The Dubious Historical Relationship Between the "Miracle" and State Tax Policy

From our January-February 2016 edition of Fiscal Focus.

Ask policy observers when the Miracle derailed and many would point to the across-the-board income tax rate cuts of the Ventura Administration.  The rate cuts reduced the revenue raising capacity of Minnesota’s individual income tax by about 10% and certainly affected the state’s ability to support local governments and commit to property tax buy-downs going forward.  But ever since the Miracle was established, the state has struggled mightily with securing enough general fund revenue to keep the Miracle’s engine running – and employing a lot of questionable tax policy in the process.

When the Miracle was enacted, the state income tax featured 11 income brackets, some of which were $500 wide.  In 1977, to further prime the Miracle pump, policymakers created two additional top brackets, bringing the total to 13.  No less crucially, throughout the 1970s income brackets were not indexed to inflation resulting in bracket creep on steroids.  During the early Miracle years (1971-1983), consumer inflation averaged 7.8% per year, hitting double digits in three of those years.  As wages and income grew to keep up with inflation, taxpayers could jump two tax brackets – with major tax implications – with average increases in income.

The adoption of tax bracket indexing in 1979 fulfilled a campaign promise by Governor Al Quie, who objected to cost of living increases pushing families into higher tax brackets.  But to illustrate the political grip the Miracle had on Minnesota, Governor Quie was forced to agree to big increases in state aid to local governments and another bump in the homestead property tax credit just to achieve this most basic and simple improvement in tax fairness.

What was the result?   To quote Red from The Shawshank Redemption, “oh my Lord how the money rolled in.”  From 1973-1984, individual income tax collections per capita increased from $150 to $557 – nearly tripling in just over a decade.  A new political problem emerged: these policies propelled even average Minnesotans to the top of the nation in income tax burdens.  Public grumbling now shifted to income taxation.  Noting that having the top national income tax ranking for married couples with one wage earner at so many income levels was simply not competitive or acceptable, Governor Rudy Perpich successfully pushed for lowering income tax rates, reducing the number of brackets, and making other structural modifications.  However, these policy changes disrupted the major fuel line for the Miracle.

By the late 80s, with income taxes reformed and inflation largely in check, the continuation of state property tax buy-downs became much more difficult.  How then could policymakers continue to deliver on the Miracle’s promises?  The answer was to shift the burden to business by jiggering the state’s property tax classification system.

From 1985 to 1990, effective residential property tax rates increased 3.5% while effective commercial/industrial rates increased 26.7%.  By 1993, business property owners were paying well over 4 times the property tax per dollar of value than homeowners were.  Unsurprisingly, it was now business property taxation’s turn to assume the mantle of being number one in the nation with a bullet.  But just with income taxes a decade earlier, concerns over competitiveness implications and the lack of local accountability resulted in calls for reform.

Over the next decade the state compressed classification rates – assisted hugely by the booming general fund revenues of the dot com era.  These unique economic circumstances made both class rate compression and the continuation of the Miracle-based buydown of local property taxes politically possible.

So while the tax cuts of 1999 and 2000 didn’t do the Miracle any favors, finding enough money to keep homeowners happy has really been a 45-year challenge.  Over that period, the practice of the Miracle vividly demonstrates perhaps the most fundamental and important economic lesson of all:  there is no such thing as a free lunch.