Minnesota Governor Mark Dayton’s recent tax proposals
include many changes to the state’s tax code, and one that stands out is the
“snowbird tax.”This tax is intended to
address a perceived loophole in the state tax code that allows residents to not
pay any income taxes to the state of Minnesota if they live there less than
half of the year.Governor Dayton is worried
that so-called “snowbirds” (who are people, usually retired, who spend the
winter months in warmer climates—some of whom who go to states like Florida and
Texas that don’t have any state income taxes) are filing their taxes in other
states while using Minnesota services for a considerable portion of the year.
The law would tax non-residents who live in the state for
two to six months out of the year.Rather
than taxing income on wages and salaries, this tax would be only tax income earned from stocks, bonds, capital gains and dividends.This strategy appears to indicate that the policy is aimed at retirees who may not
be earning income from working anymore.The
Minnesota Department of Revenue estimates that the tax would generate $30
million in revenue, or 1.5% of Governor Dayton’s proposed $2.1 billion dollar overall
revenue increase.The proposed 2013
overall budget totals $37.9 billion.
One element of the issue that the governor is considering is
the idea of equity.The governor sees
people who spend considerable time in the state and use Minnesota goods
services such as infrastructure, public works, and parks, to not pay taxes that
help maintain that level of services as being free-riders who are not paying
their fair share for services that they are using.Fairness is a concept that Governor Dayton is
making a central part of his defense of this proposed tax.
While in principal this tax might increase equity, it may be
difficult to collect.It would either
force nonresidents to disclose the amount of time they spent in the state, or
it would require the state to add some type of mechanism that would enable it
to monitor and/or verify how long these nonresidents spend here.Either of these options complicates the
methodology for levying this tax, and with the expected revenue stream from the
“snowbird tax” being so low, it may not be worth it.
If it passes, Minnesota would be the first state to
implement such a measure.It is strange
that the governor would go to such an extent to pass a groundbreaking tax like
this for such a small amount of revenue.Perhaps this is a case where the governor’s sense of fairness is
overshadowing practical considerations and political pressure.
State governments, unlike the federal government, have to
balance their budgets according to law. A tough task in normal times, but after
the Great Recession it became much more difficult for many states as economies
around the nation suffered. Here is a list of the state’s entire projected
deficit for the fiscal year of 2012.It also orders the states in terms of the projected
deficit as a percent of 2011 total spending. For 2012, there are only six
states that are not projected to have a budget shortfall: Alaska, Arkansas,
Montana, North Dakota, West Virginia and Wyoming.
The state budget crisis got to such
critical levels that a task force was created to examine the problem of fiscal
sustainability more closely in six states: California, Illinois, New Jersey,
New York, Texas and Virginia. The report found there are six major threats hindering
the states abilities to balance their budgets, and fiscal stability.
(1) Medicaid spending growth-
Escalating health care costs and increasing enrollments will cause state
Medicaid spending growth (at recent rates) to surpass revenue growth by a
considerable margin, at least $22 billion annually within five years.
(2) Federal deficit reductions- As
the Federal government tries to remedy its own budget crisis, fewer government
dollars in terms of grants or other federal spending might decrease, putting
states in a fiscally unstable situation. Federal grants accounted for 32
percent of state’s revenues in 2009.
(3) Underfunded retirement promises-
Pension funds for state and local government workers are underfunded by $1
trillion dollars (or up to $3 trillion if more conservative investment
assumptions are used. Health care liabilities are also underfunded by over $1
trillion dollars across the nation.
(4) Decreasing tax bases and Volatile
tax revenues- Income taxes have become increasingly volatile, especially since
the economic crisis. Sales tax bases are eroding due to untaxed transactions;
gasoline taxes are also eroding causing less money for transportation
infrastructure.
(5) Local Government fiscal stress-
The weak economy and reductions in intergovernmental transfers have put a lot
of pressure on local governments. As a result spending on education, law
enforcement and welfare programs have decreased. This threatens the overall
economic and social status of the states.
(6) State budget laws and practices- Lack
of transparency and reporting have made it difficult for the public to gauge
the critical nature of the budget situation. Using borrowed funds or other
temporary ‘one-shot’ measures to balance the budget are not uncommon. These
practices make fiscal stability extremely difficult.
A summary of the main report may be
found here. Links to the individual state reports and the full main
report may be found in the previous link.
State budget crises have led to some
serious consequences for the states’ residents. At least 46 states have decreased services provided,
including some to the most vulnerable families, while more than 30 states have
raised taxes to some degree and some quite significantly. During the recent
economic downturn, when residents expected and needed services and benefits
from states, they were unable to sufficiently provide them. Raising taxes to
help balance the budget also puts the economic recovery at risk.
Many states have to make some
difficult decisions when trying to balance the annual budgets. In
Texas, the state government cut $5.4 billion dollars in spending on education
statewide. Part of the cuts involve having to lay off 25,000 public education workers,
including 11,000 teachers. These cuts are occurring while student enrollment is increasing, by more than
80,000 per year. Texas is facing a two-year budget shortfall of $27 billion.
California last election passed new regulations raising the
income tax rates for the wealthy, 10.3% for those earning over $250,000 and
13.3% for those earning over $1 million. The increases are expected to lower
the budget shortfall, a projected $16 billion in 2012, down to $1.9 billion by
the end of summer in 2013. But the tax hikes might cause an exodus of the wealthy from the state, who do
not wish to pay the higher tax. The wealthy already feel they carry enough of
the burden. The top 2 percent of earners, those over $450,000, pay 46 percent
of the state’s taxes. Those earning over $1 million account for 25 percent of
the entire state’s taxes.
