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MN2020 - Tax Fairness: How Minnesota Compares to Other States
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Tax Fairness: How Minnesota Compares to Other States

June 23, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Low- and middle-income households pay a disproportionate share of Minnesota state and local taxes relative to high income households. However, these taxpayers can take some consolation from the fact that Minnesota’s income-based tax disparities are less pronounced here than in most other states, as demonstrated in a recent Minnesota 2020 report, Minnesota Moves Ahead: Tax Fairness in the 50 States. That report further demonstrates that Minnesota made strides toward increased tax fairness as a result of the 2013 tax act.

The level of taxes are commonly measured in terms of the “effective tax rate” (or ETR), which—as used in this article—refers to combined state and local taxes as a percentage of income. In a regressive tax system, low- and middle-income households tend to have higher ETRs than high-income households. In a progressive system, high-income households tend to have higher ETRs. In a proportional tax system, the average ETRs of high- and low-income households are the same.

We can measure the degree of regressivity or progressivity in a tax system using the "Suits index." The Suits index has a range from -1.0 to +1.0. The closer to +1.0, the more progressive a tax system is and, conversely, the lower the value (i.e., the closer to -1.0) the more regressive it is. A perfectly proportional tax system has a Suits index of zero.

Based on the Suits index, Minnesota had the 16th least regressive state and local tax system in the nation in 2010, the last year for which tax incidence information for all 50 states is available.* In that year, Minnesota's Suits index was -0.0331. By comparison, California has the nation's most progressive tax system (ranked #1), with a +0.0497 Suits index.† Florida has the most regressive system (ranked #50), with a -0.2152 Suits index.

If we adjust Minnesota’s Suits index to reflect the progressive impact of the 2013 tax act, Minnesota improves from the 16th to the 10th least regressive state, holding all other states constant. Minnesota's Suits index increases from -0.0331 prior to the 2013 tax act to an estimated -0.0178 after the 2013 act.

The Suits index is admittedly an abstract measurement of tax regressivity. For that reason, it is difficult to translate into layman’s terms the significance of the increase in Minnesota's Suits index. Furthermore, it is difficult to interpret the significance of the difference between Minnesota’s Suits index and that of other more regressive and less regressive states.

The task of expressing the degree of regressivity or progressivity associated with a Suits index of a particular value in concrete terms is made difficult by the fact that ETRs generally do not increase or decrease at a uniform rate from the lowest income decile (i.e., the ten percent of households with the lowest income) to the highest decile (i.e., the ten percent of households with the highest income). However, it is possible to make useful generalizations about the degree of regressivity associated with a particular Suits index if we assume that ETRs increase (or decrease) at a uniform rate from the lowest to highest income households.

The following analysis uses a technique developed by Dr. Paul Wilson of the Minnesota Department of Revenue (DOR) to illustrate the distribution of Minnesota taxes by population decile from lowest to highest income under various Suits index values assuming (1) an average ETR for all Minnesota taxpayers of 11.6 percent (the actual ETR for Minnesota after passage of the 2013 tax act), (2) an income distribution by decile as projected by DOR for 2015, and (3) a uniform rate of change in ETRs from low- to high- income deciles.

Based on these assumptions, the graph below shows Minnesota ETRs by income decile under four scenarios. The ETRs for the highest income decile and the middle-income quintile (a combination of the fifth and sixth deciles) are displayed.

  

Before the 2013 tax act, based on the assumptions above, high-income households (those in the highest income decile) would have an 11.0 percent average effective tax rate. Meanwhile, middle-income households (those in the middle quintile) would have a 12.5 percent average ETR. Expressed another way, state and local taxes per dollar of income are 13.2 percent higher for middle-income households than for high-income households. If we assume instead a Suits index of -0.0178—Minnesota’s estimated Suits after the 2013 tax act—the disparity in taxes per dollar of income between the middle-income and high-income households would shrink from 13.2 percent to 6.9 percent.

