Mark Dayton's 2013 budget proposal includes numerous changes to the tax code which include closing the loopholes on the corporate tax, giving some property tax relief while at the same time decreasing the overall sales tax. The way in which he is able to achieve these goals is through increasing the taxes on the top 2% and expanding the current Minnesota sales tax. His rationale is that property tax , income tax and sales tax should be more like the chairs of a stool in that they are "fair" across the spectrum of taxable revenues.
Dayton's Tax Reform
What is hardly discussed on the govenor's budget and his highly publicized is the reaction to the change in the tax code for the Mom and Pop type companies that might have to add sales taxes to any sale over $100.
Initial Star Tribune Article
Follow Up Article
It has become such a hot button issue that the proposal and the video that the star tribune created is currently the most watched.
Interviews at the Mall of America
So where do we go now?
Considering that sales tax is the largest revenue generator for the state, it would seem that if the increase in a sales tax's breadth makes sense for Minnesota but the public outcry against it might make it politically unfeasible even if it is the optimal solution for Minnesota's tax code. Ironically this would actually move Minnesota down in the national sales tax from #7 (at 6.875%) to around # 29 (at 5.5%) at the overall rate. The numbers I do not have is what is the percentage of revenue by tax base that Minnesota currently uses compared to the nation.
And just because I like the economic (not specifically the financial) theory behind why it is so hard to change tax codes, here is a bit on the status quo bias.
Super nerdy Econ Theory on why people hate change
Showing posts with label reform. Show all posts
Showing posts with label reform. Show all posts
Monday, February 18, 2013
Thursday, April 15, 2010
Minnesota Miracle: Part Deux?
In the past, when education financing came up in conversation local gophers might have mentioned the “Minnesota Miracle” – the 1971 bi-partisan effort to reform the state’s property-tax-based funding of public education. For over thirty years the effects of these reforms helped to reduce the disparity between localities with different property tax bases.
These days, education financing brings a different phrase to mind: “Race to the Top.” And in this case, Minnesota’s performance is far from miraculous. At a time when the state faces a $4.8 billion two-year deficit and K-12 and Higher Education expenses total 50.3% of total general fund expenditures, President Obama’s offer of $4.35 billion in competitive grants to states that have progressed and show promise to make improvements in four key areas is tempting, to say the least. The critical reform areas are:
- Adopting rigorous standards and assessments;
- Recruiting and retaining effective teachers;
- Turning around low-performing schools; and
- Establishing data systems to track student achievement and teacher effectiveness.
Delaware and Tennessee won the first round of The Race, taking home a combined $600 million for their reform plans. According to Secretary of Education Arne Duncan, "Both states have statewide buy-in for comprehensive plans to reform their schools. They have written new laws to support their policies. And they have demonstrated the courage, capacity, and commitment to turn their ideas into practices that can improve outcomes for students." Minnesota (along with 38 other states) fell short of the top spot by over 70 points, scoring just 375 out of the total 500 possible. Marks against the state’s plan included that it failed to demonstrate progress in closing the achievement gap, in equitably distributing effective teachers and principals, and that it lacked “alternative pathways for aspiring teachers and principals.”
Going in to the competition and following the release of the winners, Minnesota Department of Education and Governor Pawlenty complained that Education Minnesota – the statewide teachers union – was “dragging down the state” and keeping Minnesota from making reforms through the years. The lack of union support for the plan (just twelve percent signed on to the state application) led reviewers to question whether Minnesota educators shared a coherent vision and whether they had the “political will to dramatically improve schools.” However, as seen below, Education Commissioner Alice Seagren and Governor Pawlenty were not ready to admit defeat.
States may compete for a second round of Race to the Top funding by a June deadline. Pawlenty says Minnesota will only compete again if the state legislature enacts new laws and that Education Minnesota needs to “lighten up, loosen up its grip on the status quo.” Education Minnesota President Tom Dooher says Pawlenty’s “’take it or leave it’ ultimatum makes it clear he’s made a decision to not attempt a second application.” Who to believe? And what is it about the status quo that must be changed?
