2013 Tax Bill: Progress on Revenue, Tax Fairness
Yesterday—after nearly five months of proposing, debating, deliberating, and compromising—the House and Senate passed the 2013 omnibus tax bill. While certainly not perfect, the tax bill made real strides toward revenue adequacy, budget stability, and tax fairness.
The centerpiece of the 2013 omnibus tax bill is the new fourth tier income tax bracket, which will affect the top two percent of Minnesota income tax filers by income. After intense deliberations last week, House and Senate tax negotiators ultimately settled on the income tax plan proposed by Governor Dayton, which would increase the income tax rate from 7.85% to 9.85% on the portion of taxable income in excess of $250,000 for married joint filters, $200,000 for heads of households, and $150,000 for single filers. Income above these levels constitutes the new “fourth tier.”
The income tax provisions of the 2013 tax bill—including the new fourth tier and other changes and interactions—are projected to generate an additional $1.14 billion in FY 2014-15 and $1.12 billion in FY 2016-17 and comprise just over half of the total new revenue in the bill.
The tax bill also closes several corporate tax loopholes. Major revenue raisers in this category include repeal of the foreign source royalty deduction and foreign operating corporation provisions, which alone are projected to generate $233 million in FY 2014-15 and $192 million in FY 2016-17. In addition, the bill will count all Minnesota sales of a unitary business group in the apportionment factor for determining the portion of corporate income that is taxable in Minnesota. The bill will also the repeal real estate investment trust dividend deduction and make the research & development credit “non-refundable” so that a business cannot receive a credit that is greater than its entire corporate tax liability.
Combined with increases in the corporate minimum fee (which has not been adjusted for inflation since 1990), the loophole closing and other provisions in the corporate section of the bill are projected to generate $424 million in FY 2014-15 and $331 million in FY 2016-17.
The omnibus tax bill includes a sales tax exemption for counties and cities beginning in 2014. This exemption will reduce county and city expenses and help to hold down property taxes. In addition, the bill will convert the capital equipment refund for businesses into an upfront exemption, thereby reducing administrative hassles and the need to apply for a refund. The repeal of the capital equipment refund in favor of an upfront exemption has been a bi-partisan tax reform goal for several years.
The bill will also extend the sales tax to several business services, although the list of business services affected is minimal in comparison to what was in the Governor’s original budget from last January. Among the business services that would become taxable in the tax bill are warehousing and storage services and electronic and commercial equipment repair and maintenance. In addition, purchases made over the internet through companies with Minnesota affiliates would be subject to the state sales tax. This provision, referred to as “affiliate nexus,” eliminates a competitive disadvantage between main street businesses—which must collect a tax on their sales—and on-line retailers with a Minnesota presence—which frequently do not collect taxes on similar sales.
While the sales tax changes in the bill are significant, the revenue increases in the bill resulting from the sales tax base expansion is largely offset by the tax reductions resulting from the county and city sales tax exemption and the upfront capital equipment exemption. In aggregate, the sales tax provisions in the omnibus tax bill result in a projected net state revenue gain of just $59 million in FY 2014-15 and $83 million in FY 2016-17.
Another significant revenue raiser in the bill is the $1.60 per pack cigarette tax increase, along with the decision to apply the cigarette tax to “little cigars.” These policies have the twin advantages of generating revenue for the state while also deterring tobacco consumption, particularly among price sensitive teens. The total revenue increase resulting from tobacco product tax increases is projected to be $408 million in FY 2014-15 and $439 million in FY 2016-17.
The tax bill will also close loopholes pertaining to estate and gift taxes, thereby generating a projected $78 million in FY 2014-15 and $128 million in FY 2016-17. The estate tax primarily affects only estates of considerable size and value, which is why it is the single most progressive tax in Minnesota. While the revenue generated through the estate tax changes in the omnibus tax bill comprise a relatively small share of the total new revenue generated, they nonetheless have a discernible impact in reducing the regressivity of the overall state and local tax system.
In aggregate, the tax bill will generate a projected $2.12 billion in new state revenue in FY 2014-15 and $2.12 billion in FY 2016-17. However, a significant portion of these dollars will be returned to taxpayers in the form of property tax relief through a sizable expansion in the homeowners’ and renters’ property tax refund (PTR), increases in city Local Government Aid and County Program Aid, and school property tax relief. In total, the omnibus tax bill increases property tax aids, credits, and refunds by a projected $411 million in FY 2014-15 and $760 million FY 2016-17.
The omnibus tax bill not only increases funding for property tax relief programs that have been repeatedly slashed over the last decade, but also restores funding for critical public investments in K-12 education, higher education, public safety, and public infrastructure. Furthermore, revenue in the tax bill will make new public investments possible. For example, the omnibus education finance bill will provide dollars for statewide all-day Kindergarten and early childhood education—both policies that will produce an excellent long-term return-on-investment for the state.
The omnibus tax bill will also balance the state budget in the upcoming biennium in a fiscally responsible way. The budget FY 2014-15 budget will be balanced without the use of K-12 funding shifts or by selling off future state revenue streams for the sake of an upfront one-time cash infusion,* as was the case in the last biennial budget set during the 2011 special session. The 2013 tax bill marks the return of responsible fiscal tax policy to Minnesota.
Finally, the 2013 omnibus tax bill will make Minnesota’s state and local tax system less regressive. While the cigarette tax increase and the corporate tax increases in the bill are regressive,† these will be more than offset through the powerfully progressive fourth tier income tax increase and the estate tax increase, as well as through the reduction in regressive property taxes. The homeowners’ and renters’ PTR increases are targeted to low- and middle-income taxpayers and are particularly effective in reducing tax regressivity.
The 2013 omnibus tax bill will be signed into law shortly by the Governor, marking the fulfillment of promises made by Dayton and other progressives to increase revenue adequacy, improve budget stability, and increase tax fairness in Minnesota. However, the work of improving Minnesota’s tax and budget system is not over. More on this tomorrow.
*Specifically, legislation passed during the 2011 special session sold future state tobacco settlement revenue for the sake of $643 million in one-time upfront cash, which was used to balance the FY 2012-13 budget.
†While corporate income taxes are generally regressive, a large share of corporate income taxes are shifted outside of Minnesota and thus have no impact on tax regressivity within Minnesota.