Lessons from 60 Years of State Tax Commissions

This article from the March-April 2012 edition of Fiscal Focus looks at 60 years of state tax commission studies and explores how thinking about tax policy principles related to the unique circumstances and concerns of the different eras.

As the 2012 legislative session grinds to its conclusion, groundwork is already being laid for a 2013 session that promises to be of considerable interest to tax policy watchers. Revenue Commissioner Myron Frans has been on a barnstorming tour across the state to talk about Minnesota’s tax system and collect suggestions on how to make it fairer, simpler, and more supportive of economic growth. The department will compile this information and present a draft tax reform proposal to Governor Dayton this fall. The Governor will present his final tax reform recommendations to the 2013 Legislature.

Governor Dayton is not alone in wading into the waters of tax reform. Hot on the heels of the Pawlenty 21st Century Tax Reform Commission, a proposal to create a new “tax reform action commission” was included in this year’s omnibus House tax bill. (The “action” descriptor is purposeful – the commission would be charged with developing bipartisan recommendations that are politically achievable, not just conceptually and theoretically appealing).

With this flurry of activity in mind, the always – helpful Minnesota Legislative Reference Library has made several state tax commission reports available on-line 1 . It’s an interesting walk through history to see how thinking about tax policy principles meshed with the unique circumstances and concerns of the eras in which the recommendations were developed. Even though the design and features of past tax systems are often unrecognizable today, many of the themes and conclusions behind the recommendations merit as much consideration in 2013 as they did decades ago.

Property Taxes and the State/Local Relationship

Back when the state income tax was largely a school funding mechanism and the state sales tax was just a twinkle in the eye of some policy makers, tax reform meant property tax reform. Both the 1954 and 1962 commissions focused heavily on the need to establish a uniform system of property tax administration to address equity issues and create a “healthy” property tax system. The property tax’s abiding role as the cornerstone of local finance was confirmed in the 1962 tax commission recommendation stating, “in the long run local governments are better off if they levy taxes according to their needs instead of looking to the state for grants – a practice which usually results in the state directing how expenditures shall be made.” The 1954 and 1962 commissions both found wisdom in leaving this source of revenue to local governments.

Attitudes evolved as a boomer population coming of age and an extraordinary period of urbanization created an exploding demand for public services in Minnesota. The result was relentless pressure on the property tax and resulting calls for revenue diversification and state revenue sharing culminating with the Minnesota Miracle. By the time the Minnesota Tax Study Commission (a.k.a. “Latimer Commission”) convened in 1983, Minnesota had over a decade of experience with the promises and pitfalls of this increasingly complicated state/local fiscal relationship.

While confirming the intent and goals of the Miracle, the Latimer Commission found “the manner in which recent legislatures have attempted to make this philosophy operational has frustrated the very goals of tax relief and explicitness that were originally envisioned.” The commission noted that the system of property taxation and intergovernmental aids as currently constituted was “unnecessarily complex and cumbersome” resulting in diminished taxpayer confidence that “poses a serious concern in a democracy.” The commission found that the system had become so complex taxpayers were reluctant to participate in their local council hearings on tax matters (a reaction that many local officials choose to interpret today as either taxpayer satisfaction or indifference).

The result was a system “controlled by technicians, not taxpayers” which “actually results in higher net property tax burdens over time…by stimulating local spending to levels significantly higher than would otherwise occur.” Recommendations included significant reductions in property tax classifications and major consolidation of tax credit and aid programs.

The state has made many changes to the property tax system and the system of aids and credits since then to address these concerns, but few would argue that lasting progress has been made on the issues the Latimer Commission flagged. Instead, it appears that heading into 2013 we have merely cycled back to the late 60s with citizens and policy makers expressing concerns about system imbalance due to increasing reliance on property taxation and calling for new revenue to address this issue.

