Clean Up on Aisle 2021

Between the start of the session and the release of the February forecast -- when the budget goalposts are set and the session really gets cranking -- tax committee hearings serve as a time to educate, cogitate, deliberate, pontificate, but seldom legislate.   The exception is the occasional early federal conformity bill, an expedited effort to respond to the federal government’s (often end of year) tax policy decisions in hopes the Department of Revenue can make necessary changes in time for tax filers.  However, the political and budget implications of conformity are often too large, and the time constraints too great, to get a bill passed.   The result is a potential accumulating layer of these issues over time generating filing complications, delays, cost, and administrative hassle.

Something Old, Something New

The layers are thickening these days.  For starters, there is the usual inventory of temporary federal tax provisions scheduled to expire at the end of the 2020 calendar year.   Many have been reauthorized before on a temporary basis (hence their nickname “extenders”).   They are an affront to good tax policy since their uncertain staying power is antithetical to the stability and predictability a good tax system should strive for.  In many cases the primary policy purpose of temporary provisions is to make tax cuts look cheaper in the context of the federal government’s 10-year budget baseline and game federal budget rules in the process.  Temporary tax provisions were the sine qua non of the TCJA’s passage.

According to the Joint Committee on Taxation, 33 federal tax provisions were due to expire on December 31.  Most all of these provisions were minor, narrowly targeted tax cuts for very specific activities and businesses.  Many have been extended before.  True to historical form, Congress let the shot clock run down to the very end before acting on these provisions.  Their fate was part of the nearly 6000 page “Consolidated Appropriations Act, 2021” which included the latest COVID relief deal.  According to the Tax Foundation, of the 33 temporary provisions, one was allowed to expire, six were made permanent, and eleven received a five-year extension to coincide with the scheduled expiration date of the TCJA’s individual provisions in 2025 (making for a rather spirited tax debate heading into the 2024 elections).  Shorter extensions were authorized for others.

However, this megabill comprises just part of Minnesota’s current conformity decision-making landscape.  Minnesota is already tardy in addressing provisions and extenders included in the “Further Consolidated Appropriations Act” from December of 2019.  Some of the notable tax policy matters in that act dealt with permissible distributions from section 529 college savings accounts, “empowerment zone” incentives, and several tax policies to aid individuals affected by natural disasters. 

Then there are the waves of temporary policies enacted in 2020 to address the significant health impacts and recessionary fallout of the COVID pandemic.  These included substantial tax cuts in response to the recession.  Conformity decisions on these tax matters offered the prospect of much larger state fiscal impacts than the usual slate of end of year extenders.  The Families First Coronavirus Response Act and the CARES ACT included provisions affecting business deductions, charitable contributions, and early retirement distributions.  

As opposed to a “rolling conformity” state which automatically conforms to relevant provisions of new federal law, Minnesota is a “static conformity” state requiring lawmakers to adopt, modify, or reject changes.  Federal conformity offers several important benefits:[1]

• It allows state administrators and taxpayers alike to rely on federal statutes, rulings, and interpretations, which are generally more detailed and extensive than what any individual state could produce.
• It provides consistency of definitions for those filing in multiple states, and reduces duplication of effort in filing federal and state taxes.
• It permits substantial reliance on federal audits and enforcement, along with federal taxpayer data.
• It helps to curtail profiting just from differences in how activities are taxed and reduces double taxation.
• For the filer, it can make things easier by allowing the filer to copy lines directly from their federal tax forms.

The tax compliance and administration benefits are especially crucial for businesses and individuals working and operating in multiple states and for tax-related situations and calculations that span multiple filing years.  In short, although Minnesota might wish to have even greater flexibility to “go its own way” on taxation, it’s simply not realistic or practical for a state to require taxpayers to deviate too much from the federal system.  The 2020 House omnibus tax bill included an article addressing these three federal tax acts, conforming to most but not all federal changes. However, the conformity provisions were ultimately left out in the end.

A Political Problem at its Core

It’s not surprising that federal conformity decision-making often gets left by the legislative roadside.   Practically, the time crunch between federal action and state tax filing can be prohibitive.  Substantively, tax administration and compliance benefits lack sex appeal and are not the stuff to woo voters in campaign literature.   More significantly, conformity legislation is almost always revenue reducing.  It competes against other budget priorities and makes balancing the budget more difficult, especially in tough economic times like today.   Even if bipartisan consensus is that non-conformity has gone on too long and needs to be tackled, one really big conformity issue can suck up all the fiscal oxygen available for other conformity matters.  Such was the case this year as the short-term price tag of full conformity with Section 179 expensing pushed all other conformity matters off the table.

