Initial Reaction: House Tax Bill

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The House Tax Bill released Monday delivered as expected: a lot of highly targeted relief focusing on low to moderate income households with kids combined with a healthy dollop of aid to local governments.  The only real suspense revolved around how $8-9 billion plus in various tax relief proposals were going to get culled and scaled to fit into a $3 billion target which declines to only $1.3 billion in the out-biennium.  

The big picture for FY24-25:  $3.03 billion in biennial tax relief/reductions consisting of

  • One-time refundable credit (rebate) totaling $1.125 billion
  • 15 new/expanded/reformed individual income tax credits and subtractions totaling $1.715 billion
  • $187 million in net property tax relief, 2/3rds of which consists of a one-time 13.8% increase in renter and homestead refunds for taxes payable 2023.

The most notable modifications are the size of the proposed rebate (now $550 per married couple plus $275 for up to three dependents up to $150,000 in income)  and a restructuring of the state’s Working Family Credit to establish a new state child tax credit -- albeit substantially scaled down from what was introduced earlier this session.  A few higher profile tax credits left on the cutting room floor include the “Great Start” child care tax credit, renewal of the Angel and Historic Rehabilitation credits, and a couple of climate related income tax credits for solar system and energy efficiency purchases.

The General Fund impact also includes $268 million new sales tax exemptions (almost all construction materials-related for government and non profit projects) and $426 million in local and tribal aid increases.  (The tax bill does not include $600 million in one-time public pension aids). 

Add it up and new money was needed to meet the tax budget target.  The revenue raisers chosen were also rather predictable:

  • $529 million in individual income tax increases (ex one-time conformity items) from a new 10.85% fifth tier for taxable incomes over $1 million (married couples filing joint returns) and $600,000 (single filers).
  • $452 million in corporate income tax increases from adopting worldwide combined reporting

Testimony will be heard today with mark up Wednesday.

A Couple of Observations and Comments

If we're going to do it, this is how you do it.

We do not doubt constituents have made it clear to lawmakers they want a full exemption of Social Security income from taxation.  We also do not doubt that a significant number of these constituents think their Social Security income is being taxed when it really is not or believe they will be taxed as they approach retirement when it would not be.  That is why if we insist on making a bigger mess of horizontal equity in the state income tax system, the House’s approach is the best way to do it. 

By basing the exemption on adjusted gross income rather than provisional income, it makes the existence of any taxation of Social Security benefits much more visible and understandable to taxpayers.  If the House version prevails, lawmakers would be able to tell their married joint filing constituents if their adjusted gross income is less than $100,000 their Social Security income will not be taxed. Period. If their AGI is less than $120,000 some extra above what is already excluded will not be taxed.  For perspective, the median senior income in the state aged 65-74 is $60,100.  

This provision won't mollify everyone, but perhaps lawmakers will be able to eat in peace at the local café a little more often.

The Paradox of Progressivity

It’s well established that the United States has one of the most progressive tax systems in the world yet at the same time features some of the highest degrees of income inequality and weakest transfer and social welfare programming.   Fiscal sociology scholars have asked why this is. They have found that progressive policies succeed within a larger political economy that is more favorable to business.  Among other things that includes the tax code.  The most generous welfare and redistributive governments rely more heavily on regressive taxation recognizing it to generate the revenues needed for social spending and investments without harming economic growth.  

The converse is also true: countries with stronger progressive tax codes and more punitive business taxation triggered much stronger and more aggressive resistance to social welfare policies and related spending.  These findings are from national tax policy investigations.  Arguably these findings have as much or more relevance with respect to subnational taxation and its open borders.

We have never been more reliant on individual income taxation and more reliant on the highest income earners in the process.  From a standpoint of attracting capital and talent, ensuring balance and stability in the state revenue system and supporting the type of social welfare spending and investments the state is known for, Minnesota is in danger of playing the same policy card too often.

Darts May Be Just as Accurate

The largest revenue raiser in the bill is the adoption of worldwide combined reporting for corporate income taxation generating a projected $1.17 billion over the next four years.  The problem is information about multinational activities and decision-making in hundreds of subsidiaries across the globe makes generating reliable forecasts on this matter extremely challenging.  Research has shown firms do not provide sufficient information for even close observers and sophisticated users like financial analysts to interpret and predict the future tax implications of foreign operating activities, and forecasting difficulty is greater for multinational firms regardless of whether foreign operations are inside or outside of tax haven countries. 

For this reason, to develop its revenue estimate, the Department of Revenue had to rely on the assumptions, extrapolations, and findings contained in study by a progressive tax policy advocacy group on revenues lost to tax havens.  According to the Council on State Taxation, a business membership group comprised of practitioners who actually do this work for a living, this study “relies on highly generalized and problematic global tax data, but makes no effort to customize its estimate to reflect the laws of particular states or make adjustments to reflect changes in national corporate income tax laws.”  

Some might dismiss that assessment as nothing more than corporate self-interest talk.  However, a paper presented at the 2019 National Bureau of Economic Research Taxation of Business Income Conference found the profit shifting estimates contained in that study “overstated due to researchers misunderstanding of accounting treatment,” leading to “double counting of foreign income and to its misattribution to incorrect jurisdictions.”  The result was an overstatement of profit shifting estimates by as much as two-thirds. 

Administrative, legal, and political complexities of this proposal aside, for anyone buying the vision of worldwide combined reporting being a large, reliable geyser of corporate tax revenue on which to build permanent spending and tax relief, caveat emptor.