higher-income Minnesotans,
  • higher cigarette and tobacco excise taxes,
  • a new property tax provision that would increase local government aid and fund a renter’s and homeowner’s property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. refund,
  • extension of the “Minnesota Working Family Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. ,” and
  • closure of “business tax loopholes” (although I’m finding it difficult to locate specific details of this provision).

Governor Dayton removed all of the promising parts of his original plans—such as the corporate income tax reduction and the sales tax base expansion. The sales tax portion, though not without serious issues, could have been fixed by exempting business inputs. Instead of using the state’s more promising revenue projections to push for positive tax reform, the Governor instead proposed an easy-sell tax plan that does little to improve the business and tax climate within the state.

More on Minnesota here.

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