Dayton's objections to now-vetoed tax bill stand on shaky ground

Long before he vetoed the 2018 tax bill Wednesday, Gov. Mark Dayton had been unsparing in his criticism of its substance. The focus of his anger has been the "misguided priorities for corporations" — how it emphasizes "tax cuts for corporations over real people."

There is no question that, at the federal level, tax reform has delivered large benefits for some corporations. But the claims of corporate favoritism in the now-rejected state measure deserve more scrutiny. State policymakers will still have to respond to the federal changes next year.

For starters, the claim of excessively favorable treatment of corporations doesn't match the reported numbers. Conforming to the federal government's broadening of the corporate tax base actually exposes more Minnesota corporate income to the state's tax rates. According to nonpartisan legislative staff, the vetoed tax bill was projected to increase Minnesota's corporate franchise tax collections by nearly $50 million in the state's next two-year budget cycle.

That doesn't exactly meet the test of a huge giveaway to big corporations.

What about the bill's phased-in state corporate tax rate reduction whose full impact would have extended beyond the state's budget window? According to a study by the accounting firm Ernst and Young, even if a state decides not to conform to any of the new provisions imposing a tax on foreign source income, the increase in the state corporate tax base from other federal conformity provisions is likely to average 10 percent. Applying that estimate to Minnesota means that even if we left foreign earnings alone, lowering the corporate tax rate to 8.8 percent would still have kept us revenue-neutral.

Since the tax bill did capture some of these foreign earnings and would have brought the corporate rate down to only 9.1 percent by 2020, there's an argument to be made that it would have increased state taxes on corporations over the long term.

It's the unwillingness of the Legislature to still more aggressively pursue taxing foreign profits that lies at the center of the governor's frustration and his arguments of corporate favoritism. Big bucks are certainly at stake. The governor has proposed adopting the federal government's new foreign earnings provisions, which would raise an estimated $378 million in corporate income taxes in the state's next budget cycle. That money was needed to fund the governor's proposed Working Family Credit expansion and tax relief for low-income families. The Legislature was unwilling to be as aggressive in laying claim to multinational corporate profits, and those priorities were left by the wayside.

Putting aside the administrative difficulties and challenges that a state would have with these provisions, there are basic constitutional questions in play regarding whether and how states can tax this income and whether such state taxation discriminates against foreign commerce. Sorting all this out will put tax attorneys' kids through college for years to come.

Worst-case scenario: Minnesota aggressively pursues these revenues and relies on them to fund permanent spending and individual tax relief only to find out they flunk constitutional or other legal tests. That would result in a double-whammy for the state's budget — leaving both a budget hole needing to be filled plus the potential for big corporate income tax refunds.

All of this is compounded by the existing, long-abiding challenge corporate income taxes present for state fiscal stability — their extraordinary volatility. According to Minnesota Management and Budget, state corporate income tax revenues are over two times more volatile than individual income taxes and nearly five times more volatile than the general sales tax revenues.

The real world complexities relating to corporate income taxation always have a tough time competing with political rhetoric. But good tax policy demands their recognition. With respect to tax conformity, prudent, fiscally responsible action would involve taking a big, deep breath and pursuing tweaks over time as some of these abundant constitutional, legal and administrative issues get worked out.

The fiscally irresponsible action would be to march full speed ahead and bank on hundreds of millions of inevitably litigious, uncertain, volatile — and in many cases one-time — revenues to pay for permanent spending increases and individual income tax relief. That would jeopardize the very fiscal stability the governor applaudingly wants to leave as his legacy.