One point of disagreement is whether Q Comp, Pawlenty’s voluntary teacher performance pay system, should continue to be expanded throughout the state. Q Comp is currently funded by $169 in state aid and up to $91 in local funding per enrolled pupil. A Star Tribune investigation revealed over 99% of participating teachers received pay increases through the program during the most recent school year. Given the high cost and low accountability within the program, Education Minnesota would prefer the dollars be added to general school to reduce class sizes, increase resources, and update materials.
State lawmakers are currently moving to pass a set of reforms by May 1 to facilitate a more competitive application. New plans include alternative pathways to teacher licensure, strengthening teacher training, and enhancing the effectives of teaching evaluations. If the resulting legislation spurs a second Race to the Top application, if that application is successful, and if the resulting funding enables meaningful reforms for all meaningful students, perhaps we will have a second miracle in Minnesota. But then, miracles don’t often happen more than once…
Monday, April 5, 2010
Is Balance a Good Thing When It Comes to a Tax System?
According to the Minnesota Department of Revenue's (DOR) "General Tax Principals", Minnesota's tax system should approximate a "three-legged stool" with roughly equal amounts of revenue coming from income taxes, property taxes, and sales taxes. A quick review of state tax receipts suggests that Minnesota is adhering to this principle fairly well. Of total state and local revenue collected in 2006, 37% was from income taxes, 30% was from consumption taxes (sales taxes and fees), and 33% was from property taxes. Click here to review the 2009 Minnesota tax Incidence Study. Such balanced revenue generation is intended to promote stability, predictability, and adequacy in the tax system, but despite its low level of reliance on any one revenue source the state is still plagued by revenue volatility and a catastrophic imbalance between projected revenues and future expenditures. Such stability and sustainability concerns raise questions about the wisdom of the state's three-legged approach. Perhaps, some taxes are more reliable than others. If so, then maybe DOR should abandon the stool in favor of an approach based on a different metaphor.
The problem with Minnesota’s tax system is that it generates more than two-thirds of the state’s revenue from tax bases (income and sales) that fluctuate with the state’s economy. The result is a boom and bust budget cycle in which the state runs budget surpluses when the economy is growing and budget deficits when the economy is in decline. Theoretically, cyclical fluctuations in revenue can be mitigated through the use of budget reserves, but as we know, political realities usually prevent this from occurring in practice. Over the past decade, Minnesota has consistently responded to projected surpluses (FY00-01, FY02-03, FY08-09) with increased spending, tax cuts, and other measures designed to return revenue back to the public. These measures are generally popular and may be justifiable on ideological and/or policy grounds, but they leave the state ill equipped to deal with inevitable budget deficits. In the face of immediate revenue shortfalls, governors and legislatures have little choice but to pursue solutions that prioritize short-term cost controls over long-term objectives.
In the absence of a robust budget reserve, a revenue system tied to volatile tax bases will tend to prohibit a prudent level of investment in long-term priorities like education and infrastructure. Recognizing this, Budget Trends Study Commission drew considerable attention to revenue volatility in its 2009 report the Legislature. Although the report stopped short of recommending major revisions to the state’s tax system, many of its findings addressed the relative volatility of different forms of taxation. A recreated table summarizing some of the Commission’s findings on tax volatility is included below.
It should be noted that volatility is not the only, or even the most important, criterion to consider when evaluating a tax system. Property taxes (not included in the table) are far away the least volatile source of revenue (since state or local government officials readjust rates annually to generate the desired level of revenue), but they are generally among the most regressive. For this reason, few lawmakers would propose reducing Minnesota’s budget volatility through increased reliance on property taxes (although it may be some politicians default position). A more promising discussion about revenue volatility is likely to center on the state’s current balance between income taxes and consumption taxes.
As you can see from the table above, the sales tax is the state’s least volatile revenue source (excluding the property tax.) This suggests that one way for Minnesota to decrease the volatility of its tax system would be to increase its reliance on the sales tax. The idea is particularly attractive when you consider that the Budget Trends Study Commission looked only at the volatility of the state’s current sales tax. Under current law, Minnesota exempts necessities (such as food and clothing) and services from its sales tax base. As a result, in 2006 only 28.5% of personal expenditures in Minnesota were assessed a state sales tax. One could reasonably assume that if the state were to expand the sales tax base to include food, clothing, and other necessities, its volatility as a revenue source would decline even further. This assumption is supported by a 2008 study done by the Federal Reserve Bank of Kansas City, which estimated that consumer spending on durable goods was roughly 5 times more volatile than spending on clothing and 15 times more volatile than spending on food.
