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Minnesota’s Taxes are High. Are They Too High?

Republicans in Minnesota often focus on the state’s high taxes, while DFLers focus on all the services the state delivers for that money — a divergence was put on display at the Minnesota Capitol this week.

Minnesota’s Taxes are High. Are They Too High?
Jared Walczak, the Tax Foundation's senior policy analyst, and Minnesota Center for Fiscal Excellence executive director Mark Haveman speaking to the Senate Taxes Committee. (Photo: Peter Callaghan)

Legislators of both parties concede that Minnesota is a high-tax, high-service state: While it raises a lot of money, it also ranks highly in the stuff that tax money pays for.

The difference between the sides is one of emphasis. Republicans tend to focus on the high-tax part, DFLers on the high-service part. As recently as the 2018 election, DFL nominee for governor Tim Walz argued that Minnesotans just want to know what their taxes are paying for — and that what they’re getting is worth it. His GOP rival Jeff Johnson wondered why Minnesota couldn’t do just as well being in the top 10 or top 15 states in taxation, rather than the top five.

That divergence was on display at the Minnesota Capitol this week, when the Senate Taxes Committee heard from two non-governmental analysts. The point of the hearing before the GOP-controlled Senate committee appeared to be to highlight the high taxes part of the age-old debate. But the testifiers, despite coming from national and state groups friendly to business and a free market point of view, offered a more nuanced perspective of Minnesota’s tax policies.

Jared Walczak, a senior policy analyst for the Washington, D.C.-based Tax Foundation told the members that Minnesota ranks 43rd in its state tax climate index, which seeks to compare how well states structure their tax systems. “Frankly, we don’t rank Minnesota very well,” Walczak said. “Forty third overall, including 42nd on corporate rates, 46th on individual and more middle-of-the-pack on sales, property and unemployment [taxes].”

Income of just $26,521 is taxed at the rate of 7.05 percent, he said. “That is more than the top rate in 10 states. …  And 9.85 percent as the top rate is the fourth highest in the nation after only California, New Jersey and Oregon.”

Minnesota corporations pay the sixth highest rate among states, he said. “And yet, for many businesses, this hasn’t mattered much. Again, 19 different companies here are on the Fortune 500, many of them in manufacturing. Most of the states that rank poorly on our index, I can point to a lot of adverse consequences,” he said. And even with the state reporting Thursday morning that the surplus had fallen by nearly a third, to $1.05 billion, “there are many states that would be very happy to trade places with you and where you will continue to be.”

Concluded Walczak: “You are a progressive tax state. You are a high tax state. You also are a state that has prioritized good government and it has worked. There are a lot of reasons why people like to be here. But it is not limitless, especially if the amount of income subject to taxation is a lot higher than it has been in the past.”

That last comment was in references to changes in Tax Cuts and Jobs Act, the federal tax reform law passed in 2017. Minnesota is just one of seven states that has yet to sync its tax code with that law, a process known as conformity, which states do after any federal tax law change.

Tax conformity could be done this year by Minnesota’s divided Legislature, but it will almost certainly come after state taxes have been paid. Any changes made after filing could trigger refunds for state taxpayers.

“You have fairly high taxes, certainly fairly high rates, among the highest in the country,” Walczak said. “It’s been working pretty well for you. But now you’re perhaps at a crossroads because of the tax conformity issue.”
 

The pinch of SALT

Mark Haveman, the executive director of the Minnesota Center for Fiscal Excellence, urged the committee to put simplicity for taxpayers and tax administrators at the top of its priorities, even if will be harder to align the state with the new federal law this year than most.

“That shouldn’t negate the idea that making the tax system simpler and easier to deal with and less costly for both taxpayers and the state doesn’t deserve priority attention in any conformity decision,” Haveman said.

