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MN2020 - Is the Dayton Tax Proposal Progressive?
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Is the Dayton Tax Proposal Progressive?

February 05, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

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.

[ graph: click article title to view in browser ]
click to enlarge

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.
 

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6 Comments:

  • Kipling Thacker says:

    February 12, 2013 at 9:17 am

    There appears to be an error in the analysis.  The property tax has a negative Suits value and is shown as a positive in the graph.  If you graph it correctly, then the areas above the curve and below the curve are approximately equivalent, with a slight favor to regressivity.  The property tax refund is the goofiest portion of the plan.  There is already a mechanism in the income tax system to provide some property tax relief for lower income citizens.  That should be enhanced or tweeked as necessary to provide a positive Suits benefit, rather than an across the board decrease.

  • Jeff Van Wychen says:

    February 12, 2013 at 11:29 am

    Kipling:
    You are correct that the property tax has a negative Suits index.  However, the Governor is proposing to reduce property taxes; a reduction in a regressive tax has a progressive impact on the overall tax system, and thus—for purposes of this graph—the bar appears above the line because the impact of the proposed change is progressive.

    You are not the first to be critical of the Governor’s homeowner rebate proposal.  This rebate appears to be designed to replace the homestead credit, that was eliminated during the 2011 special session.  At the same time that the homestead credit was eliminated, a convoluted homestead value exclusion was inserted in its place; to make a long story short, this exclusion caused a shifting of taxes from one class of property to another and made the property tax system even more complicated than it already was.  I would be more enthusiastic about the Governor’s homeowner rebate if it was replacing the complicated value exclusion.  I would concede that having both a homeowner rebate and a homestead value exclusion could be overkill.

  • Robert Helland says:

    February 16, 2013 at 6:39 pm

    Jeff:

    Two questions:

    (#1) What are your thoughts on Minnesota’s property tax classification system? The complexity is mind-boggling starting with the 55 different property classifications each entitled to their own rate?

    There is plenty of good homeowner data to do the type of analysis you reference, but few people are aware of this aspect of Minnesota’s property tax system:

    Tax rates (i.e. Net Tax Capacity rate) have effect on a “classified” value:

    Residential Homestead
    The $500,000 is classified at a 1.00% property class rate for tax purposes.
    The amount greater than $500,000 is classified at a 1.25% rate.

    Business Property
    The first $150,000 is classified at a 1.50% rate.
    The amount over $150,000 is classified at a 2.00% rate.

    Apartments
    There is no threshold, they are classified at a 1.25% rate.

    Is this not, by class, saying that (a) non-homeowner renters feel property tax effectively some 25% higher than homesteaded counterparts and businesses apporaching 100% percent higher burdens, effectively?

    (#2) Take a look at page 14 of the sales tax explanation handout being used currently by the Datyon Administration: http://www.revenue.state.mn.us/tax_reform/Documents/SalesTaxBooklet Feb2013.pdf

    It says “you save $1.37”. Does anybody realistically think that consumer, retail prices will not be increased with the addition of $2.0B+ in business-to-business services?

    By my math, using these numbers, a 0.95% increase in prices as a result of the added 5.5% (not to mention local rates in major cities and the metro AND new compliance costs) would completely wipe away any saving. That, and all the additional service taxes households would now be paying? (and services are 67% of the consumer spending, according to the DOR handout!)

    ~Bob
    .(JavaScript must be enabled to view this email address)

  • Robert Helland says:

    February 17, 2013 at 1:33 pm

    I guess you kind of answered #1 on the thread about Renter’s and regressivity. I just finished reading the Property Tax Working group report last night. Seems like all the right moves and well-written… you can replace my question #1 with open comments on that report if you’d like. Feel free to contact me in private at .(JavaScript must be enabled to view this email address)

    ~Bob

  • Jeff Van Wychen says:

    February 17, 2013 at 8:59 pm

    You are correct that rental property taxes are generally passed on to renters.  However, many feel that a reduction in rental property taxes will be pocketed by property owners, rather than passed along to renters in the form of reduced rent.  That is why the income sensitive renters’ property tax refund may be a better way to ensure that tax relief gets into the hands of low-income renters.

    Regarding business property, you correctly note that businesses in Minnesota are subject to higher class rates than are homesteads.  However, it is worth noting that personal property in Minnesota is not taxable (with the exception of electrical generating machinery).  The exclusion of personal property from taxable value tends to benefit businesses much more than homeowners because a larger share of business value is in the form of personal value.  This is particularly true for industrial properties.  Most other states tax personal property much more heavily than Minnesota; the extent to which personal property in Minnesota is exempt provides a tax advantage to Minnesota businesses that partially offsets the higher class rates.

    In general, I would not disagree that simplification of the property tax system would be appropriate.  One change that I would have liked to have seen in the Dayton tax plan is the elimination of the convoluted homestead value exclusion that was adopted during the 2011 special session.

    Moving on to the issue of business-to-business sales, you are certainly correct that some—though not all—of the increase in business sales taxes will be shifted to consumers; however, the remainder will be borne by capital and labor.  In addition, it is important to note that at least a portion of any sales tax increase on businesses will be exported out of state.  I do not know if the Revenue Department takes into account the extent to which the tax on business-to-business sales are shifted to consumers when they assert that the sales tax base expansion will have no impact on consumers.

    I hope this answers at least some of your questions.  As always, thank you for reading MN 2020.

  • Jeff Van Wychen says:

    February 21, 2013 at 11:26 am

    Robert:
    You are right—there are some good ideas in the property tax working group report.  A reduction in the number of class rates may be in order, but it becomes a thorny problem for legislators because the consolidation of classes usually creates tax reductions for some classes of property and increases for others.  Given the budget deficit and the scarcity of resources, it is difficult to “buy down” taxes on the classes of property that are adversely affected.  The cost-free option from the perspective of the state would be to simply let property taxes on the adversely affected properties go up, but this is something that both Democratic and Republican legislators are reluctant to do.

    I would argue that business properties are not as adversely effected by MN’s property tax system as is frequently claimed.  The exemption of personal property provides a big tax break for businesses (especially industrial) that partially offsets the effects of the classification/class rate system.  Please see my earlier comment in this chain regarding this subject.

    However, the bottom line is that some simplification is in order.  For example, the “relative homestead” law allows properties to receive homestead classification even when the homeowner does not live on the premises; in some instances, this provision creates not only complexity, but unintended consequences.  Simplification of the property tax system is definitely a subject that merits consideration.