Friday, March 30, 2012

Minnesota's Overall Revenue System could be changing

Minnesota’s revenue system, like others across the county, is a mix of different political philosophies, generational values, and remnants of past swings in the economy. These differences come to light every year the differing tax proposals make their way through the legislature. This comes to fruition in the tax bill created through choices in new revenue sources, cuts to revenue sources, and changes to fees and credits.

Minnesota’s legislature is currently debating the appropriate amount of taxes that should be levied. Their choice is going to have rippling effects on individual's taxes, on cities budgets, and on county budgets as well.  The two different bills that passed out of committees are the Minnesota House of Representatives File HF 2337 and the Minnesota Senate File SF1972. Since there are differing measures within each proposal, it means they are going to go to a conference committee to work out the differences. A conference committee is composed of members from the Minnesota House and the Senate who come together to produce a single piece of legislation that can hopefully be passed by each body and signed by the governor.


The House bill relies on cuts to Minnesota’s renter’s credit. This credit helps low and moderate-income renters with their housing expenses. This reduction in renter’s credit is being used to fund other tax cuts helping different populations in Minnesota.

The Minnesota House bill provides significant cuts in taxes.  These, according to the Minnesota Budget Project (MBP), would add significant increases to the state’s deficit, ranging from $228 million to $1.1 billion in revenue shortfalls by FY 2014-2015. The bill further creates future problems because it would gradually eliminate business property taxes through 2025. MBP estimated if property taxes were cut it would cost $1.7 billion by FY2014-2015.

The Senate bill passed out of the tax committee includes $104 millionin tax cuts in FY 2012 – 2013 and $195 million FY 2014 – 2015 (information located below House projections). As with the House version of the bill, this tax bill attempts to phase out certain property taxes paid and would fully eliminate business property taxes by 2026. At the same time, this bill freezes local government aide at the 2012 level, putting cities in a difficult place with their budgets. For instance, this brief summary of the city of Minneapolis’s budget shows that a significant portion of the city’s budget revenues come from property taxes. Eliminating a large portion of taxable property could have a very large impact on the way cities finance their services.

James Schowalter, The Commissioner of Minnesota's Office of Management and Budget has expressed his concerns about the impacts that the Senate bill could have on Minnesota's overall financing. He has said he is worried this bill will take the state in the wrong direction after it is starting to recover after the tough economic times of the last few years.

This current fight over what the correct mixture of revenue raisers is constantly a hot button issue in politics in Minnesota and efficiency, equity, sustainability, and feasibility all are changing based on the proposals being pushed through the legislature. Although the proposals passed through the committees are sure to change in conference committee and with the Governor’s input. This battle will always highlight that smart long-term revenue planning is not always a guiding principle when a legislature figures out their revenue raising strategy.

Wednesday, March 28, 2012

Affiliate Nexus Sales Tax: The Internet Sales Tax

House File 1849: Affiliate Nexus in Minnesota

                The new affiliate nexus in Minnesota was introduced to the House and Senate on January 24, 2012.  The bill would require affiliates of such vendors as Amazon and Overstock to pay sales tax for all transactions conducted in Minnesota.  This bill is a departure from the current sales tax which requires that the vendor have a physical presence in the state of Minnesota in order to be taxed.  If the bill becomes law, it would take effect for any sales and purchases made after June 30, 2012.  Currently bolstered by bi-partisan support from the House, Senate, and Governor, the affiliate nexus bill is likely to pass.  

Information about the Bill is found below:

Affiliate Nexus Tax in Other Jurisdictions

                The affiliate nexus tax has currently been passed in eight states: Arkansas, California, Connecticut, Illinois, New York, North Carolina, Rhode Island, and Vermont.  The State of New York was the first state to pass the legislation, enacting the tax in 2009.  Thus, the New York affiliate nexus served as a model for other states to pursue such legislation. 

                Regarding the effectiveness related to the affiliate nexus tax around the country, there is serious doubt and criticism about its ability to effectively raise significant revenue.  While the projected revenues for the tax appear high in some states ($317 million in California), the cancellations of affiliate agreements by Amazon and other vendors could reduce these figures, as well as decrease income tax generated by affiliates.  In other words, the tax may prove to be counterproductive in terms of generating additional revenue.

Issues surrounding the Tax

Some issues surrounding an affiliate nexus tax deal with the fairness of the tax, the amount of revenue the tax could raise, and whether the law would be constitutional.  The first issue of fairness comes from brick and mortar businesses being undersold by Internet retailers.  Secondly, the affiliate tax in Minnesota is not set up to raise a significant amount of revenue. Thirdly, there are concerns the affiliate nexus tax may not be constitutional because it may not be covered by the US commerce clause.  If it were deemed unconstitutional, no revenue could be raised.

Evaluating Affiliate Nexus

Based on the four measures used to assess a tax – efficiency, equity, sustainability, and feasibility - this tax is an okay revenue raiser, a three on a scale from one to five.  The first reason for this is that the tax is fairly inefficient because larger Internet retailers may use other methods, other than Minnesota companies, to drive traffic to their websites, meaning local businesses could lose a source of income.  Secondly, this tax does pretty well equity issue because of the tier of $10,000 included in the bill, but it is a sales tax and those are generally regressive in nature.  Third, on sustainability the tax is fairly small, this comes from the facts showing the tax base as being narrow and the law may also be deemed unconstitutional at some point – both limit the revenue raising capacity of the tax.  Lastly, the bill is in the middle on the feasibility scale because it seems politically feasible, but it may be administratively difficult for businesses.

