Minnesota Lawyer
Revenue Commissioner Myron Frans has been touring the state discussing tax policy. (FILE PHOTO)
A short tour of four potential scenarios as the Dayton administration and the DFL Legislature weigh the next Minnesota budget
Raising additional revenue to pay the state’s bills will be at the center of discussions at the Capitol during the coming legislative session. And pretty much to a person, the incoming DFL majorities have indicated that they support some form of tax hike.
The exact figure will be bandied about for weeks leading up to Gov. Mark Dayton’s budget release in late January, and again for weeks thereafter leading up to the February forecast delineating exactly how much of a fiscal hole the state has to plug. AFSCME Council 5’s call for $6 billion in additional revenues earlier this month — a nearly 20 percent increase in the general fund — was almost certainly nothing more than a rhetorical shot across the bow. When Dayton and DFL legislators ultimately seek a significantly smaller amount (most pre-session guesses appear to be running in the $2 billion range), they want to be able to portray it as a compromise between the demands of their left flank and the insistence of Republicans that the state already has plenty of money.
But the number of ways in which revenue can be generated are legion. Dayton’s proposal to increases income taxes on the state’s wealthiest residents is merely the bluntest tool available. Legislative Democrats will likely want a more nuanced discussion on the topic; hence all the talk of “tax reform,” which generally means simplifying the tax code by closing exemptions.
Revenue Commissioner Myron Frans has been touring the state discussing the topic. Senate DFLers have set up a separate Tax Reform Division chaired by Sen. Ann Rest.
“I expect to see some very interesting and important discussions taking place before that subcommittee,” said Mark Haveman, executive director of the Minnesota Taxpayers Association, a nonpartisan advocacy group.
But how much money can be raised through the many possibilities out there? It’s impossible to say exactly, because most of the Minnesota Department of Revenue documents detailing revenue possibilities are about a year out of date.
But with that caveat in mind, here’s a rundown of some of the most likely options:
Income tax
Dayton’s initial budget proposal in 2011 called for adding a fourth-tier tax bracket of 10.95 percent for individuals making more than $85,000 per year and families taking in more than $150,000. (Currently the top bracket is at 7.85 percent.) That proposal, which would have given Minnesota the second-highest state income tax rate in the country (after Hawaii and Oregon at 11 percent), was projected to raise $1.9 billion over the course of the biennium.
But assuming that legislative DFLers aren’t anxious to make their mark by establishing one of the highest income tax rates in the country, how much revenue would smaller increases generate? For every 0.1 percent increase in the rate for top bracket filers, the state would take in an additional $29 million per year. For the middle bracket that figure grows to $40 million. And increasing the income tax rate by 0.1 percent for the lowest earners would generate $50 million annually. So if the income tax rates for all Minnesotans were increased by 0.5 percent, the state could expect to take in an additional $1.2 billion over the biennium.
Sales tax
At 6.875 percent, Minnesota’s sales tax is relatively high — but likewise more narrowly applied than in most states. (Currently, for example, it is one of just five states that do not tax clothing purchases.) Numerous products and services are exempted from taxation. Eliminating these exemptions could raise significant amounts of revenue in the next biennium and beyond.
Services are the single largest potential source of revenue. Applying the sales tax to accounting fees, legal bills, and other services would bring in more than $3 billion annually. But most of that money —about $2.7 billion — would be raised through taxing business-to-business services, which few tax experts advocate. That leaves a little less than $500 million in potential tax revenue from consumer services that aren’t being collected. If the state collected sales taxes on legal services, for instance, it would take in roughly $100 million annually.
But there are also numerous tangible products that are currently exempted from taxation. Applying the sales tax to clothing, for instance, would raise $331 million per year. Similarly, taxing medicine would bring in $335 million a year. In other words, eliminating those two exemptions would bring in enough revenue to eliminate the state’s entire projected deficit of $1.1 billion for the next two-year budget cycle.
On the lower end of the spectrum, applying the sales tax to carnival prizes would bring in $200,000 annually (good luck applying that one), while taxing feminine hygiene products would collect $1.8 million. The annual cost of other exemptions: prescription glasses ($38.9 million), caskets and burial vaults ($4.6 million), farm machinery ($47.6 million) and logging equipment ($1.8 million).
Of course, each of these exemptions has constituency groups that will argue vociferously against eliminating them.
There’s also the possibility, although rarely broached, of increasing the sales tax across the board to generate more revenue. For every half a percentage point that the sales tax is increased — assuming current exemptions — the state would bring in roughly $350 million in additional revenue annually.
Sin taxes
Almost any discussion of raising additional revenue includes the possibility of raising taxes on alcohol and cigarettes. The most recent such tax increase occurred in 2005, when a 75-cent-per-pack “health impact fee” was added to purchases of cigarettes as part of the solution to end that year’s protracted budge showdown, which culminated in a nine-day government shutdown.
Increasing taxes on booze by one cent per drink would bring in $26 million annually. A single drink is defined as 12 ounces of beer, 5 ounces of wine or 1.5 ounces of liquor. There’s also the possibility of boosting the gross receipts tax on liquor, which is currently 2.5 percent. Increasing it by 0.5 percent would bring in an additional $15 million per year.
Raising the tax on cigarettes by 50 cents per pack would generate nearly $100 million annually. But the revenue returns diminish as taxes increase. The revenue department estimates that raising taxes by $1 per pack would only bring in $155 million per year. That’s because consumption is expected to decrease if cigarettes become significantly more expensive.
Corporate income tax
The corporate income tax accounts for just 5 percent of the general fund, or $925 million in fiscal year 2011. Currently corporate income is taxed at a rate of 9.8 percent. But there are numerous exemptions and loopholes, meaning that few corporations actually pay anywhere close to that amount.
One possible target of DFL legislators: the exemption for income from foreign operating corporations. Currently companies are able to exempt 80 percent of income derived from overseas operations. That adds up to more than $80 million in forgone state revenue annually. The exemption for foreign operating corporations has been a frequent target for criticism by DFLers in the past.
“Corporate income taxes are almost certainly going to be on the table in some way, shape or form,” said Haveman.
