Minnesota Governor Drops Reform Parts of Tax Reform Proposal

March 18, 2013

Last month, we analyzed the disappointing tax plan suggested by Minnesota Governor Mark Dayton (D). The proposal would have added a new top income tax bracket and sharply hiked cigarette taxes, and included a poorly-designed revamp of the state’s sales tax system, a sharply-criticized property tax rebate program, and a welcomed corporate income tax rate reduction.

In theory, promising sales tax reform includes base broadening 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 pyramiding and leads to associated economic distortions. Although expanding the sales tax to services is generally a good way to broaden the tax base, 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 tax rate.

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

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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A 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.

The 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.

A 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.

A 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.

Base 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.