Admittedly, sales taxes are a regressive form of taxation and increasing the state’s reliance on them could introduce additional regressivity into the tax system. It is possible, however, that this negative consequence would be offset by additional revenue stability. When deficits occur, it is usually low-income populations that suffer the most in the form of budget cuts to state services. A more reliable revenue system may enable legislatures to preserve programs and maintain safety nets in times of recession. Additional revenue stability at the state level could also preserve local government aid funding and thus reduce the need for property tax increases. If so, then an expansion of the sales tax base might end up being neutral in its equity effect. In any case, expanding the sales tax base holds great potential to reduce volatility in the overall tax system, suggesting the days of the three-legged stool may soon be over.
The problem with Minnesota’s tax system is that it generates more than two-thirds of the state’s revenue from tax bases (income and sales) that fluctuate with the state’s economy. The result is a boom and bust budget cycle in which the state runs budget surpluses when the economy is growing and budget deficits when the economy is in decline. Theoretically, cyclical fluctuations in revenue can be mitigated through the use of budget reserves, but as we know, political realities usually prevent this from occurring in practice. Over the past decade, Minnesota has consistently responded to projected surpluses (FY00-01, FY02-03, FY08-09) with increased spending, tax cuts, and other measures designed to return revenue back to the public. These measures are generally popular and may be justifiable on ideological and/or policy grounds, but they leave the state ill equipped to deal with inevitable budget deficits. In the face of immediate revenue shortfalls, governors and legislatures have little choice but to pursue solutions that prioritize short-term cost controls over long-term objectives.
In the absence of a robust budget reserve, a revenue system tied to volatile tax bases will tend to prohibit a prudent level of investment in long-term priorities like education and infrastructure. Recognizing this, Budget Trends Study Commission drew considerable attention to revenue volatility in its 2009 report the Legislature. Although the report stopped short of recommending major revisions to the state’s tax system, many of its findings addressed the relative volatility of different forms of taxation. A recreated table summarizing some of the Commission’s findings on tax volatility is included below.
General Fund Revenue Volatility Study; 2005-2007
| Trend Growth Rate | Tax Base Volatility | |
| Individual Income Tax Base | 5.40% | 3.10% |
| Corporate Income Tax Base | 14.90% | 12.10% |
| MN Sales Tax | 5.20% | 2.10% |
| Other Revenue (fees) | 11.00% | 10.90% |
| Total (excluding local taxes) | 6.50% | 2.60% |
| Inflation | 2.00% | --- |
Source: Minnesota Management and Budget
It should be noted that volatility is not the only, or even the most important, criterion to consider when evaluating a tax system. Property taxes (not included in the table) are far away the least volatile source of revenue (since state or local government officials readjust rates annually to generate the desired level of revenue), but they are generally among the most regressive. For this reason, few lawmakers would propose reducing Minnesota’s budget volatility through increased reliance on property taxes (although it may be some politicians default position). A more promising discussion about revenue volatility is likely to center on the state’s current balance between income taxes and consumption taxes.
As you can see from the table above, the sales tax is the state’s least volatile revenue source (excluding the property tax.) This suggests that one way for Minnesota to decrease the volatility of its tax system would be to increase its reliance on the sales tax. The idea is particularly attractive when you consider that the Budget Trends Study Commission looked only at the volatility of the state’s current sales tax. Under current law, Minnesota exempts necessities (such as food and clothing) and services from its sales tax base. As a result, in 2006 only 28.5% of personal expenditures in Minnesota were assessed a state sales tax. One could reasonably assume that if the state were to expand the sales tax base to include food, clothing, and other necessities, its volatility as a revenue source would decline even further. This assumption is supported by a 2008 study done by the Federal Reserve Bank of Kansas City, which estimated that consumer spending on durable goods was roughly 5 times more volatile than spending on clothing and 15 times more volatile than spending on food.