Minnesota's Revenue System: "Fair", "Understandable", and Obsolete?

Minnesota relies on nearly $36 billion in own-source revenue each year with a vast majority of that amount - $25.3 billion - coming from taxes. The issue of reliance on tax revenue is always a hot-button issue in Minnesota politics. Republicans often point to Minnesota as one of the most highly-taxed states in the country, while Democrats feel more revenue should be generated to make up for budget shortfalls in recent years. In reality, Minnesota is on-par with most states in regard to sales tax, excise taxes, and corporate taxes. The state lags behind on property taxes, but relies more heavily on income taxes than most other states.

The National Conference of State Legislatures (NCSL) notes 9 features of high-quality state revenue systems, and based on a number of those criteria, Minnesota appears to fare well. For example, the NCSL discourages competition between state and local governments over the tax base. Recognizing that Minnesota relies less heavily on property taxes than most other states for its own-source revenue, it would seem that local governments (which rely more heavily on property taxes) are able to count on property taxes for a greater share of their own-source revenues  without having to compete with the state government for adequate resources. 

In other criteria, the NCSL discusses the importance of stability, certainty, sufficiency, and transparency of the tax system. Here again, Minnesota appears to do well. In a survey done by the Minnesota Department of Revenue, 48% of Minnesotans said they felt the state’s tax system was “predictable”, 47% felt it was “understandable” and 39% believed it was “fair” according to the “ability to pay”.

Despite Minnesota’s seeming success at establishing a predictable, understandable, and fair revenue system, there are those who argue that the current revenue structure for state governments is becoming obsolete. The Brookings Institution makes this case, pointing specifically to the shift away from goods to services in our systems of commerce which makes it difficult to rely on sales tax for a stable source of revenue. They also note that as more and more commerce occurs via the Internet, states will have to adapt in order to capture revenue associated with those transactions. 

However, Minnesota seems to be addressing some of those concerns, in particular, by attempting to change commerce laws that would result in greater sales tax revenue generated from online purchases.

Overall Revenue Options in Minnesota

In class, we have examined and analyzed various revenue sources for state and local governments such as the property tax, sales tax, income tax, user fees and intergovernmental grants.

The Minnesota Budget Project, an initiative of the Minnesota Council of Nonprofits, conducted a study with various revenue raising options to help close the 2012-2013 budget deficit.  The analysis, while not representing a complete tax reform, does provide an analysis on revenue raising options that have been part of public discussion.

Income Tax
The income tax is the tax that relates the most to the ability to pay thus attempting to make Minnesota taxes less regressive.  During the past few years there have been various proposals to create “a fourth tier” income tax bracket.

Another way to raise revenue through the income tax would be an income tax surcharge.  This is an efficient mechanism to raise revenue.  A 10% income tax surcharge would generate between $1.4 billion-$1.6 billion in revenue.

In Governor Dayton’s Budget, a new 10.95 percent tax bracket for taxable income above $150,000 a year for a married couple was created.  This proposal would raise $2.0 billion in FY 2012-13.  In 2010, the legislature passed a 9.1 percent rate on taxable income above $200,000 for a married couple.   This proposal was estimate to raise $271 to $495 million in revenue in FY 2012-13.

Property Tax
Property taxes are generally levied at the local level, however there is a statewide property tax on businesses and cabins.  A state property tax on homes valuing above $1million would generate $63 million.  This proposal is estimated to only apply to 7,800 properties and be an average increase of $5,600.

Sales Tax
Minnesotans pay sales tax on most goods but pay no sales tax when they purchase most services, even as services have become a larger share of the economy.  Also, Minnesota is one of only five states that have a sales tax exemption on clothing.  The elimination of the sales tax exemption on clothing would generate an estimated $580 million in revenue.  Another option highlighted in the study would be removing the exemption on consumer purchases of many services such as car repair and maintenance, personal care services (like hair styling and body piercing), legal services, accounting services and funeral services , which would raise $834 million in FY 2012-13

According to the Minnesota Tax Incidence Report, sales taxes are considered regressive.

Alcohol and Tobacco Taxes
Minnesota has two alcohol taxes: an excise tax on manufacturers and wholesalers and a gross receipts tax for retail sales on on-sale and off-sale purchases.  The Minnesota Legislature’s 2009 omnibus tax bill increased the alcohol gross receipts tax from 2.5 percent to 5.0 percent, and increased the alcoholic beverage excise tax by about two cents a drink for beer and wine and about three cents a drink for distilled spirits. This legislation was vetoed and didn’t become law.  It was estimated that this proposal would generate $263 million in FY 2012-13.

In 2009, legislation was proposed to raise the cigarette tax by $1 per pack and double the separate tobacco products tax from 35 percent to 70 percent.  It was estimated to generate $314 million in FY 2012-13.

Looking Forward 
Currently, the legislature is in the final year of the biennium.  In February 2012, state budget officials projected a $323 million surplus.   While this news is optimistic, this report is still useful as it still provides a comprehensive analysis of revenue raising options that can be examined in the upcoming budget setting year starting in January 2013.