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…

Pawlenty "Holds Back" Equity In Funding for Public Schools

In trying to find a topic for this blog post I solicited the help of my brother, Andy Fyten, who is a school administrator and teacher for a local charter school in north Minneapolis. When I asked him if there are any big funding issues facing public schools right now he immediately responded with one word: "holdback"

What my brother is referring to is the percentage of state per pupil education funding held back from all public schools in Minnesota in a fiscal year. A "holdback" is a state of Minnesota education finance tool that withholds a certain percentage of allocated per pupil school funding until the state sees final enrollment statistics from every public school. Once the state receives the final enrollment statistics the funding that was withheld is distributed to schools in the first half of the following school year. The amount each school receives is proportional to the previous year's final enrollment statistics.

By statute, 10% of education funding in Minnesota is held back. But last summer Governor Pawlenty, using unallotment, increased the figure from 10% to 27% in an effort to cut the state budget without increasing taxes. This action sent public schools scrambling to make up for an unexpected 17% current school year budget shortfall since schools count on per pupil funding to balance their budgets. This site does a nice job of depicting the impacts of the 27% holdback.

This action by the Governor has significantly impacted charter schools in particular because charter schools have a much greater reliance on state per pupil funding than many district public schools do, especially in low income areas where there is very little property tax revenue to help pay for public schools. However, this map shows that in comparison to the rest of the country, Minnesota charter schools are funded by the state at a much higher level than in most states.

Nevertheless, charter schools seem to be feeling the crunch more in Minnesota. According to this post, charter schools in Minnesota are having to take out loans just to pay their teachers. This means that future school funding is going to have to go towards paying interest on these loans when the funding really should be going directly into the classroom. I know at my brother's school they have already been forced to fire two teachers because of the budget shortfall created by the 27% holdback imposed by the Governor.

The significant impacts of the 27% holdback on charter schools I believe demonstrates the bigger issue at hand: funding equity. Essentially, the Governor's decision has a much more severe impact on students and schools in low income areas when compared to its impact on students and schools located in higher income areas.



The chart above (taken from this site) illustrates that, on average, about 42% of public school funding comes from local property taxes. Therefore, schools situated in low income areas rely more on state funding. So when the state cuts funding to public schools across the board, schools that are situated in low income areas are affected much more severely. I think we can all agree that students going to public schools in low income areas are suffering enough. So the last thing they need is the state imposing a statute that forces them to suffer even more than students going to public schools in higher income areas. So in the future if the Governor defends his 17% increase in education funding holdback by saying that it impacts schools across the board equally, don't buy it.

Benchmarks: A (Better?) Way to Measure Supply of Public Goods

According to Fisher, there are three primary ways of measuring the supply of public goods produced by state and local governments. Output can be measured by:

1. Amount of money spent (expenditures).
2. Directly produced outputs (number of recycling facilities per household).
   
3. Results (recycling rate by weight).

Expenditures are the most commonly used measure for state and local governments. However, just calculating expenditures alone might not be enough. That is why it is important to also track and measure the results of the public goods that governments are responsible for providing.

This concept of a results-driven approach is generally known as benchmarking and is being used by many levels of government. According to our text, Mississippi shifted to use benchmarking in the 1990s so that results would drive the budgeting process.

Mississippi is not alone in this effort. Here in Minneapolis, the city government has created an entire website to not only measure results but share the results with residents. The purpose of their website is to help the City in their "continual quest to become a more results-driven and transparent municipality." All of the City goals are listed, with graphs and data about each measure. One example is the goal: "Lifelong Learning Second to None". While tracking the amount of money spent on the public school system could be one way to measure local government inputs, another way would be to track the high school graduation rate:

Ultimately, local and state governments hope that this way of measuring inputs will be useful for allocating resources. Essential to benchmarking is the ability to accurately track and measure all of the results. Furthermore, results need to be shared--both across departments within local governments but also with other governments to make comparisons.

The National Neighborhood Indicators Project is a project by the Urban Institute and local partners (one of which is CURA, based here at the Humphrey Center) whose aim is to provide neighborhood level data that makes tracking possible. According to their website, "NNIP partners have built advanced information systems with integrated and recurrently updated information on neighborhood conditions in their cities," a major breakthrough. Without this type of data, tracking benchmarks would not be as valuable or meaningful to local governments.