But general attitudes toward taxation and politics also play an influential role in the failure to take action on conformity matters.  We would likely see more timely action and greater prioritization of conformity efforts if offsetting rate, bracket, and other changes to pursue conformity on a revenue neutral basis would ever be considered a political option.    This is especially true for dealing with bothersome end of year minor extenders whose costs are typically low and the needed revenue adjustments would often be imperceptible.  But that is a tough sell among Republicans.  Lower taxes have become the defining tax idea of the caucus, and it is too easy to have even small revenue neutral adjustments portrayed as tax increases.   No less influential is the simple fact that better tax administration has no political home or natural advocate.   It is quintessential “good government,” and history shows a reluctance for any of the three players in budget negotiations to be willing to step up and be the one to “pay for” conformity measures in negotiations and subordinate their other tax and spending priorities. 

These factors have tended to overwhelm the ability of the Minnesota legislature to respond quickly on conformity matters.  That is true for even minor federal tax bills, like extenders, for which conformity actions have sometimes been in limbo for one or two years.  The result is an unnecessarily more complicated and expensive tax system for both government and taxpayers for no real tax policy reason.

A Modest Proposal for Modest Tax Changes

The barrage of federal tax actions in recent years have made life challenging for state tax policymakers, administrators, and taxpayers.   For big federal tax reforms and changes like the TCJA and other major tax-related actions Congress enacts to deal with special circumstances like recessions (“Great” or otherwise), there is no mechanism or short cut for the hard work required to go through provisions systematically and determine what makes sense for the state both budgetarily and administratively.   However, for the persistent congressional practice of tax extenders and the chronic disruption they cause the Department of Revenue, tax software providers, and taxpayers, a remedy exists in a bill that was introduced a few years ago and is worth revisiting today:[2]

• Pass a law that conforms to extenders on a dynamic basis – i.e., specifically listing each extender and providing that it is in effect for Minnesota purposes, if it is also in effect for federal purposes.
• Establish a provision for a standing (ongoing statutory) appropriation to a dedicated account to fund the tax cut if congressional action triggered the contingent extenders.  The account would address the resulting possibility/probability of an unfunded future tax cut and any state budget problems.  (Federal extender conformity bills have historically had a budget impacts in the $10 - $40 million range.)
• Make conformity to each of the extenders subject to administrative approval by the commissioner of Department of Revenue to make sure the account balance is adequate.
• Have the legislature specify exactly what order the commissioner would do this to prevent the commissioner’s preferences from determining which provisions went into effect if the account’s balance was too small.

The mechanics are straightforward. Legally, this would not violate Minnesota law prohibiting the delegation of legislative power to Congress.  That’s because the legislature itself would explicitly decide which provisions would apply for Minnesota tax purposes.

The problem, as often with specific conformity actions themselves, resides in the politics.  A dedicated account requires the use of scare fiscal resources, and both sides are apt to have better ideas for how such resources should be used.  The DFL could be expected to reflexively resist committing resources to ongoing tax cuts.  Moreover, the prospects of defunding an account in a time of need that is dedicated to conforming to existing tax cuts would be fraught with public relations peril.    Meanwhile, Republicans would be committing resources to funding tax cuts that already exist (if the federal government actually extends the provisions) rather than breaking new “tax cutting ground” with this money and currying favor with those beneficiaries in the process.   Passage would require a shared belief that considerable simplification of state tax administration and compliance is an important policy objective and priority investment in and of itself, and a bipartisan “truce” not to leverage the effort for political advantage.

The resource problem might be addressed by a concurrent initiative we discussed in our last issue of Fiscal Focus: bringing tax expenditures back into the budget process.   A formal, systematic review process evaluating whether tax expenditures are meeting their purpose and identifying changes that need to be made could be expected to identify opportunities that would be able to fund a relatively modest standing appropriation.    Any revenue from implementing tax expenditure review findings could be dedicated to reducing filing complications, delays, cost, and headaches for taxpayers — a “twofer” for good state tax policy. 

Current conformity challenges are a byproduct some very unusual circumstances combined with congressional dysfunction and Minnesota inattention.    The first will go away, the second won’t, and the third is in lawmakers’ own hands.  It remains to be seen to what extent elected officials will consider tax administration and compliance problems stemming from lack of conformity to be important enough to commit budget and political resources to address them.