Are we really back to the future? The problem with the structural imbalance argument is that such imbalance is exactly what should be expected – even welcomed – in a recessionary period. As volatile sales and income taxes decline, the much more stable property tax will by its very nature pick up tax share, providing sorely needed stability to the fiscal system. It’s ironic that the property tax is so frequently publically criticized for the very characteristic that public finance experts find so valuable and indispensible.

Table 1

Minnesota Tax Collection Rankings, FY 2009

Tax Type Per Capita Per $1,000 of Income
Individual Income Tax (State and Local) 7 6
Corporate Income Tax (S & L) 11 17
Property Tax (S & L) 21 27
Property Tax (Local only) 24 32
Sales Tax (S & L, including motor vehicles) 24 29
Total Taxes (S & L) 13 14
Table 1: Source
  • MTA, How Does Minnesota Compare? November 2011 and Minnesota Department of Revenue

Moreover, whereas Minnesota’s property tax burdens in the 50’s and 60’s were really among the highest in the country, the same certainly cannot be said today. At least certainly not for voters. As the accompanying table shows, Minnesota ranks a relatively modest 21st nationally on property tax collections per capita and 27th on a per $1,000 income basis. If only local property taxes are considered (removing state levies) Minnesota ranks 24th per capita (32nd on a per $1,000 income basis). The Department of Revenue’s Voss Study database confirms increasing but still eminently affordable homeowner property tax burdens around the state in both absolute and relative terms.

Shifting more of the responsibility for funding public services onto income taxes, which already rank much higher, should give some pause; even excluding the accountability issues routinely flagged in historical tax commission reports. Sales tax rankings suggest more “headroom” to maneuver but statewide rates are already among the nation’s highest and so new revenues would have to come through some politically difficult base broadening. Unlike in decades past, where “new” revenue windows needed simply to be opened, today’s reforms would need to open revenue windows even further – an equally challenging exercise.

Over 60 years, specific tactics and strategies recommended by tax reform commissions have changed but key property tax-related themes abide: making it a local tax, linking it to truly local decision-making, dramatically simplifying the system, and developing a comprehensive aids and credits program from the perspective of a statewide system rather than in a piecemeal fashion. The issue of non-property tax support for local governments is ripe for careful review, but the problems associated with continuing to condition Minnesotans to expect local government services below reasonable and real local cost is no less critical.

Taxes and Economic Development

The relationship between jobs and taxes has been front and center during the 2012 legislative session. Over the years, state tax reform commissions have had something to say about this issue. The most substantive contribution came in 1985 which featured a high profile commissioned study on this topic. The findings made major waves not just in Minnesota but in national public finance circles for years to come. 2

The study examined employment growth in six different general industry classes: manufacturing, transportation, services, wholesale trade, retail trade, and finance/insurance/real estate. The researchers developed an econometric model to test the relationship between location and employment trends in these industries and a host of potential explanatory variables. Tested factors included fiscal variables (including tax features), labor variables, weather, energy prices, and relationships with other businesses.

For the six industries as a whole, higher wages, energy prices, and higher percentage increase in tax effort had a negative and statistically significant effect on percent change in employment. Conversely, higher spending on education as a proportion of income had a positive and statistically significant relationship. Notably, findings did vary by type of industry supporting the idea that there is industry-level variation in the significance of factors in location decisions.

With respect to taxes, the study concluded that overall tax burden trends had a negative and statistically significant effect in the manufacturing, retail trade and service industries, while the individual income tax had a negative and statistically significant employment effect on wholesale trade, retail trade, and financial/insurance/real estate industries. Interestingly, nether the statutory or effective corporate income tax rate demonstrated significant employment impacts. The researchers concluded that “Minnesota employment growth would benefit from a reduction in personal income tax rates” and that a more diverse state-local tax structure could have resulted in more job growth. Specifically, “Minnesota’s employment growth would have been stronger during this period [1973-1980] if it had shifted from income taxation to more reliance on the sales tax.”

