Gov. Mark Dayton has dropped the fiscal puck into play with his proposals for a broader-based but lower-rate sales tax plus higher marginal income tax rates on high incomes.
Which goal the puck ends up in is anyone’s guess. Given the short- and long-term fiscal problems our state faces, concrete proposals are welcome. But successful tax reform depends on some level of public consensus, and it is not at all clear if there is any greater consensus on fiscal issues here in Minnesota than at the national level. In any case, we will see.
Consider for yourself some basic questions since these are ones we face collectively: How much government do we want? How much do we need? How much are we willing to pay for? Who is affected most by which taxes and what is fair in this regard? Is there a tradeoff between fairness and economic efficiency or, in other words, between fairness and economic growth or fairness and jobs?
Let’s start with some basics.
First, contrary to the beliefs of many, government is not growing out of proportion to the rest of the economy. The “price of government,” or total spending at state and local levels relative to personal income as calculated by Minnesota Management and Budget, has been pretty constant at 15 percent for a decade. This is down from 17-18 percent levels common in the 1990s.
Second, ignore any claims that the outgoing Legislature or former Gov. Tim Pawlenty balanced the state budget. Much of any such highly touted balancing depended on one-time smoke-and-mirrors gimmicks like selling off a stream of future tobacco settlement payments for a single lump sum or fiscal-year shift borrowing from school districts. We have faced a structural deficit (one that is not just due to a temporary recession) for several years now and it will get worse in the future, especially as the state share of health care and retirement costs increases.
Third, remember that when the economy boomed in the late 1990s and before we cut income tax rates, the state ran up budget surpluses. We once had “a boatload of money” and, in 1999, my wife and I were part of a crowd as we traipsed off to spend our state tax rebate on a better car. But that prosperity was due to an unsustainably strong economy and not any long-term excess of revenue over spending.
Fourth, recognize that Minnesota has relatively high state and local tax burdens, both in absolute dollars and relative to income, compared with most other states. The Tax Foundation, a conservative but very reputable national research organization, places Minnesota sixth-highest in terms of personal income tax rates and seventh-highest in the nation, at 10.8 percent, in terms of total state and local taxes relative to state income. (Note that this calculation is made with a different methodology and assumptions than the “Price of Government” tabulated by Minnesota Management and Budget.)
Liberals will argue that we are a high-tax state, but also a high household income and high government service state. Minnesotans can pay more in taxes and still have more money left over to spend than in most other states. And Minnesota has better higher education, better parks, better public health and so forth than many other states. They are correct.
Conservatives point out that our ranking relative to other states is important. This is especially true because businesses’ decisions on where to locate or expand and seniors’ decisions on where to retire are sensitive to how Minnesota’s taxes will hit them compared with alternatives. This also is correct.
Fifth, remember that the burden of local property taxes is an issue that has been contentious for at least 50 years, and that has resulted in a cycle. When times are good, starting with the “Minnesota Miracle” of 1971, we have the state assume a larger fraction of state and local spending, especially for schools. But then when the economy sours, we tend to renege on the deal. And then when economic conditions improve, as Dayton and the state economist apparently believe they have now, we start all over again. Also remember that the “miracle” was a bipartisan effort, involving Republicans like Charlie Weaver (father of the Charlie Weaver who also was in the Legislature, was Pawlenty’s chief of staff and now is at the Minnesota Business Partnership) and Democrats like former Gov. Wendell Anderson, and that the key legislation came out of Republican-majority Legislatures in 1967-1971.
Now think a bit about the property taxes, state sales tax and state income taxes that make up the three-legged stool of Minnesota’s state and local financing.
First, the tax on real property is one that goes back through the middle ages to antiquity. It embodies a long history of local control. In our state, as well as in nearly all others, it has been the cornerstone of local government finance since we achieved statehood.
It has the problem of not being closely linked to ability to pay, especially for retirees or for young families with a high value of house relative to income. It can be regressive, taking a higher percentage of income from lower-income households than from higher-income ones, although some analysts dispute the extent to which this really is true.
It has the advantage of being relatively insensitive to booms and busts. The past five years being an exception, property values usually don’t fluctuate as income or taxable sales do. So the property tax forms a stable revenue stream.
Second, the sales tax often is regressive, since lower-income households spend a higher proportion of their income than do higher-income ones. This problem can be ameliorated by exempting “necessities” like groceries and clothing. This is what Minnesota has chosen to do, and it is thus better to be poor in Minnesota than in many other states, particularly those that tax groceries.
Unfortunately, the more necessities you exempt, the more volatile you make the revenue stream from the tax. When the economy sours and people get laid off or work fewer hours or receive no bonuses, they keep going to grocery stores and don’t cut back much on basic clothing. But they don’t buy cars, appliances or other big-ticket items. If most of the state’s sales tax income comes from discretionary purchases, then revenue will yo-yo.
The same can be true for income taxes. You can structure exempt amounts and marginal rates to make high-income households bear a high proportion of the total bill and leave low income ones out entirely. But since the incomes of higher-income people fluctuate more with business profits and returns on financial assets, this move toward perceived fairness narrows the base and makes revenue highly variable.
Much more could be said, and probably will be before this is all sorted out. But this is a good starting point for understanding the debate.