This link shows all 50 states, estimated budget shortfalls,
tax change percentages, and cuts to various programs. Minnesota from Jan
2010-March 2011: personal income tax increased 17%, corporate income tax
increased 30.6%, and sales taxes increased 3.6%.
The states unlike the Federal
government cannot borrow large sums of money to balance their budget. This
creates a difficult situation, especially after an economic downturn, where
states scramble to find revenues or cut spending in order to avoid a shortfall.
Citizens want states to have balanced budgets, but they might not always agree
with the path taken to get to a balanced budget especially if services are cut
or taxes are raised. Today many states are put in the seemingly impossible
position of determining how to reduce deficits and without cutting too many
services to residents or raising taxes too high.
Like nearly every state, Minnesota needs more revenue. The current recession has exacerbated systemic imbalances between ongoing revenue and long-term expenditures, resulting in a projected $4.4 billion deficit for the FY2012-13 biennium. One possible solution, popular among Democrats, is the creation of a 4th tier state personal income tax bracket (4th tier). Under current law, the Minnesota personal income tax is a graduated tax with three rates: 5.35%, 7.05%, and 7.85%. The rates are applied to income tiers that vary by filing status (married joint, single, or head of household). Click here for more information about Minnesota's personal income tax A 4th tier would cap the 3rd tier at a high level of personal income, allowing income above that level to be taxed at a rate greater than 7.85%.
Most of the political debate surrounding the 4th tier involves equity concerns. Between 2002 and 2006, Minnesota’s tax system became increasingly regressive largely due to rising inequality between high and middle income earners and the state’s growing reliance on local taxes, which are generally regressive. According to the Suits Index – a -1.0 to 1.0 scale that measures the degree to which a tax or tax system is regressive (-1.0), proportional (0), or progressive (1.0) – the regressivity of Minnesota's tax system increased from -.018 to -.053 over that four year time period (2009 Minnesota Tax Incidence Study). Since the income tax is the state’s only major progressive tax, its promotion is seen by many as the key to reversing this regressive trend. Click here to read a report on tax fairness put out by the Minnesota Budget Project (sponsored by the Minnesota Council of Non-Profits)
But is the 4th tier an adequate source of revenue for the state? The answer to this question hinges on the 4th tier’s composition, its tax rate, and efficiency effect. For the purposes of 4th tier revenue projection, a good source for 4th tier composition and tax rate is House File 885 (HF 885), which passed the Minnesota Legislature in 2009 but was vetoed by Governor Pawlenty. Under HF 885, a 9% tax rate would have been assessed to income above $250,000 for married joint filers and $141,250 for single filers. If HF 885’s tax rate and income brackets are used to define the 4th tier, then a preliminary estimate of the 4th tier’s revenue potential can be made using Minnesota Department of Revenue (DOR) wage data (available online). In 2007, roughly $33 billion in taxable income was generated above the proposed 4th tier floors. At the 3rd tier tax rate of 7.85%, this tax base produced slightly more than $2.59 billion in income tax revenue. Were HF 885’s 9% tax rate applied with an assumption of no effect on efficiency, then this same tax base would have generated nearly $2.97 billion, for an estimated revenue gain for the state of about $380 million.
Of course, the assumption that a 14.6% income tax increase (7.85 to 9) would have no efficiency effect is unrealistic. It is much more likely that the implementation of the 4th tier would have some negative effect on economic activity in the state. A literature review conducted by Marsha Blumenthal and Charles Quimby for the think tank Growth and Justice suggests that interregional tax elasticity estimates typically range between -.1 and -.6. In 2006, income taxes represented roughly 58% of the total tax burden for the state’s wealthiest 5% (about half of whom would be assessed a higher rate on some of their income under the proposed 4th tier.) For these high income earners, a 14.6% income tax increase would equate to an approximately 8% increase in total tax burden. Using this figure and the midpoint of the tax elasticity estimates (-.35), we can reasonably estimate that Minnesota would lose 2.8% of its 4th tier tax base given a 9% tax rate (.08 * -.35 = -.028). In absolute terms, a 2.8% decline in the 4th tier tax base would cost Minnesota slightly more than $83 million in tax revenue. However, this loss is more than made up for by the additional revenue generated by the higher tax rate. All told, we estimate that had HF 885’s version of the 4th tier been implemented in 2007, Minnesota’s income tax would have generated slightly less than $300 million in additional revenue in that year alone.
Income Tax Revenue Generation from High Levels of Income
3-Tier and 4-Tier Income Tax Systems
(High Levels of Personal Income > $250,000 married joint filers, $212,500 heads of household, $141,250 singles)
3-Tier System
(Observed Data)
4-Tier System
(Hypothetical Estimates)
2007 High Income Tax Base
$33 billion*
$33 billion
2007 Tax Rate
7.85%
9.0 %
Efficiency Effect due to 4th tier
---
-2.8%**
Modified Tax Base
$33 billion
$32.08 billion
Tax Revenue Generated off of High Levels of Income
$2.59 billion
$2.89 billion
*Estimated from 2007 Individual Income Tax Statistics (Minnesota Department of Revenue). Tax base was calculated from aggregate wage data for singles making over $150,000 and married joint filers making over $250,000. The resulting sum was multiplied by .65 to provide an estimate of total taxable income after deductions.
**Estimated by Nick Petersen using a -.35 tax elasticity assumption.
Based on this analysis, the 4th tier’s efficiency effects do not appear to significantly impact its adequacy as a revenue source. This finding suggests that the 4th tier is a viable option in the state’s search for new revenue.