Indicator projects are useful in helping local governments share information and collect the data that is necessary to use benchmarks, which can provide local governments with more information than a graph of their expenditures. Results tracking is valuable in not only helping determine how much resources certain public good need but also in how those resources should be spent. For example, if our spending remains consistent, we might not notice that our graduation rate has steadily decreased over time. Knowing the graduation rate can help identify problem areas in the public goods that local government provides and thinking critically about how to improve these important services. This is valuable both to local governments, that have the responsibility of providing the services, and to residents, who receive the services.

Recycling

If managed correctly, recycling programs should cost cities (and taxpayers) less than garbage disposal for any given equivalent amount of material. The city of Saint Paul currently partners with a Twin Cities based nonprofit, Eureka Recycling, to administer its recycling program.

In Saint Paul, Eureka Recycling provides curbside recycling for single family and multi family homes of under ten units. For commercial properties and large apartment complexes, they operate a pick-up on demand program with a communal 95-gallon recycling cart. Currently, they do not offer single stream recycling as the initial costs to implement a single stream program are currently prohibitive among other reasons that can be found in this report(link).

In May of 2002, Eureka Recycling partnered with the city of Saint Paul and the Minnesota Office of Environmental Assistance (MOEA), to undertake a 14-month study that would examine and evaluate five different ways to pick up recycling at the curb. The final recommendations of the study can be found here.

This table from Eureka Recycling’s report shows the costs of all five methods of recycling pickup.

How do these costs compare to garbage pickup? Until 2007, the cost to dispose of one ton of refuse in Saint Paul was approximately $68. To only landfill the refuse would cost the city significantly less at $38 per ton, or $7 less than the cheapest recycling method. Is savings of $7 per ton enough to abolish an otherwise successful recycling program and landfill everything? Some critics would have you believe that this $7 savings IS enough to abolish the program, as the benefits of recycling are “nonexistent.”

An interesting note is that recycling costs are hidden to residents while the refuse costs are billed directly to residents, thus increasing their visibility, which could positively impact the rate of recycling. They could use a slight increase as the City is currently under the metro’s goal of having a 50% recycling rate. They are currently hovering around 49% and have been for quite a few years.

Michael Shapiro, the former director of the U.S. Environmental Protection Agency’s Office of Solid Waste, had this to say about the cost of recycling versus garbage collection:

“A well-run curbside recycling program can cost anywhere from $50 to more than $150 per ton…trash collection and disposal programs, on the other hand, cost anywhere from $70 to more than $200 per ton. This demonstrates that, while there’s still room for improvements, recycling can be cost-effective.”

According to the chart above, Saint Paul is providing the service in a very cost effective manner in all five of the options, just barely above the minimum average cost presented by Mr. Shapiro. In option A, the City is actually under the national average and below the contracted refuse removal costs of Saint Paul, unless they do begin only land filling the refuse, in which case that number is difficult to beat.

The City of Saint Paul, Eureka Recycling, and the State of Minnesota SCORE funds through Ramsey County provide funding for the Saint Paul recycling program. In 2002, SCORE (some detail) funding reached over $4 million for Ramsey County with additional funding provided by the county and also the individual municipalities such as the City of Saint Paul. Total SCORE funding for multiple counties can be seen in the following graph that was taken from an OLA report regarding SCORE funding effectiveness.

As a final note, even though the benefits of recycling over disposal are plentiful, individuals should keep in mind that it better serves the environment to “reduce and reuse” before recycling even becomes an option.

Pension Shortfalls & Baby Boomers

Corporations based in the United States, unlike most developed nations, have abandoned the concept of “defined benefit plans”, most commonly referred to as pensions, for most occupations. However, there is one large part of the economy where pensions are still used: the public sector. Most commonly pension funds provide benefits via a calculation based upon the amount of time served multiplied by salary at retirement multiplied by an accrual rate. US corporations first offered pensions following WWII, but as life expectancies began to rise they sought to extricate themselves from agreements that proved to be very costly. Government employees have been able to preserve these arrangements, and with the oncoming wave of Baby Boomer retirees, many pension funds are in danger of becoming insolvent. The state of California pension fund is facing an unfunded “pension time bomb” of $500 billion dollars.