While the information presented above does not represent actual ETRs paid by Minnesota taxpayers (although the reduction in the ETR disparity between the middle-income and high-income households turns out to be similar to the actual reduction), this approach illustrates how significant Minnesota’s Suits increase from -0.0331 to -0.0178 is in terms of who pays state and local taxes.

Where this approach is most useful is in illustrating how the distribution of state and local taxes by income could change if Minnesota’s Suits index were to dramatically increase (i.e., become less regressive) or decrease (i.e., become more regressive). For example, if Minnesota’s Suits index looked like California's (the most progressive state at +0.0497), the average ETR for middle-income households would fall to 10.4 percent, while that of high-income households would increase to 12.6 percent under the assumptions described above. In other words, Minnesota's middle-income taxpayers would go from paying almost 6.9 percent more in state and local taxes per dollar of income than high-income households (assuming a -0.0178 Suits index) to paying 17.4 percent less.

Meanwhile, if Minnesota’s Suits index looked like Florida's (the most regressive state at -0.2152), the average ETR for middle-income households would increase to 17.1 percent, while that of the top decile would fall to 7.7 percent. Under this scenario, middle-income Minnesotans would go from paying 6.9 percent more in state and local taxes per dollar of income than the top decile to paying 124 percent more!

State officials should avoid policies that would allow Minnesota to drift in the direction of the extreme regressivity observed in Florida. For reasons explained in Minnesota Moves Ahead, excessive regressivity not only undermines tax fairness, but also jeopardizes revenue adequacy and economic growth.

Minnesota’s tax system remains regressive, even after the improvements made in the 2013 tax act. Whether Minnesota wants to move in the direction of significant progressivity such as that seen in California is another question and beyond the scope of this article. However, even if policymakers seek to make Minnesota’s state and local tax system truly progressive instead of just less regressive, they should not do it in the way that California has done.‡

A closer examination of Suits index disparities using the approach developed by Dr. Wilson shows that the 2013 tax act has succeeded in making significant progress toward tax fairness by reducing the tax disparity between middle- and upper-income households by nearly 50 percent. The same approach also helps to illustrate the range of disparities among states in terms of who pays state and local taxes and the magnitude of change necessary in Minnesota in order to make our tax system comparable to other more regressive and less regressive states.

 

*The Minnesota Suits indices in the 2013 Minnesota Tax Incidence Study and a subsequent Minnesota Revenue Department tax incidence analysis of the 2013 tax act are more accurate and reveal a greater degree of Minnesota tax regressivity than the Suits indices calculated by Minnesota 2020 using data from the Institute on Taxation & Economic Policy (the basis of the interstate comparisons in Minnesota Moves Ahead). However, this article uses Suits indices calculated using ITEP data because this is the only set of Suits indices that are comparable across all fifty states.  That information is based on 2010 data but incorporates tax changes enacted through January 2013.

†Only two other states in the nation have positive Suits indices based on 2010 ITEP data; in other words, only two other states have progressive state and local tax systems. They are Oregon (+0.0230) and Delaware (+0.0115).

‡Ironically, California’s drift toward greater progressivity is largely a product of a conservative tax policy that requires a supermajority for any legislatively approved tax increase; as a result, California frequently foregoes the legislative process in favor of a direct appeal to voters via an initiative statute. In order to improve the likelihood of public approval, state tax increases in California frequently target only extremely high income households. An example of this is California’s “millionaires tax” approved via the initiative process in 2012. Income tax increases targeted to extremely high income households has made California’s tax system more progressive—an unintended consequence of a conservative policy designed to restrict California tax revenue.

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13 Comments:

  • Steve Elkins says:

    June 30, 2014 at 10:04 am

    Florida’s tax structure is so regressive because they have chosen to rely very heavily on sales taxes, even at the local level, reasoning that a disproportion share of them are collected from tourists. As a result, Florida is heavily “over retailed”, with about 30% more retail square footage per capita than the national average. This has a terrible impact on urban form, as all of the cities compete for big box retail.

  • Mike T. says:

    June 30, 2014 at 11:30 am

    California is bankrupt because they can’t stop spending.  It is no surprise that MN2020 wants to advocate for a tax and spend policy like theirs and have poverty for all.  More proof that Democrats are bad at math.  The Pursuit of Happiness.