The biggest change coming out of the federal tax bill is the $10,000 cap on the deduction that taxpayers filing itemized returns can claim for paying state and local taxes. The new law also doubled the standard deduction from $12,000 for a married couple to $24,000, making it less likely middle-income taxpayers will itemize at all.

But the cap on state and local taxes, known as SALT, leaves more income exposed to both state and federal taxation and is more likely to impact higher earners. Haveman says the federal tax reform “effectively raised the top marginal rate of every state with an income tax. But I think the magnitude of that change may come as a surprise to many.”

“The SALT deduction repeal in effect raised the tax price of progressive state income taxes by almost 40 percent for taxpayers in the highest bracket,” he said.

In Minnesota, according to legislative tax staffers, that would have the effect of raising its top rate from 9.85 percent to 16.3 percent.

The cap on SALT has led some governors of other high tax states to urge changes. New York Gov. Andrew Cuomo, for example, met with President Trump this month and has claimed the impact of the cap is causing high-earners to flee the state.

Both Haveman and Walczak said it is hard to measure how taxes impact relocations of individuals or businesses. But both said it could become more of a factor with the changes to the federal tax laws. “Obviously it’s an ongoing debate about what taxes do or do not do with respect to location decisions,” Haveman said. “That debate is usually dominated by whether people or activities leave the state. But I think it is potential for in-migration of capital and talent that is deserving of as much if not more attention.”  

Sen. Eric Pratt, R-Prior Lake, cited a string of departures of corporate headquarters to other states or other countries, including Honeywell, Medtronic, Norwest Bank, SuperValu, Buffalo Wild Wings and now TCF Bank. “To me that’s a disturbing trend that says our corporate headquarters, which add a lot of value to our economy and to our communities, are finding better options,” Pratt said.

Yet Walczak said some of the companies Pratt cited moved due to mergers with other companies, not simply because they were fleeing high taxes.  “It’s one of the easiest points to move a firm because you’re already going to have to move someone,” he said. “It’s not easy to move a corporate headquarters, but if you have to move one of them anyways you’re going to take these things into consideration.”

For individuals, the lack of full SALT deductibility doesn’t impact lower income earners as much as higher income earners, who have more ability to vote with their feet. “The question will be at what point do you see mobility?” Walczak said. “You are going to see a significant increase in effective rates and top marginal rates. And decisions are made at the margins for your higher earners, some of whom have significant mobility and could move.”

Yet Sen. Melisa Franzen, DFL-Edina, reflected the high-service argument of many Democrats in arguing that businesses and people appreciate good services. “When people and businesses come here, they’re not doing us a favor to pay their taxes,” she said. “They know what they’re getting in return with the investments that we make in our roads and bridges and education and workforce. We still have a ways to go but compared to other states, I’m sure we are at probably the top in terms of having 19 Fortune 500 companies and so many others. They’re here paying taxes because of something that we offer.”
 

‘Minnesota … takes its progressive ethic very seriously’

Haveman told the Senate committee that the state has high rates of income taxation but protects lower-income taxpayer well and collects far more of its income taxes from wealthy residents than from lower-income ones. A state analysis showed that in 2014, the top fifth of state households that had 58.5 percent of total income paid 75.5 percent of individual income taxes.

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The rate for a married couple with taxable income of $35,000 is the lowest in the U.S., something Haveman attributed to the state’s generous working family tax credit. “At the other end of the spectrum, Minnesota’s married joint-filer at $1 million is the fourth highest in the nation, paying 48.7 percent more in the net tax than the U.S. average at that filer level,” he said.  

Haveman said he doesn’t think it is fair for critics to say the state doesn’t do well by its lower income earners, at least where income taxes are concerned. “I would argue that Minnesota obviously takes its progressive ethic very seriously,” he said. “People may argue we need to do more for them, but I always get concerned when it is presented as an issue where Minnesota is abdicating its responsibilities. There’s nothing in our tax system that suggests that past legislators haven’t done a very good job of addressing ability to pay concerns.”

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