The caveat for all these findings, of course, is that Minnesota and the world are extremely different today than they were in the late 1970s or early 1980s. Since 1985, many studies have attempted to replicate this analysis, yielding very ambiguous results. Even one of this study’s initial reviewers has “rethought” its findings noting that while all the attention was given to the eight tax variables demonstrating significance, twenty others failed relationship tests.

However in the new global economy, a shift toward consumption-based taxes as recommended in 1985 (over income-based taxes) is still seen as a smart thing to do. Such a recommendation was the centerpiece of the most recent study effort – the 21st Century tax reform commission. Concerns over increased tax regressivity from such policy have been expressed for decades. Ideas to address this concern are just as old. The most familiar approach – a tax credit on income – is an idea actually traceable to the 1956 Governor’s Tax Study Committee.

Perhaps an even more important lesson is the 1985 finding that higher education spending relative to income is one of the most important factors influencing employment growth. Frequently lost in the debate about tax levels/increases/cuts is the concept that how government spends its resources is just as, if not more, important than the level of collections. It’s a critical lesson as pressure amounts to redirect ever-increasing amounts of tax resources away from improving the productive capacity of Minnesota’s economy and toward social welfare programs like elderly care.

Tax Progressivity

It should come as no surprise that “ability to pay” has always been an important principle behind the work of Minnesota’s tax study commissions. It’s an idea that has seemed to grow stronger over the years. While acknowledging ability to pay concerns, the 1951 report of the Minnesota Interim Committee on Tax Research was also keenly interested in ensuring every citizen, regardless of economic circumstance, had a financial stake in government. That committee noted, “the power to tax is the power to destroy” and “taxation must be levied primarily and principally for the purpose of supporting constitutional government services, neither to favor one group at the expense of another.” By 1985, times had changed and a guiding principle for reform recommendations was “within limits dictated by economic reality, Minnesota’s tax burden should be distributed according to ability to pay.”

The problem with progressivity is that “no precise policy prescriptions can be made solely on the basis of economic reasoning.” Such was the conclusion of a paper prepared for the 1985 tax study commission by a 33-year-old Joel Slemrod, now one of the nation’s most distinguished tax policy academics. 3

Instead the paper lays out relevant issues that deserved consideration in 1985 (and still do today):

  • “Fairness” concerns and values aside, there are valid public policy reasons for a state to pursue progressivity in its tax system; for example to support horizontal equity objectives where significant regional differences exist in living costs and other amenities.
  • The system of federal deductibility of state taxes provides a strong financial incentive to retain progressivity in state income taxation.
  • Evidence supporting out-migration due to higher individual income taxes is not robust. However, wage effects (higher wages demanded by higher tax rates) may have implications for firm location decisions (as noted in the Latimer economic development study).

The result is a judgment call for policy makers attempting to strike a balance between allocating the burden fairly and minimizing the disincentive effects. This conclusion is understandable if not particularly satisfying.

But it’s important to recognize that Minnesota already ranks among the most progressive income tax systems in the nation. Moreover, it is only when the incidence of taxes on businesses are assigned to individuals and added to the overall tax burden that Minnesota’s revenue system becomes notably regressive. In addition, as important as this concept is, others like simplicity of administration, stability, and transparency are more crucial to the quality and reliability of public finance systems. Placing too much emphasis on politically popular principles to the exclusion of others may have harmful long term repercussions for budgets and revenue systems – just ask Californians.

The most important lesson 60 years of tax commissions may provide is that the tax principles the public find least interesting are often the most relevant to sound public finance.

  • 1 1985 Minnesota Tax Study Commission, 1962 Governors State Tax Study Committee, 1954 Minnesota Tax Study Commission, 1951 Report of the Interim Committee on Tax Research
  • 2 Michael Wayslenko, “The Effect of Business Climate on Employment Growth” Final Report of the 1985 Minnesota Tax Study Commission.
  • 3 “The Optimal Progressivity of the Minnesota Tax System: A Presentation and Analysis of the Important Issues” Background Paper for the Minnesota Tax Study Commission, October 10, 1984.