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2014 Tax Acts Increased Tax Fairness

June 30, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Minnesota’s tax system is regressive, meaning that low and moderate income households pay a higher percentage of their income in state and local taxes than do high income households. Fortunately, the 2013 tax act led to a significant reduction in tax regressivity. A new analysis from non-partisan staff at the Minnesota Department of Revenue (DOR) reveals that the two tax acts passed during the 2014 session not only reduced total state and local taxes paid by Minnesotans by 1.7 percent, but also further nudged Minnesota’s tax system toward reduced regressivity and greater tax fairness.

The DOR analysis estimates the impact of permanent tax changes made in the two tax acts (chapter 150 and chapter 308) passed during the 2014 legislative session, assuming all provisions of both acts are fully phased-in. For example, the first tax act included a substantial reduction in Minnesota’s estate tax phased-in over five years. The DOR analysis shows the tax impact of this provision once it is fully phased-in. In addition, the DOR analysis excludes the impact of temporary tax changes. The DOR analysis is based on projected 2015 data.

The 2014 tax acts contained federal conformity and other provisions which reduced state and local tax regressivity, including an increase in the Working Family Credit which targets tax relief to low-income working families, an increased child and dependent care credit, an increase in the standard deduction for married joint filers, elimination of three business-to-business sales taxes, and a combination of provisions that led to a small net reduction in property taxes. (The second tax act contained one-time increases to the homestead credit refund and renters’ property tax refund that will provide substantial tax relief to low and moderate income families in 2014, but they are excluded from the DOR analysis because they are temporary.) On the other hand, the estate tax reduction and gift tax repeal will lead to increased regressivity.

The graph below, taken directly from the DOR analysis, shows the change in average state and local effective tax rates (defined here as state and local taxes as a percentage of income) for Minnesota households grouped by deciles (groups of ten percent), ordered from lowest to highest income.* The highest income decile is further broken down into three parts consisting of the first five percent (i.e., the bottom half of the tenth decile), the next four percent, and the top one percent. The combined height of the red and blue portions of each bar represent the effective tax rate (ETR) prior to enactment of the 2014 tax acts, the red portion represents the ETR reduction resulting from the 2014 tax acts, and the blue portion represents the ETR after the 2014 tax acts.

Impact of 2014 Law Changes on Effective MN State and Local Tax Rates, by Decile

The largest ETR reductions occur among the first five deciles with incomes ranging from $0 to $47,000, while the smallest reductions occur among the top two deciles with incomes in excess of $102,000. The top one percent receives a significant ETR reduction (0.25%) largely as a result of the estate tax reduction and gift tax repeal, although the decline is still smaller than that in any of the first five deciles. In general, this analysis reveals that the overall impact of the 2014 tax act—even excluding the impact of the one-time property tax refund increases—is still significantly progressive, focusing relief on low and moderate income households.

While high income households are receiving the smallest ETR reductions as a result of the 2014 tax acts, complaints about “soaking the rich” are unwarranted. As the graph shows, the top decile—and specifically the top one percent—still have lower ETRs than any other income group even after the 2014 tax act reductions. Collectively, the tax acts passed in 2013 and 2014 have merely reduced, but not eliminated, the state and local tax advantage enjoyed by Minnesota high income households.

DOR analysis of the 2013 and 2014 tax acts demonstrates that progressive state policymakers followed through on their commitment to restore a portion of past funding cuts to K-12 and higher education and enhance state investments in early childhood education, affordable healthcare, workforce development, and other critical public assets, while at the same time reducing tax regressivity. Not only did the 2013 and 2014 tax acts shore up important state investments and increase tax fairness, but they also reduced taxes for the majority of Minnesotans. More on this in part 2 of this series.

*The first decile is omitted from this graph due to data anomalies described in the recent DOR analysis and, more extensively, in the 2013 Minnesota Tax Incidence Study.

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