    • Jeff Van Wychen says:

      June 30, 2014 at 8:06 pm

      California is also struggling because of ill-conceived super-majority requirements for any tax increase—a policy successfully pushed by conservatives back in the 1970s.  This has produced political gridlock that has made it difficult to work out coherent compromises on taxes and spending in CA.

      But then again, why look to California?  Over the last two years in Minnesota, we have restored a portion of funding cuts to critical public assets like K-12 and higher education and increased our investments in early childhood education, workforce development, and affordable healthcare and housing.  At the same time, we’ve ended the perennial budget deficits resulting from the “no new tax” policies of the preceding decade and we have an economy that is outperforming other Great Lakes states, which was NOT the case back when Pawlenty and the conservative clique were in charge.  And by the way, while we did increase the state budget during the 2013 session, real per capita state general fund spending is still much less than it was a decade ago.

      Bottom line: MN conservatives are the least people on earth who should be pointing fingers about “bad math.”

      • Dan Conner says:

        July 22, 2014 at 3:25 pm

        I think mike T. needs to better evaluate the fiscal condition in CA.  Gov. Brown has greatly improved the fiscal shape of CA, compared to the terrible financial shape Schwartznegger left the state.

  • Mike Downing says:

    June 30, 2014 at 11:48 am

    Jeff,

    The only truly regressive tax is property tax. Why not support property tax reform that is based on one’s ability to pay? For example, property tax could be tied to our income tax system and homeowners would pay 3% of income for property taxes.

    I assume you have studied the VOSS Report which confirms the 3% average…

    • Jeff Van Wychen says:

      June 30, 2014 at 7:52 pm

      Mike:
      Three points.  First, the property tax is not the “only truly regressive tax.”  For example, sales and excise taxes are both significantly more regressive than the property tax.

      Second, I have consistently supported “property tax reform that is based on one’s ability to pay.”  The expanded renters’ property tax refund (PTR) and the new homestead credit refund (basically an significantly enhanced version of the old homeowners’ PTR) effectively target tax relief based on the ability to pay and have contributed to a reduction of tax regressivity in Minnesota.  Both programs were significantly expanded during the 2013 session, with an additional one-time bump provided during the 2014 session.  Thanks to progressive leadership, few states have a more robust system for targeting tax relief based on income.

      Third, what you are proposing comes close to converting the property tax into an income tax.  While I am a big fan of the income tax, I don’t want it to entirely replace the property tax for fear of revenue volatility.  I fear your 3% cap would become prohibitively expensive during a recession, when incomes decline and the need for counter-cyclical public spending increases.  Also, I question the propriety of letting someone choose to live in a huge estate and never have to pay more than a 3% effective tax rate.  But then again, we’ve had this conversation before.

      • Dan Conner says:

        July 22, 2014 at 3:22 pm

        I agree with you Jeff.  Property taxes are not the most regressive tax.  After all, the taxes collected and the rate generally increase with the value of the house.  And generally higher earning people live in more expensive homes.  That is not “generally” regressive.  I think Mr. Downing needs to explain his definition of “regressive”, if he has one.

        • Mike Downing says:

          July 25, 2014 at 8:26 am

          Dan,

          If you are truly interested in learning the facts, I direct you to the VOSS Study from the MN DOR. It will clearly show even you that MN property taxes are the only truly regressive tax in MN. The average property tax in MN is 2.9% of their income with the rich paying 1% and the poor paying 5,10 and even 20% of their income. Property taxes hit retired seniors on a fixed income the hardest.

          • Jeff Van Wychen says:

            July 25, 2014 at 10:45 am

            Mike:
            The Voss Study does show that property taxes are regressive, but it does NOT show that property taxes “are the only truly regressive tax in MN.”  The Voss Study looks only at property taxes and is silent on the subject of which tax is most regressive.  Dan is correct in asserting that “property taxes are not the most regressive tax.”  A long line of Minnesota Tax Incidence Studies from the Dept. of Revenue has repeatedly shown that sales and excise taxes are more regressive than property taxes.

