Governor Dayton’s budget uses taxes to solve about half of budget deficit

In the State Taxes and Local Aids and Credits portion of his budget, Governor Dayton proposes tax changes intended to help close the state’s budget deficit and reverse recent trends towards a more regressive tax system – that is, one where low- and middle-income Minnesotans pay a higher share of their incomes in total state and local taxes than the wealthiest Minnesotans. The Department of Revenue’s Tax Incidence Study projections for 2011 that find that, while on average Minnesotans pay 11.4 percent of their incomes in total state and local taxes, the wealthiest one percent of Minnesotans pay 8.8 percent.

Governor Dayton’s budget raises $3.3 billion in taxes in the FY 2012-13 biennium. In keeping with his priority on addressing regressivity, his largest initiatives are in the individual income tax, the only major tax based on ability to pay. These include:

• A new fourth income tax bracket, which would raise $1.9 billion in FY 2012-13. This “fourth tier” proposal applies a tax rate of 10.95 percent on taxable income above $150,000 for married joint filers. The Department of Revenue estimates that 5.5 percent of income tax filers would be impacted.
• A temporary additional three percent tax rate on taxable incomes above $500,000 (for all filing statuses). This proposal would raise $918 million in total during the three years it would be in effect (2011 to 2013). Less than one percent of all income tax filers would be impacted.

The Minnesota Department of Revenue has estimated the number of households who would pay higher taxes under the fourth tier and the additional three percent surtax in 2011, as summarized below. They note that federal deductibility will reduce the average tax increase and tax increase as a share of income amounts shown below by about one-third.

Concerns have been raised that the Governor’s tax proposals will lead to high-income individuals leaving the state. The research suggests that, while some may leave the state for tax reasons, the majority will stay.

Another common concern is how these income tax proposals would impact small businesses. It actually is difficult to know the impact on small businesses per se, but there is data on “pass-through” income, which is the kind of business income that shows up on the individual income tax. Department of Revenue analysis finds that only 11 percent of tax returns with pass-through income would be impacted by the fourth tier. (Want to understand more about businesses taxed on the individual income tax? House Research has a helpful issue brief.)

Governor Dayton’s budget also anticipates raising $30 million in FY 2012-13 from requiring more part-year residents to pay income taxes on a portion of their income. Currently, part-year residents who maintain a home in Minnesota need to be in the state for 183 days or more to be subject to the income tax. The Governor’s budget would reduce that threshold to 60 days.

Governor Dayton puts a high priority on not raising local property taxes, and his budget does not include any cuts to state aids to local governments or to state-paid property tax refunds to Minnesota residents.

Property taxes are primarily a local revenue source, but there is a statewide property tax paid by businesses and cabins. Governor Dayton proposes to add home values over $1 million to the statewide property tax, raising $80 million in FY 2012-13 and $108 million in FY 2014-15. The property tax would apply only to the amount of a home’s value over $1 million, at an estimated rate of about one percent.

Governor Dayton’s budget would raise $355 million through changes to the corporate tax and $31 million from sales and use tax changes. His goals in this area are “to close corporate tax loopholes, ensure that corporations that profit from sales to Minnesota also pay tax in Minnesota, [and] modernize statutory definitions to ensure the collectability of certain taxes.” Major initiatives in the corporate tax area include:

• Repealing Foreign Royalty Subtractions and Foreign Operating Corporation (FOC) preferences (raises $272 million in FY 2012-13)
• Indexing the minimum fees paid by businesses, raising $16 million in FY 2012-13. The brackets and fee amounts have not been adjusted since 1990. While the fees are increasing, the brackets are also becoming larger, so some businesses will pay lower fees while some will see higher fees. The maximum fee would rise from $5,000 to $8,690.

Minnesota uses federal law as the starting point for both the individual income tax and the corporate franchise tax. When the federal government makes tax changes, the state must decide whether to conform to those changes. Regarding federal conformity, Governor Dayton’s budget conforms to many of the changes in four federal bills passed since last legislative session, with a resulting loss of $42 million in state revenues over three years (FY 2011 to FY 2013). Where the Governor does not conform, the budget argues that doing so would be “too costly” or “would benefit only a limited number of high-income Minnesotans.” He continues the practice of not conforming to Section 179 expensing and bonus depreciation, and does not conform to the federal additional standard deduction for married couples, the repeal of the limit on itemized deductions and the phase out of personal exemptions.