In Minnesota the Minnesota Center for Public Finance Research and the Minnesota Taxpayers Association released a joint reportin 2006
that detailed the current condition of major public pension plans. The study analyzed the three primary pensions: MSRS or Minnesota State Retirement System General Plan; PERA or Public Employees Retirement Association General Plan; and TRA or Teachers Retirement Association. It revealed unfunded liabilities, and contribution deficiencies to each of the major plans. Prior to the release of this study in 2006 policy makers had passed laws to remedy these shortfalls, however the recent recession has been very hard on the financial bottom line for these funds, and each is in worse position than when the article was released.

One of the primary dangers of the pension shortfalls is that the approved fixes require increased local government contributions. According the 2006 report local governments throughout the state would have a $380 million dollar spending increase through the end of the decade. This was a challenging prospect even prior to the massive Minnesota state budget deficit that led to millions in local government aid cuts, but after local communities lost large amounts of revenue, it becomes even more complicated. Municipalities are faced with the thorny decision of cutting services or raising taxes, neither of which is a popular decision with citizens. One common, though contentious, solution currently being supported is to follow the lead of corporations and privatize the public employee retirement system. Supporters of this proposal point the potential cost savings in the long run as a reason to take this step, however, in the face union opposition, passing such a measure will take a severe pressure. However, the situation could reach crisis level in a few years as the projected budget deficit for the state is set to increase and even more baby boomers will be leaving the workforce and collecting their pension checks.

Water

There is a well researched problem regarding the the matching of costs and usage of public goods. This lack of cost appropriation can have big implications on the usage and supply of these goods. Nowhere is this mismatch more evident than in the supplying of a necessary staple, such as water, where the price needs to be accessible for lower income individuals, but if the price is too low, more affluent individuals may over-use water because it is supplied so cheaply. Activities such as lawn watering and golf course maintenance may be over-utilized due to the seeming vast supply and low cost (especially in areas like Minnesota where water is viewed to be an abundant resource).

Differences in natural endowments of water have forced municipalities to pursue different types of financing structures for supplying water. For instance, poorer countries may not be able to bear the burden of the cost of major infrastructure improvements, so they are turning to private companies to bridge the gap. This privatization of water is a charged debate. Public Citizen lists many reasons for the opposition of privatization, however the CATO Institute lists positive attributes of private water.



Minneapolis has the good fortune to have the ability to fund improvements to its water infrastructure and provide water as a public good to its citizens and some surrounding communities. Their distribution area includes Golden Valley, Crystal and New Hope, among others. The city recently opened a new ultrafiltration plant, which replaced a treatment facility built between 1913 and 1918. It's actually relative common knowledge that Minneapolis city employees are strongly discouraged from drinking or serving bottled water, due to the large investment in the ultrafiltration system. The mayors of San Francisco, Salt Lake City, and Minneapolis proposed a resolution at the U.S. Conference of Mayors in 2007 in support of using municipal water, and ridding offices of the bottled alternative. The resolution passed.

Perhaps not all cities benefit from natural abundance of water. Western states struggle to provide sufficient water to their residents. Public private partnerships have emerged, trying to provide water (and subsequent wastewater treatment) to residents without overburdening local governments, but also not completely turning the power over to private corporations. Perhaps a good middle ground.

The words of my Physical Geography professor are ringing in my ears, "You should go into water, that's where things are going to get really interesting in the future." Perhaps she was right. It's hard to imagine insufficient water, living in the land of 10,000 lakes. However, water IS a scarce resource that has historically been supplied publicly; perhaps this tide will turn in my lifetime.

can you put a price on safety?

Deciding whether or not to publicly fund a good or services requires thinking through several questions, including:
• Is the use available to everyone?
• Does it provide safety and public health?
• Does it provide for the general welfare of American citizens in society?

