State of the State: Minnesota Tax and Spending Rankings

If there’s one rule of policy debate, it’s this: nothing tends to get attention like a ranking study.  Since 1969, MCFE has been putting Minnesota tax and fiscal policy in a national perspective – taking the U.S. Census Bureau’s annual state and local government financial data and ranking state revenues and spending in various categories in our often-referenced How Does Minnesota Compare report – free on our website at http://www.fiscalexcellence.org/our-studies/how-does-mn-compare.html.

As is always the case, some background is in order.  The Census Bureau goes to great lengths to rigorously survey local governments to create as accurate a financial picture as possible.  This leads to considerable frustration when we release a report in October of 2015 that covers fiscal year 2013 for the state and school districts (July 1, 2012 to June 30, 2013) and calendar year 2012 for cities, counties, townships, and other local governments.  With a time lag of roughly 2-3 years, it is impossible to produce How Does Minnesota Compare in a “timely” fashion.  It’s important to keep in mind that this information basically precedes the effects of the 2013 legislative session, which saw the enactment of the fourth income tax tier and significant additional state spending in various budget areas.  And it clearly precedes the increases in state aid to local governments, which for all intents and purposes only because effective during calendar year 2014 (and so will show up in the FY 2015 Census data – two years from now).

Back to the Future Tax Policy: A Return to the Top Ten

On the tax side, Minnesota has reestablished its reputation as a high-tax state.  Minnesota’s rankings for tax collections fell during the 2000s, with the per personal income rankings between 19th and 23rd between 2005 and 2008.  Our rank has climbed slowly upward since then, and our 9th place ranking for 2013 is the highest since 2000, when we ranked 8th.  Given both that lawmakers made relatively little changes to our tax code between 2005 and 2013 and that the 2013 changes are not fully incorporated into these results, such findings demonstrate how the changing fortunes of other states affect these rankings as much or more as our own policymaking decisions do.

As Table 1 shows, collections in FY 2013 were 13% above the national average and took up 11.7% of total personal income – the highest share since 2007.

Although Table 1 conveys a Lake Wobegon aspect to our tax system, the rankings do vary considerably.  For all the angst about property taxes, total collections are only a tick above the national average.  Consumption taxes – sales and excise taxes on items such as alcohol, tobacco, and motor fuels – are about 5% above the average.  Income taxes are more notably above the national average, while collections of the extraordinarily volatile corporate income tax are a whopping 46% above the average.

 

As noted earlier the Census data covers fiscal year 2013 – which for state government ran from July 1, 2012 to June 30, 2013.  Importantly, that period largely predates the fourth income tax tier that legislators and Governor Dayton enacted near the end of the 2013 legislative session.  Estimates at the time suggested that the fourth tier would raise about $585 million in the first year alone.  Adding $585 million to the FY 2013 revenue totals gives a sense of where Minnesota might fare in the FY 2014 numbers that will come out next year.  Those additional tax revenues raise Minnesota’s income tax collections by about 6.5% – to $37.13 – which in turn raises the state’s ranking two spots, from sixth to fourth – behind high-income New York, sales tax-less Oregon, and Maryland.

Spending: And the Winner Is…Human Services (Again)

On the expenditure side governments in Minnesota are spending at levels close to the national average, continuing a trend that is now almost a decade long.  Table 2 shows Minnesota spending amounts, ranks, and spending relative to the national average for large- to medium-sized budget areas.  Over half of state and local spending is concentrated in two areas: what the Census defines as “public welfare” (spending toward the “support of and assistance to needy persons contingent upon their need” – essentially “human services”), and education (both K-12 and higher ed).  As the table indicates, relative to other states Minnesota has prioritized three areas of spending: highways, natural resources and parks, and human services.

