Revenue Analysis: Pawlenty's Proposal

Racing to the Bottom: Pawlenty’s shift in the tax burden

Recently, Gov. Pawlenty announced in his State of the State Address his proposals for Minnesota to foster the creation and retention of jobs, and encourage revenue growth in the long term. Among those proposals was the extension of his prized Job Opportunity and Building Zones (JOBZ) program to the St. Paul Ford Plant, and a reduction of the Corporate Franchise Tax (more commonly known as the corporate income tax) rate by 20%. Although the corporate income tax represents a small portion of the general tax revenue (7.58% in 2007), and JOBZ has had received modest amounts of applications (312 tax exception deals in 7 years), Gov. Pawlenty doesn’t acknowledge the potential costs of these two initiatives in both tax revenue lost, and the tax incidence shift from corporate generated revenue to other revenue sources.

MN JOBZ Program

The extension of the MN JOBZ program to the Ford Plant in St. Paul, represents and expansion of the scope of a corporate tax exemption program beyond its original intent of encouraging firm growth or relocation in depressed cities in the state. Gov. Pawlenty’s proposed expansion of the JOBZ program does not recognize the initiative’s past criticisms reflected in the 2008 evaluation by the Office of the Legislative Auditor or potential costs associated with creating a precedent that increases the eligibility for corporate tax exceptions. Since its inception, JOBZ has distributed approximately $76.8 million in tax benefits to businesses in Minnesota. An expansion in eligible businesses would increase this figure.

What is the Corporate Income Tax?

Within Minnesota, the corporate income tax (or corporate franchise tax) is a fixed rate tax on the profits earned by a company who resides, or whose headquarters reside, within the state boundaries. The current corporate income tax rate in Minnesota 9.8%. Nationally, the corporate income tax accounts for about 7.57% of total tax revenue generated by state governments as of 2007. In Minnesota, the corporate income tax accounts for 7.58% of tax revenue generated in 2007, or about 6.53% annually from 2000 – 2006.[1]

The Corporate Income Tax and Minnesota Competitiveness

Currently, Minnesota has one of the highest flat rate corporate income tax rates in the county; however, there are a few difficulties comparing the competitiveness of Minnesota’s tax rate with other states. The first difficulty in comparing corporate income tax rates across state lines, is the complexity how states have their corporate income taxes structures. Currently, 33 states have a flat rate corporate income income tax, 13 states have a graduated corporate tax rate structure, and 4 states do not have a corporate income tax. States with graduated rates, typically have lower corporate income tax rates for companies with less than $100,000 in profits, and progressively higher rates for companies that generate more than $100,000 in profits. Of the states with flat corporate income tax rates, they range from 4% to 9.99% with 39% having a higher corporate income tax than the Governors proposed corporate income tax of 7.84%. In all, 75% of the States in the US, including the District of Columbia, would maintain a corporate income tax that would be lower than Minnesota. States that would have a higher corporate income tax would include Massachusetts, California, New Jersey and Rhode Island. Because of additional competitiveness in corporate income tax rates maintained by other states, the proposed reduction in Minnesota corporate income tax rate would have limited effect on increasing Minnesota’s competitiveness int the nation. Additionally, firms relocating in Minnesota may still be eligible for the JOBZ tax exception, decreasing the need for a reduction in the corporate income tax.

Country/State	Top State Corporate Tax Rate
Iowa	12
Pennsylvania	9.99
Dist. Of Columbia	9.975
Minnesota	9.8
Massachusetts	9.5
Alaska	9.4
New Jersey	9.36
Rhode Island	9
West Virginia	9
Maine	8.93
Vermont	8.9
California	8.84
Delaware	8.7
Indiana	8.5
New Hampshire	8.5
Wisconsin	7.9
Nebraska	7.81
Idaho	7.6
New Mexico	7.6
Connecticut	7.5
New York	7.5
Kansas	7.35
Illinois	7.3
Maryland	7
North Dakota	7
Arizona	6.968
North Carolina	6.9
Montana	6.75
Oregon	6.6
Arkansas	6.5
Tennessee	6.5
Washington	6.4
Hawaii	6.4
Michigan	6
Georgia	6
Kentucky	6
Oklahoma	6
Virginia	6
Florida	5.5
Louisiana	8
Missouri	6.25
Ohio	5.1
Mississippi	5
South Carolina	5
Utah	5
Colorado	4.63
Alabama	6.5
Texas	0
Nevada	0
South Dakota	0
Wyoming	0

Eliminating Tax Revenue

Since 2000, the corporate income tax has seen the largest percentage gains in increased as a share of total revenue compared with sales and income tax, regardless of its high rate. In 2000, Minnesota generated $814 million from the corporate income tax. In 2007, the tax revenue generated by the corporate income tax had increased to $1.174 billion, with a median increase of revenue by 10.55% over 7 years. The increase seen by Minnesota is slightly higher than the national median increase in corporate tax revenue of 8.25%. A 20% reduction in the CIT would reduce the CIT rate to 7.84%, result in a loss of tax revenue of approximately $235 million, or approximately 1.52% of the total tax revenue, according to 2007 tax revenue data.

Although Gov. Pawlenty argues that the reduction in the corporate in come tax will encourage firm growth and relocation to Minnesota in the long-term, revenue generated from this tax decrease would not be fully realized for multiple years because of a) the time needed for firm creation or relocation can be great; b) the current recession could continue to suppress corporate revenue into the near future, decreasing taxable profits; or c) the continuation of the Minnesota Department of Employment and Economic Development over use of the JOBZ program to attract firms to Minnesota will decrease the amount of taxable profit from firms due to the JOBZ corporate income tax exemption. To account for the revenue lost in the short term, the Governor’s office, and the MN State Legislature would have to further reduce current expenditures, or offset the decrease in revenue through increasing tax revenue from other sources. (such as a 3.24% increase in income tax revenue, or a 5% increase in sales tax revenue)

Regardless of the scenario chosen (reduction in expenditures or increase in alternative taxes) the reduction in the tax rate for the corporate income tax decreases the tax incidence on corporations, and shifts the tax burden on residents. Although, individuals will gradually assume greater tax burden for the generation of state revenue, it will be unlikely that citizens will fully realize the shift in burden until an attempt to offset the revenue loss through an alternative means of generating revenue because they do not directly pay the corporate income tax. Additionally, the benefits for the reduction in revenue from a reduction in the corporate income tax can not be immediately realized by the state. Considering the current financial situation of the Minnesota State Budget, a proposed reduction in revenue can add difficulties in ensuring a balanced budget for the next budget cycle.

“The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing” - Jean Baptiste Colbert

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[1] Proportion of tax revenue generated supplied by state revenue data collected by the Nelson A. Rockefeller Institute of Government. http://www.rockinst.org/government_finance/revenue_data.aspx