Implications of GOP Tax Plan on Minnesota Taxpayers

A look at the "average filer" effects

With attention largely focused on the federal tax relief and burden shifting arising out of the proposed GOP "Tax Cuts and Jobs Act" (TCJA), it’s important to recognize that the changes would have sizable effects at the state level, too.  The GOP plan would effectively broaden the individual income tax base through its mix of larger standard deductions, the elimination of personal exemptions, and the reduction or elimination of various itemized deductions.  Since the starting point for calculating Minnesota income taxes is federal taxable income, the GOP plan  has the potential to expose more Minnesotans' income to the state's individual income tax rates.

To examine how such reform may play out in Minnesota, we modeled the effects this plan would have on federal and state income tax burdens for income tax filers at selected incomes and filing statuses.   Our modeling is based on taxpayer data that the Department of Revenue provided for our latest Multistate Individual Income Tax Comparison Study (tax year 2014).  This information allows us to model the "average taxpayer" for each filer type at various incomes.  The findings from that study establish our comparative baseline, and we modeled tax returns for those filers under the TCJA proposal.

Two major caveats apply:

  • We assume federal taxable income remains the starting point for Minnesota returns and Minnesota’s only policy response is to fully conform to the new calculations of federal taxable income.
  • Any individual taxpayer situation at these income levels may differ wildly from this “average” taxpayer.  Changing the number of dependents or the total amount of itemized deductions a filer claims would yield much different results; households with more kids and/or bigger itemized deductions will see less federal relief or possibly pay more because of reform.  (All our married filing jointly filers are assumed to have two children and our head of household filers are assumed to have one child.)

Federal Changes Included

The TCJA would eliminate or modify many itemized deductions.  Some of these changes – such as the changes to the deduction for mortgage interest – are not included in our modeling because they do not apply to any of our “average taxpayers”.  The proposed changes that do apply to our average taxpayers are as follows.

  • Standard deductions increase to $12,000 for single filers; to $18,000 for head of household filers; and to $24,000 for married-joint filers.
  • Personal exemptions are eliminated
  • The overall limitation on itemized deductions is eliminated
  • The deduction for state and local income and sales taxes is eliminated
  • The deduction for property taxes is capped at $10,000
  • The child tax credit is increased to $1,600 per child (with the refundable portion continuing at $1,000)
  • A new nonrefundable family credit of $300 per person not eligible for the child tax credit is added.
  • The phaseout threshold for the child tax credit and the family credit is increased to $230,000 for married-joint filers and to $115,000 for all other filers
  • The income tax is reconfigured into four brackets of 12%, 25%, 35%, and 39.6%
  • Pass through income is subject to a maximum tax rate of 25%
  • The alternative minimum tax is eliminated

The table presents our results and offers some perspective into how this plan would have affected filers’ 2014 tax burdens (the most recent taxpayer profiles available).

Some observations:

Disallowing deductions and rolling the personal exemption into the standard deduction is not enough to offset the lost federal revenue from increasing the standard deduction and changing the rate structure.   Even though businesses -- one of the main beneficiaries of  tax relief --  are largely excluded in this analysis, all the individual taxpayers we modeled realize some level of federal tax relief

With one exception, all the filers we modeled would see enough federal tax savings to offset higher Minnesota income taxes resulting in aggregate tax reductions.  The proposal would direct tax relief to families with children by enhancing the child tax credit.  However, this enhanced credit is non-refundable, which creates an issue for the average $50k married-joint filer.  Because those filers’ tax burdens are relatively low, they cannot take advantage of the $3,200 maximum credit – leaving over $1,500 of non-refundable credit on the table.  In this case, the enhanced credit does not offset the additional tax generated through by the increases in taxable income.

The GOP reform would have a major impact on the amount of itemizers in the state.  Under the current tax system five of the filers above – the average single filer at $100,000 of income and the average married-joint filer at $100,000 and above – itemize their deductions.  Under the TCJA, with its higher standard deduction and elimination of the deduction for state income taxes, only our typical married-joint filer at $500,000 would itemize. 

All else held constant, the impact of federal tax reform would make the state tax income tax system less progressive assuming Minnesota adopts the new calculations of taxable income.  On a proportionate basis, for the married-joint filers we looked at, the tax increases are generally smaller as income grows.

How do these results jive with national “full sample” modeling suggesting many taxpayers would pay more taxes under the reform plan?   The answer lies in our second caveat – the “average filer” fails to capture the tremendous diversity that exists in individual tax returns at any income level.   The result is the potential for some big winners and losers and major distributional swings.

This suggests that if this federal reform package were enacted, Minnesota policy makers would face some very interesting federal conformity and related tax policy decisions.  For example, any desire to maintain personal exemptions at the state level to adjust tax burdens for family size could likely turn most of these projected state income tax increases into additional tax relief with potentially significant consequences for the state budget.  All this makes the November economic forecast more momentous than usual.  The smaller the surplus (or the bigger the deficit), the harder any state tax policy response on the fly will be.