Is Simple Tax Reform Possible?
Last summer, U.S. Senate Finance Committee Chair Max Baucus and U.S. House Ways and Means Committee Chair Dave Camp began touring the nation—including a stop in the Twin Cities—in a bi-partisan attempt to jump-start federal tax reform.
The complexity and sheer size of the federal tax system is not only daunting, but a drag on the national economy, the chairmen conclude. The “complexity in the [federal tax] code is eroding confidence in our economy and creating uncertainty for America’s families and businesses.”
Complexity is not only a problem at the federal level. Minnesota’s income, property, and sales tax systems are riddled with exclusions, exemptions, credits, and various other special provisions that not only make the state tax code more complicated, but also undermine the goals of tax efficiency and transparency. In the build-up to the 2013 legislative session, Revenue Commissioner Myron Frans toured the state making the case for tax reform; one of the slides from Frans’ presentation notes that the number of adjustments used to calculate Minnesota’s individual income tax had increased from nine in 1987 to fifty by 2010.
The tax act enacted during the 2013 legislative session made progress in generating adequate revenue to fund state services and in reducing the regressivity of Minnesota’s tax system. However, only modest progress was made in simplifying Minnesota’s tax code. True, the 2013 tax act did eliminate some inefficient and unnecessary corporate tax breaks, such as the exclusion for foreign royalties, special rules for foreign operating corporations, and real estate investment trust dividend deduction. However, most of the heavy lifting in terms of tax simplification remains ahead of us.
In recent years, discussion of tax simplification has focused on the need to reduce “tax expenditures”—special statutory provisions such as exemptions, deductions, credits, and special tax rates—that provide preferential tax treatment for some taxpayers and thereby reduce the amount of revenue that would otherwise be generated. For the most part, the income tax deductions, subtractions, and credits listed in the above figure qualify as tax expenditures. Tax expenditures are designed to increase employment, stimulate desirable investments, reduce taxes for some taxpayers in response to concerns regarding equity or fairness, or accomplish some other public good. However, while all tax expenditures add complexity to the tax system, not all are equally successful in achieving their stated public benefit.
An example of a tax expenditure that may be ripe for revision is the home mortgage interest deduction. This deduction is estimated to reduce state revenue by approximately $670 million a biennium, but its efficacy in promoting its stated goal of increasing homeownership is questionable. According to the Center on Budget and Policy Priorities, the home mortgage interest deduction “appears to do little to achieve the goal of expanding homeownership. The main reason is that the bulk of its benefits go to higher-income households who generally could afford a home without assistance…”
The tricky part of tax simplification will be in identifying the tax expenditures that are worthwhile and those that are not. In making this determination, policymakers have access to two excellent resources. The first of these is the Minnesota Tax Expenditure Budget—published in every even-numbered year by the Department of Revenue*—which quantifies the fiscal impact on a wide array of tax expenditures. The second is “A Review of Selected Tax Expenditures” prepared by non-partisan staff of the Minnesota House of Representatives,† which provides a review of the available literature as to whether various tax expenditures are successful in achieving their stated goals as well as information on the regressivity/progressivity of various tax expenditures.
The elimination of tax expenditures will allow the state to increase the size of its income and sales tax bases, which in turn will allow the state to lower tax rates while generating the same amount of revenue. This, of course, assumes that tax simplification efforts will be revenue neutral—in other words, resulting in no net increase in state taxes. Revenue neutral tax simplification will result in tax reductions for many taxpayers (due to reduced tax rates) and a tax increase for others (due to the loss of preferential tax expenditures). However, assuming that tax simplification successfully eliminated those tax expenditures that were unjustified, the net result should be a more equitable distribution of state taxes.
So what are the prospects for tax simplification in Minnesota over the next two years? The fact that the legislature achieved a significant increase in real per capita state revenue during the 2013 session—successfully restoring approximately one-third of real per capita state general fund spending cuts over the last decade—will make it easier for progressives to agree to tax simplification that does not increase state revenue. If the tea party wing of the legislature can set aside its proclivity to cut state revenue, the prospects for revenue neutral tax simplification will brighten.
However, as noted above, revenue neutral tax simplification will invariably lead to tax increases for some and tax reductions for others. This leaves the door open to opportunistic political attacks, as opponents of simplification—or perhaps more accurately, opponents of those who proposed the simplification—can highlight the tax increases, ignoring the tax reductions and the overall merits of a simplified tax system. This could be an appealing strategy, insofar as negative news (i.e., the tax increases) often carries more traction in a political campaign than positive news (i.e., the tax reductions).
Regardless of which party controls state government, the prospects for revenue neutral tax simplification will further brighten if bi-partisan accord can be achieved so that one party cannot lay blame for the resulting tax increases at the feet of the other in the next general election.
“Simple Tax Reform – Is That Possible?” will be the subject of a session at the 29th Annual Conference on Policy Analysis on October 16, sponsored by the University of Minnesota College of Continuing Education. The “Simple Tax Reform” session will be moderated by Steve Dornfeld of MinnPost and include presentations by Rep. Jim Davnie, chair of the Property and Local Tax Division of the Minnesota House, Beth Strinden Kadoun of the Minnesota Chamber of Commerce, and yours truly.
*The last Minnesota Tax Expenditure Budget (TEB) was released in February 2012 and contained data for state fiscal years 2012 through 2015. The next Minnesota TEB is scheduled to be released in February 2014.
†This report was released in 2009. An updated version is expected to be released next month.