Admittedly, sales taxes are a regressive form of taxation and increasing the state’s reliance on them could introduce additional regressivity into the tax system. It is possible, however, that this negative consequence would be offset by additional revenue stability. When deficits occur, it is usually low-income populations that suffer the most in the form of budget cuts to state services. A more reliable revenue system may enable legislatures to preserve programs and maintain safety nets in times of recession. Additional revenue stability at the state level could also preserve local government aid funding and thus reduce the need for property tax increases. If so, then an expansion of the sales tax base might end up being neutral in its equity effect. In any case, expanding the sales tax base holds great potential to reduce volatility in the overall tax system, suggesting the days of the three-legged stool may soon be over.
Wednesday, February 24, 2010
A Fresh Look at Federal Taxation?
A few years ago an interesting, but improbable idea for tax reform was discussed during the presidential primaries. It has been labeled the “fair tax,” and proposes replacing all existing federal taxes with a single federal sales tax on all final goods and services. It also includes several related tax policies. Its proponents cite many benefits of this tax system, including:
- Making taxation more transparent. With a single uniform tax, Americans will have a clearer idea of what they spend on taxes, and how the effective tax rate is changing over time. This should result in greater government accountability.
- Reducing public and private tax administration and collection costs. The Government Accountability Office estimates that Americans spend between $200 and $300 billion each year complying with the federal tax system. That is between two and five percent of GDP! Relying only on a sales tax could reduce these costs substantially, considering that transactions increasingly occur at large retailers with automated payment systems.
- Allowing collection from all American consumers. The fair tax would collect from all consumers in the country, regardless of nationality, citizenship, or country of residence.
- Incentivizing “societally beneficial” spending behaviors. The fair tax would influence the spending decisions of the wealthy Americans. The fair tax will be a disincentive to spending money on “additional” consumer goods at the margin of benefit. Conversely, they will choose to invest in job creating companies, finance research and development, and donate more to charities and non-profits—all of which improve others’ standard of living.
- Increasing the global competitiveness of companies operating in the United States. The elimination of all corporate taxes will encourage companies to keep their most important functions domestic. It will also encourage foreign companies to move production to the United States. The United States currently has one of the highest corporate tax rates in the world.
- Making it easier to save. Currently, the American private savings rate is an abysmally low 4.6 percent, and was negative only a few years ago. The fair-tax will help Americans prepare more quickly for retirement and unexpected expenses. Additionally, increases in savings will lessen the strain on our already stressed social welfare system.
The fair tax need not be regressive
After learning more about the fair tax, many of my initial objections to it disappeared. Critics of the fair tax incorrectly label it as regressive, suggesting that it taxes those with lower incomes at a higher rate than those with higher incomes. In reality, the fair tax incorporates a “prebate.” Every taxpayer will receive a monthly rebate equal to the amount of sales tax that they will pay on purchases below the poverty level. The result is that those living below the poverty level will pay no net taxes. Additionally, the fair tax would eliminate the regressive FICA payroll tax that is currently paid by low-income Americans.
Many current sales taxes often excludes categories of products like food for home consumption and prescription drugs to give the appearance of “progressivism.” However, economists have found that the wealthy often spend a great deal more on unprepared foods and medical care (i.e., they are normal goods), and the positive intentions of these exemptions are often lost. Exemptions are not a particularly effective way to make the sales tax less regressive, and the practice results in market distortions that favor certain industries over others (benefits for food producers, pharmaceutical companies, etc.). The fair tax would eliminate these types of distortions.
Reliance on a sales tax will not increase instances of tax dishonesty
Few people realize the magnitude of uncollected taxes today. The IRS estimates the current tax gap (the amount that goes uncollected) to be nearly $300 billion per year. There is also not a strong likelihood of increased “underground” sales. Retail businesses will collect the tax at the point of sale, like they already do effectively in 45 states.
With the simplified system, the federal government will free up many resources to pursue tax crime and investigate fraud.
Implementation of the fair tax is not unfeasible
Adopting the fair tax will necessitate a constitutional amendment, requiring the approval of 37 states. It would include a repeal of the sixteenth amendment, which authorized the income tax.
Researchers estimate that sales tax will need to be around 23 percent to maintain current revenue levels. However, this is difficult to confirm due to difficulties in modeling.
Revenue stability is a concern with a sales tax. However, consumption is typically a more stable source of income than revenue, which is the current income tax base. Additionally, the fair tax is only currently being proposed at the federal level, meaning that a balanced budget is not required.
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