Is the Dayton Tax Proposal Progressive?
Conservative State Senator Julianne Ortman recently complained that the Dayton budget “raises taxes on the poorest of the poor.” Later that same day during the House Tax Committee meeting and using nearly identical words, Representative Greg Davids (R-Preston) bemoaned “massive tax increases on the poorest of the poor.”
Meanwhile, during both meetings, officials from the Minnesota Department of Revenue (DOR) contended that the Dayton tax proposal would help to make Minnesota’s state and local tax system less regressive—that is to say, it would reduce the share of total Minnesota taxes borne by low and middle income households and increase the share borne by upper income households.
Who is right?
Ortman and Davids are correct that some of the tax increases in the Dayton proposal are regressive. For example, the expansion of the sales tax base—even after the 20 percent reduction in the sales tax rate—will lead to a $2.1 billion increase in regressive sales taxes during the FY 2014-15 biennium.* Furthermore, the Governor’s proposal would increase regressive cigarette taxes by $370 million.
On the other hand, the Governor’s proposal will increase progressive income taxes by $1.1 billion in FY 2014-15 and will reduce regressive property taxes by $1.5 billion. Both of these changes will make Minnesota’s state and local tax system less regressive. So the question is: how do we balance the regressive features of the Dayton tax plan against the progressive features to determine the net impact on tax incidence?
Economists measure the regressivity or progressivity of a tax using a statistical measure known as the Suits index. A Suits index of +1.0 indicates a tax that is perfectly progressive, while an index on -1.0 indicates a tax that is perfectly regressive. A Suits index can be calculated for individual taxes, for a combination of taxes, or for an entire tax system.
The following analysis will be based on admittedly crude Suits approximations. However, these approximations should be sufficient to answer the question as to whether the Dayton tax plan is making the state’s tax system more or less regressive.
According to the 2011 Minnesota Tax Incidence Study (MTIS), the sales tax is significantly regressive, with a Suits index of -0.242. However, not all sales taxes are paid by Minnesota residents. About 21 percent of sales taxes are “exported” out of the state (i.e., paid by non-resident consumers and businesses).‡ Only the portion of the sales tax paid by resident Minnesota consumers and businesses matter in terms of calculating the overall Minnesota tax incidence. Based on tax export information from the 2011 MTIS, this analysis assumes that $1.65 billion of the Dayton sales tax increase will be borne by Minnesotans.
The tax on cigarette and tobacco products is even more regressive, with a Suits index of -0.582 according to the 2011 MTIS. Only about 5 percent of these taxes are exported based on the 2011 MTIS, so for the purposes of this analysis, it is assumed that $352 million of Dayton’s $370 million cigarette and tobacco tax increase will be borne by Minnesota residents.
Because Dayton’s proposed income tax increase will be paid entirely by the wealthiest two percent of Minnesota households, its overall tax incidence will be massively progressive. This analysis assumes that the Suits index associated with Dayton’s fourth tier income tax proposal is +0.8 (an estimate arrived at using unpublished Department of Revenue data) and that $1.0 billion of the $1.1 billion tax increase from that proposal will be borne by Minnesota residents.†
Nearly all of the property tax relief in the Dayton tax plan will accrue to homeowners through the maximum $500 rebate, although a small portion will accrue to businesses through the state business property tax freeze. By weighting data from the 2011 MTIS, we anticipate that the Dayton proposal will eliminate property taxes that will have an aggregate Suits index of -0.196. Furthermore, because nearly all of the property tax relief under the Dayton proposal accrues to homeowners—who are by definition Minnesota residents—only a small portion of this property tax relief will be exported; of the $1.464 billion of property tax relief in the Dayton proposal (excluding relief from the Local Government Aid and County Program Aid increases), this analysis assumes that $1.45 billion will go to resident Minnesota taxpayers in FY 2014-15.
The graph below attempts to illustrate the above information. The height of each bar represents the approximate Suits index of each of the respective tax changes in the Dayton proposal, with progressive changes shown above the horizontal axis and regressive changes shown below. The width of each bar illustrates the dollars of tax relief or tax increase accruing to resident taxpayers associated with each change. (Each tick mark represents $50 million.) By comparing the areas of the bars above the horizontal axis (progressive changes) to the areas of the bars below (regressive changes), we can get a rough idea of the overall impact of the Dayton tax plan on the regressivity of Minnesota’s tax system.
The approximate nature of the above information needs to be emphasized. This analysis applies 2008 tax data from the 2011 MTIS to a proposal that will not be implemented until the FY 2014-15 biennium. In addition, ideally the Suits indices and the export percentages from the 2011 MTIS ideally should not be applied to marginal changes in a tax, yet that approach is used here simply because there is not a better alternative at this time. The above analysis is by no means a substitute for a comprehensive tax incidence analysis of the Dayton proposal from DOR.
Nonetheless, even with its shortcomings, the information in the graph can provide a preliminary indication of the impact of the Dayton tax changes upon the degree of tax regressivity in Minnesota. The area of the bars representing the progressive tax changes in the Dayton tax proposal are nearly twice as large as the areas represented by the regressive changes. Even with the imprecision inherent in this analysis, these findings reveal that there can be no doubt that the Dayton tax proposal will reduce the overall level of regressivity of Minnesota’s state and local tax system.
Staunch proponents of tax fairness may question why Governor Dayton included any regressive tax changes in his budget. The answer is that reduction in tax regressivity is only one of several goals that responsible tax reform should recognize. In addition to reducing tax regressivity, the Dayton proposal also seeks to make the tax system more stable by broadening the sales tax base and more modern by extending the sales tax base to include the fastest growing segment of consumer purchases: services.
In addition, the Dayton budget seeks to reduce cigarette usage among price-sensitive teens by increasing the admittedly regressive sales tax. Furthermore, legitimate concerns about volatility in tax revenue put practical limits on the extent to which the state can depend on the progressive but relatively unpredictable income tax.
While reasonable people can debate the extent to which the Dayton proposal maximizes other objectives, there can be no doubt that it would increase the fairness of Minnesota’s state and local tax system by reducing the degree of regressivity. While nearly all state policymakers pay lip service to the goal of increasing tax fairness, the Dayton budget does something about it.
*The Minnesota Department of Revenue points out that the sales tax borne by the typical consumer will not increase under the Dayton plan, because the expansion of the sales tax base to goods and services that were previously untaxed will be offset by the reduction in the sales tax rate that will be applied to all previously taxable and newly taxable goods and services. Thus, the entire $2.1 billion in additional revenue is apparently being generated from the expansion of the sales tax to various business services.
‡Insofar as the incidence of taxes paid by businesses are more likely to be exported out of state, the portion of the Dayton sales tax increase that is exported could be significantly greater than 21 percent because nearly all of the net increase in sales tax is likely to be borne by businesses. (See the first footnote above.) However, so as to not overstate the progressivity of the Dayton tax changes, this analysis will assume a sales tax export percentage of 21 percent.
†According to the 2011 MTIS, 4 percent of the state income tax is exported. However, for purposes of this analysis, it is assumed that 9 percent of the tax increase resulting from the Dayton tax increase will be exported. This was done based on the supposition that exporting of income taxes would be more prevalent among high income households, which are the focus of the Dayton fourth tier proposal. In addition, the 9 percent assumption was used so as to not overstate the progressive impact of the fourth tier proposal.