When talking about police security, many of the answers to the above questions are an obvious yes. But what happens when the cost of providing the public service becomes increasingly more expensive, thus draining more and more of an already strained state budget? And do we continue spending money to provide this service when only a specific proportion of the population directly sees the benefit?

We have a great recent example of this duality with the reappointment of Minneapolis Police Chief Tim Dolan in March of 2010. Minneapolis Police Chief Tim Dolan was reappointed for a three year term after an extremely close vote by the Minneapolis City Council; much of his criticism was due to the fact that the Minneapolis Police Department has gone over budget every year except one under Dolan’s leadership. In 2009, the Minneapolis Police Department went over budget by $4 million.

However, Dolan is commended for his actions in significantly reducing crime throughout Minneapolis, especially on the North side. The three north side council members stressed the importance of having the presence of police consistently in their neighborhoods as it provides a sense of security for the residents of the neighborhood. This sense of security is not as needed in neighborhoods located in southwest Minneapolis and hence, residents in southwest Minneapolis do not prioritize police presence as highly on their personal preferences as residents in north Minneapolis do.

Another great example of a significant reduction of crime at the expense of public funds is the Franklin Avenue corridor. The Franklin Avenue corridor in the 1990s was a battlefield of drug deals; anyone, including people from the suburbs, who needed a fix came to Franklin Avenue because they knew they could get their stuff. Thanks to the efforts of Teresa Carr and the Great Neighborhood Development Corporation, formerly known as the American Indian Neighborhood Development Corporation, and her partnership with the Minneapolis Police Department, the Franklin Avenue corridor has been completely revitalized. The partnership with the Minneapolis Police Department included creating a place where on-duty police officers could stop and check in with the base department while still staying in the neighborhood. Equipment was bought and placed in a leased space so that police officers could check in and continue to provide the neighborhood with the needed security.

However, while this effort completely revitalized the neighborhood, it was also a costly expenditure as the police space on Franklin Avenue is currently not occupied. After the significant decrease in crime, there has been a correlating decrease in continued police presence. Minneapolis police officers still patrol the area, but do not have a 24 hour "eyes on the street" presence as they did previously.

How do we compromise spending public dollars on a service that is primarily utilized by a specific proportion of the population? It is clearly evident that residents in high crime neighborhoods benefit the most from police presence and hence, are strong supporters of continuing this service, despite the fact that it may cost more than what was originally budgeted for. The argument then turns to residents in low crime neighborhoods: should they be paying more for a public service that they do not use that often and do not see the benefit of?

With the example of police presence in neighborhoods to prevent crime and increase safety, it is something that public funds will always be spent on. Despite the fact that expenditures may be over budget in certain years and people arguing that there is an inequality between the money paid and the benefit received, the police force will always be funded. I guess you can put a price on safety.

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.

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.

The overall tax revenue system of Minnesota

Minnesota unbalanced budget dates back to 2001 when the strong economy made the governor decide to cut the taxes and increased the spending of K-12 education. With the present floundering economy, the budget crisis is likely to continue in the coming several years. From the Senate Research, it is anticipated that the official FY 2010-2011 Budget deficit (spending exceeds resources) will be $1,203,000,000, and $8,095,000,000 for the FY 2012-2013. From the horizontal perspective, the overall tax revenue system of Minnesota is more regressive compared with other states; from the time series perspective, the demographic and economic factors will lead a volatile tax revenue in the next 25 years, which makes the long term budget instability even more difficult to manage.

An overlook of the tax structure of Minnesota, we can see the regressivity of the overall tax system: the top 1% income earners have the lowest income tax incidence, while the low income people pay the higher tax rate compared with the wealthier people. If we include fees into our consideration, the tax and fees burden that the low income people bear will become even larger because fees are more regressive and have grown faster than taxes. Except the individual income tax, all the other types of taxes are regressive.

2009 Minnesota Tax Incidence Studies

Income range	Effective tax rate
$35,005 & Under	12.4%
$35,006 - $53,483	12.6%
$53,484 - $72,133	12.6%
$72,134 - $91,043	12.2%
$91,044 - $113,259	12.0%
$113,260 - $144,456	11.8%
$144,457 - $201,166	11.3%
$201,167 - $346,507	10.8%
$346,508 - $951,731	9.6%
$951,732 & Over	8.5%

(Source: MN Department of Revenue)

Even though we have such a regressive revenue system, the current governor Pawlenty still ruled out a number of efforts to promote the tax progressivity, such as adding a fourth bracket of income tax and increase the tax rate of the wealthy class. It is a bad decision because it not only exaggerates the income inequality, but also blocks a way of increasing the government revenue to solve the imbalance budget.