Higher-than-average highway spending isn’t much of a head-scratcher.  As a cold-climate state with a lot of transportation infrastructure Minnesota’s operating and maintenance costs (think snowplowing and freeze-thaw issues) will simply be higher than those in warmer areas.  Higher spending on natural resources and parks shouldn’t be too surprising either – the state’s traditionally high levels of spending have been supplemented in recent years by the dedicated sales tax revenues approved by voters back in 2008.  Higher spending in the human services area is more of a policy decision than the other two areas, but policymakers have made it a spending priority for as long as we have published this data.  Although human service spending relative to personal income fell about 11% from 2012, it is still the largest public sector spending area, nearly 20% higher than K-12 education, and continues to be the only spending area where Minnesota ranks in the top ten.

Much has been made about the effects an aging population will have on government finances. Although the full impact of the “silver tsunami” is still some years off, policymakers are already dealing with difficult financial trends.  Consider that since 1990:

• Public welfare spending has grown about 65% faster than personal income (351% compared to 212%)
• Public welfare spending has grown about 75% faster than state and local government tax collections (351% vs 198%)

It’s difficult to see how these spending trends can continue into the long-term without either serious crowding out of other areas of government spending and/or additional taxes and federal revenue.  Legislators on the human services committees are likely to experience their own version of Groundhog Day for a long time to come – continually trying to find ways to bend the cost curves down.

Explaining High Taxation and Average Spending

Perhaps the most striking finding that comes out of the Census Bureau data is the disconnect between relatively high tax revenues and relatively average spending.  How can Minnesota rank 27th in government spending when we’re 9th in total state and local government tax collections?  The answer is that taxes are only one source of state and local revenues.

The total spending numbers we report in How Does Minnesota Compare provide details on “general government” spending – essentially all government operations except for utilities, liquor stores, employee retirement (pensions), unemployment benefits and workers compensation.  In Minnesota, 58.4% of the total revenues governments use to support their general operations come from taxes.  That’s the 8th highest percentage in the nation – making us highly dependent on tax revenues to support this activity.

Governments use money from two other sources to finance general spending.  One source is the non-tax revenues that state and local governments raise – user fees/charges and interest earnings, among other things.  The other source is payments from the federal government – largely to support human service programs and delivery of educational services.  While Minnesota is a high-tax state, we are in no way, shape or form a high “non-tax” state.  Nor do we seem to be particularly adept at securing federal funds.  As Table 3 shows, state and local governments rank 31st in the nation in non-tax revenue collections, and we rank 36th when it comes to federal revenues.  Add this up, and we come out to be a fairly ordinary state with regard to financing government operations – total government collections are about 20% of statewide personal income – only 4.6% above the national average.  This broader look at finances helps explain Minnesota’s spending results.

That Minnesota should rely so heavily on taxes instead of user fees or other charges to finance government shouldn’t be particularly surprising, given our passionate pursuit of financing government in as progressive a manner as possible.  User fees, by their very nature, are designed to recoup the costs of providing whatever service a citizen or business is requesting.  It’s hard to bake progressivity into that cake.  The flip side is that it is very hard to finance higher-than-average public sector spending with lower-than-average federal support and non-tax revenues unless you are willing to take taxes to another level.  That was certainly a motivation behind the 2013 changes that will be fully reflected in next year’s Census results.

A Look Ahead: Redesigning How Does Minnesota Compare

We published our very first edition of How Does Minnesota Compare in December 1969.  It was a ten-page pamphlet that provided much of the same information readers can find in our expanded publication today.  Back then it represented significant investment of time and effort – our staff collected data from the Census and BEA materials that were mailed to the office, calculated the results by hand, typed up the publication and distributed paper copies by mail or in person.  The value-added proposition was real and substantial. 

But times have changed.  Today Census data is easily and freely available to anyone with a computer and Internet access.  Many other organizations, including the Minnesota Department of Revenue, routinely publish some or all of this information.  Moreover, other benchmarking and comparison studies we have done have offered insights into the limitations of metrics such as these but also into how we can make measures and comparisons more meaningful and useful from a policy analysis and development perspective.

For these reasons, over the next year we will be working on a new template for How Does Minnesota Compare – one that brings more substance and understanding to our national rankings and (hopefully) more value and relevance to state policy debates.  We look forward to sharing this new product with you.