Other Messages in the 2015 Tax Incidence Study

There is a lot more to chew on in the Department of Revenue’s recently released Tax Incidence Study than just state progress in the dogged pursuit of elusive “tax fairness.”

 

Recently, the Department of Revenue released its 2015 Tax Incidence Study, a report issued in odd-numbered years that examines the fundamental question, “who pays Minnesota’s taxes?” The report is both highly regarded and highly anticipated. It is without question one of the highest quality studies of its kind in the nation and an excellent example of Minnesota’s good government ethic in practice. At the same time, it is the one study that provides data to inform the eternal question of how fair our combined state and local tax system is.

Despite 150-plus pages of jam-packed detail on who pays what taxes, one single finding gets 99% of the attention: the breakdown of effective tax rates – the taxes a household pays compared to its income – by population deciles. This allows for comparisons of household tax burdens for different income groups. Unsurprisingly, thanks to the tax changes made in 2013, the study projects that the 10% of households with the state’s highest incomes will have effective tax rates more in line with the rest of the state by 2017, communicating that progress has been made on the “pay their fair share” front.

But behind the headline is the story itself which is a lot more complicated and nuanced. Here are three other messages to be gleaned from the results:

Message 1: Business taxation has long been a major, overlooked, and most certainly undiscussed reason why Minnesota’s tax system is regressive. Now it’s indisputably the prime reason.

For the first time ever, on a collective basis all taxes state and local governments collect directly from citizens are progressive – i.e., as income rises, so do effective tax rates.

Even before the 4th tier went into effect, our state income tax ranked second in the nation in structural progressivity after factoring in our state earned income tax credit program, one the nation's most generous and most accessible. After its recent progressive "turbocharging," the income tax (with an assist from our property tax refund programs and a tiny push from the estate tax) now more than offsets the combined regressivity of every other form of individual taxation in the state — including the especially regressive taxes on tobacco and gasoline. Frankly, that’s remarkable and deserving of much more (or at least some) attention and recognition.

So why is the overall system still regressive? Because – as the study points out – $10.5 billion in taxes governments impose on businesses eventually find their way to Minnesota households in the form of higher prices, lower wages, and lower returns on investment. And this happens in a regressive way as it always does and always has.

Message 2: Property taxation remains the more progressive way to fund local government.

Remember all the rhetoric in recent years about how property taxes are the least fair of all taxes? Reality doesn’t match the rhetoric. The Incidence Study once again shows that homeowner property taxes are less regressive than sales taxes – which are the most commonly sought after alternative source for local government revenue. Importantly, property taxes are less regressive than sales taxes even before considering Minnesota’s property tax refund programs – the most generous and broadly accessible income-tested property tax relief programs in the nation.

Message 3: To be a national leader in progressive state and local taxation you often have to forego a lot of tax revenue.

Despite our now even more progressive income tax, according to the study we still rank only 7th in the nation in overall tax system progressivity. Interestingly, half the states ranked ahead of us have no sales tax at all (Delaware, Montana, and Oregon). We feel quite confident that eliminating the sales tax is a tax fairness strategy that’s unlikely to catch on here.

These are the types of insights that demonstrate why the Tax Incidence Study is such an invaluable resource for informing state tax policy. Problems arise when the study becomes a kind of tax Rorschach test — seeing what you want to see (and in the process ignoring what you want to ignore).

So what do we make of the main headline that we now have a fairer tax system than we did before? Minnesota's state and local tax system is undoubtedly more progressive thanks to the 2013 changes, Whether that has made the tax system more “fair” is open to debate. That’s because even mathematical calculations of effective tax rates cannot be completely isolated from the value judgments and assumptions surrounding the complicated idea of tax fairness. For example:

  • The Incidence Study includes about $1 billion in user taxes such as the gas tax. These taxes are unquestionably regressive and at the same time most, if not all, economists would declare them unquestionably “fair” because those who benefit more from the service ( e.g. using the roads), pay more in tax.
  • The study also includes about $500 million in highly discretionary vice taxes that households voluntarily pay. This raises the philosophical question, is it “fair” to make the wealthy pay more in income taxes partly because they don’t engage in their “fair share” of drinking, smoking, and gambling?
  • Finally, the study allocates $10.5 billion in business taxes to Minnesota households through sophisticated statistical modeling and methods. The Department’s work is of the highest caliber but no one can really know for certain exactly where those burdens end up. As a recent scholarly review of state tax systems rankings noted, “Assessments of state and local tax progressivity are quite sensitive to assumptions about incidence, and those are by no means settled. Consequently, the only hard conclusion we draw here is that perhaps precise claims about the overall progressivity/regressivity of individual state and local tax systems should be taken with a large grain of salt” (emphasis ours). $10.5 billion buys a lot of salt.

For all these reasons, we need to be extremely careful in declaring these findings the definitive “last word” on tax fairness. And it should absolutely discourage us from making a Harrison Bergeron-like pursuit of perfect equity in effective tax rates across the entire population the singular objective of state tax policy.

The good news in the latest report is that we can be absolutely sure that Minnesota has a fair tax system. That really shouldn’t be a surprise; we have always had a very fair tax system. Minnesota's tax code reflects significant, successful — and longstanding — efforts to address ability to pay concerns and build progressivity into its tax system. Implying otherwise is a gross injustice to our legacy and the efforts of past policymakers.

The problem with the study has been and continues to be with its practical use in the political environment. It seems like the only time the Incidence Study is taken seriously is when it is being used to justify additional income taxes on higher-income earners to raise more state revenues. It’s a convenient marriage between higher spending and greater progressivity. But it’s telling that when tax proposals arise that would create greater progressivity through business tax cuts, advocates of progressivity are nowhere to be found.

Building an argument for higher taxes based on the need for additional government spending and investments can be a laborious slog. Building an argument for higher taxes based on the idea that others haven’t been doing their fair share of the lifting has proven to be a lot easier. Using the study only when one wants to make this argument does a disservice to a great policy tool.