For over a decade, the tax policy coming from the State Capitol has been giving rural and middle class Minnesotans the short end of the stick. New reforms proposed by Governor Dayton take a big step toward reversing these trends while also restoring fiscal sanity to the state budget. Taken as a whole, Dayton’s proposed reforms will increase tax fairness, adequately fund critical public investments, and solve the state’s budget deficit without shifts or accounting gimmicks.
True to recent public pronouncements, the Governor proposed a “fourth tier” income tax rate. The wealthiest two percent of Minnesotans will see a 2% tax rate increase on income in excess of $250,000 for married joint filers, $200,000 for heads of households, and $150,000 for single filers. This is the single most powerful element in the Dayton tax proposal in terms of reducing the regressivity of Minnesota’s tax system.
Currently, the wealthiest two percent of Minnesota households pay 20% less in state and local taxes per dollar of income than do middle-income households. After the Governor’s proposed income tax increase (in isolation from all other proposed changes), the wealthiest two percent will be paying about 8% less—definitely a major leap in the direction of tax fairness. At the same time, the fourth tier income tax increase will generate $1.1 billion in badly needed revenue.
The Governor’s proposal both expands the corporate income tax base while reducing the corporate income tax rate. The base broadening is accomplished by eliminating several inefficient tax preferences that were doing little to create new jobs and new economic activity, including foreign operating corporation (FOC) provisions. He also proposes adopting an “economic substance test,” which would require that corporate transactions have a legitimate business purpose other than tax avoidance.
The expansion of the corporate income tax base will be offset by a significant reduction in the corporate income tax rate from 9.8% to 8.4%, reducing the state corporate income tax rate rank from the 4th highest in the nation to 12th highest. Dayton’s corporate income tax reforms will level the playing field among businesses.
The Governor lowers the sales tax rate and broadens the sales tax base by eliminating many current exemptions, including the following.
• Selected consumer goods and services, including clothing items over $100, over-the-counter drugs, digital goods, repair services (including auto repair), personal care and instruction services, and legal and accounting services.
• Selected business services, including legal, accounting, computer, advertising, architecture, employment, specialized design, management consulting, and business support services.
• Goods sold over the internet through Minnesota-based affiliates.
To offset the broader base the sales tax rate will fall from 6.875% to 5.5%, thereby reducing Minnesota’s sales tax rank from 7th highest in the nation to 27th. As a result of this rate reduction, the tax on goods that are already taxable under current law—items ranging from school supplies and shampoo to hockey sticks and hula hoops—will fall by 20%. The Dayton sales tax proposal will generate a net revenue increase of $2.1 billion in the FY 2014-15 biennium.
Page 2 of 2 - Property tax relief has been a priority for rural communities in recent years and Dayton’s budget provides it through a direct $500 property tax rebate to all homeowners in 2014. In addition, the Dayton budget provides for an annual $80 million (19%) increase in city Local Government Aid and an annual $40 million (24%) increase County Program Aid that partially replaces cuts to these two programs over the previous decade. Dayton’s budget will result in an aggregate statewide property tax reduction of nearly 10%.
The $2 billion generated by Governor Dayton’s tax plan will be sufficient to close the FY 2014-15 structural deficit of $1.1 billion while also providing revenue to fund investments in K-12 and higher education and other areas that have been allowed to languish over the last decade.
The Dayton tax proposal is not perfect, but all things considered, it is the most comprehensive and thoughtful reform initiative since the turn of the century and represents a major move forward in terms of promoting tax fairness, revenue adequacy, and budget stability.
Jeff Van Wychen is the Director of Tax Policy and Analysis at Minnesota 2020.