            • Mike Downing says:

              July 25, 2014 at 2:23 pm

              Jeff,
              I can understand Dan not understanding the definition of a regressive tax but I am shocked that an educated man like you cannot look up the definition in an econ 101 book, in Webster’s or in Wikipedia. A flat tax is neither regressive or progressive since is income agnostic. A sales tax is a flat tax.

              Property Tax is by definition regressive since high income people pay at a much lower rate than low income people.

              The DOR refers to a 3 legged stool with income taxes, sales taxes and property taxes as the 3 legs.

              Property taxes are the only regressive tax of these 3 taxes on a definitional basis. Don’t mislead your low information readers like Dan. His opinions simply parrot your misstatements on this topic.

              • Dan Conner says:

                July 29, 2014 at 8:38 am

                Unlike many of the far more regressive taxes in Minnesota, the legislature has made efforts to mitigate the repressiveness of it.  There are refunds of income taxes made because of property taxes, farmers receive special mitigation, etc.  However, there are no mitigation to sales or excise taxes.

                As an aside, I am surprised to read about Mike Downing’s concern about the regressivity of property tax.  I am surprised he is concerned about the poor or fixed income people at all, considering his numerous posts assaulting their work ethic, inability to save and manage their money, and general drag on society.  If he has reformed GREAT!  However, if he’s simply making a specious argument in an effort to disguise his true belief in a smoke screen then shame on him.  Besides he has touted his Florida residency, to escape state income taxes, in prior posts.  His view would have more credibility as a Minnesota resident.

                Regressive in my American Heritage Dictionary says, “Having the rate lessen as the amount taxed increases.”  I don’t believe property taxes does that.  In fact, I understand the tax rate of more expensive property slightly increases.

                The above being said, it is unfortunate that people, whose circumstances have changed, are not always treated fairly by our system.  People going from work to retirement are a case in point.  People widowed is another.  Businesses suffering financial reversals being another.  Some of this is dealt with by the law and some has not.  Democrats are more than willing to assist those situations more satisfactorily.  However, Republicans fight to keep these taxes regressive. 

                I suggest Mr. Downing check his faux concern at the door.  Suggestions for improvement would certainly trumps easy criticism.  I would expect that he deals with all areas of regressivity, not just property taxes.  One very effective way to eliminate these regressive taxes would be to tax the rich more.

                While we argue regressive taxes are taxing the poor too much, it can also be said it means the rich are not taxed enough.  So maybe the fix is to reduce regressive taxes on the poor and raise them on the rich.;

                 

              • Dan Conner says:

                July 29, 2014 at 8:52 am

                MIke, I am surprised at your tendency to generalize.  You state, “Property Tax is by definition regressive since high income people pay at a much lower rate than low income people.”  That is patently untrue.  Property taxes are not necessarily regressive.  It depends on the value of the home and the income of the individual.  However, it is not regressive “by definition.”  I think you are confused.  Property tax is based on the value of the home, NOT income.  Economists have tried to interpret its economic result (regressiveness v progressiveness) on INCOME, but it is a little like comparing apples and oranges.  It’s comparing wealth to income.

              • Jeff Van Wychen, MN 2020 says:

                July 29, 2014 at 5:03 pm

                Thank you for your concern over my education, but my assertion that sales and excise taxes are more regressive than property taxes is entirely accurate and borne out by every tax incidence analysis that I am aware of.  Your indignation over a statement that is unambiguously true is confounding.

                Furthermore, a flat tax that leaves in place regressive tax exclusions, subtractions, and deductions would indeed be regressive because a larger share of the income of high income households would continued to be sheltered from taxation.  A flat INCOME tax that eliminates all such tax preferences would be proportional (i.e., neither regressive or progressive).  However, whether such a change would make the total state and local tax system more or less regressive depends on what changes are made to other taxes.  The incidence of tax changes is complicated and I advise caution making declarative statements in the absence of a thorough analysis.