Another budgetary problem has to do with the tax revenue instability in a long run. Several factors contribute to this phenomenon. First of all, demographic shift indicates that there will be a 30% jump in workers who turn into 62 beginning in 2008, while the worker population will become relatively fewer in the recent year. The ageing of population will strain the tax revenue as well as increases the expenditure to a large extent. Another reason is the slowdown growth of the tax revenue over the next 25 years. With the slower growth of the national and global economy in the coming years, it is expected that the growth rate of state revenue will become smaller too. Between 1996 to 2001, the growth rate of the state revenue was 6.8%, while between 2028 to 2033, the growth rate will decrease to 3.9%. The final concern is the volatility of the general fund tax. In the past decade, the general fund tax presented a very volatile pattern which becomes a threat to the tax sustainability. Among the three major revenue sources, corporate franchise tax is the most volatile and extremely sensitive to the economic change.

The current economic recession exerts such a devastating effect on the state and local public finance, causing all states to explore other alternatives to balance the financial bills. For Minnesota, the future challenge will be decreasing the regressivity and increase the stability of the overall tax system.

Overall Revenue Structure: Expanding and Enforcing Sales Tax

In an attempt to address budget shortfalls some states have proposed expanding current sales tax to include services and strengthening existing tax laws to regain lost revenue from internet sales. By pursuing these actions states could stabilize and grow their current tax bases to alleviate shortfalls in income and property tax caused by the recession.

For years states have been losing out on billions in revenue from online sellers that legally don’t have to collect state sales tax because they don’t have in-state property, employees, or sales representatives - otherwise known as “nexus” - in the state. In 2008, New York was the first state to enact a law to address this problem. A report by the Center for Budget and Policy Priorities highlights New York’s “Amazon law” as an important tool for states to consider in recapturing this lost revenue. The New York law has circumvented normal categories of nexus and extended it to include local web affiliates – bloggers, newspapers, nonprofit organizations and other businesses – that post links on their websites to online retailers and receive a commission when purchases are made through those connections.

Because the law only affects online sellers that operate using affiliates it only tackles part of the problem. A more comprehensive solution would have to come from federal legislation to grant states the ability to surpass the laws requiring physical presence.

Other states have proposed expanding their sales tax base by including services. Robert J. Kleine, the treasurer of Michigan, believes that this type of action makes sense in terms of updating an antiquated system. “The basic thing is that we need to update our tax structure,” he said in a recent New York Times “We’ve got a 20^th-century tax structure based on a different sort of economy. The tax base doesn’t grow as the economy grows.”

The update would create a substantial revenue source for states desperately in need. The Center for Budget and Policy Priorities estimates that a nationwide sales tax on services (excluding health care, education, housing ) is likely to generate $87 billion.

Research by the center also indicates that expanding the tax base to include services might also decrease volatility. While traditional sales tax bases are often dominated by big ticket items (like cars, appliances and furniture) whose sales decrease in times of economic downturn, research has shown that some services would not fall and raise as drastically in response to macroeconomic changes.

Proponents also sight that expanding the tax could increase economic efficiency. The current sales tax on goods subtly distorts the market and gives consumers an incentive to purchase services over goods. The Tax Foundation also notes that because most states have a number of exemptions on goods and services eligible items have to be taxed at a higher rate. By expanding the base, states could lower the the rate overall.

While reasons to tax services make sense to revenue hungry public finance departments and economists, Robert Levine illustrates political obstacles in expanding the tax. Levine was a consultant for a political candidate in Florida in the 1980s who proposed a sales tax expansion on services. Once news of the expansion got out it caused massive mobilization of already politically savvy professional organizations like lawyers, accountants and medical providers. What finally broke the legislation was the ad campaign waged by the advertising and media industries.