Tax reform has trod a tortured path at the 2013 Legislature. But the right kind of reform — lower the rates, broaden the base, close the loopholes, avoid hidden tax “pyramids” — emerged in the Senate on Thursday, reviving hope that a tax system better suited to the 21st century yet could become law this year.
Senate Tax Reform Division chair Ann Rest has fashioned a package of changes in sales and corporate income taxes that’s laudably ambitious. But she avoided the broad overreach into business services that felled Gov. Mark Dayton’s tax reform proposal earlier this year.
Dayton seemed to lose interest in tax reform after his plan hit a wall of opposition. We hope he’s recovered sufficiently from those bruises to give the Senate’s approach a hard look. It includes features that tax reformers (and this newspaper) have recommended for years to improve the state’s competitive position and stabilize an overly volatile revenue stream. They include:
• A lower sales tax rate. Rest’s package sets the rate at 6 percent (including the tax earmarked for natural resources and the arts), down from 6.875 percent today. That would move the rate from 17th-highest in the country to 36th, according to a 2011 Tax Foundation ranking.
• A broader sales tax base, reaching a bigger share of the purchases made in a modern economy. Included are digital books, music and videos, over-the-counter drugs (unless prescribed by a doctor), personal grooming services, athletic instruction, auto and machinery repair — and the big one:
• A sales tax on clothing. Minnesota is one of only four states that does not include clothing in its sales tax base. It’s an obvious way to bolster and stabilize state revenues without sustaining major competitive damage. Rest would spare lower-income Minnesotans with a refund of the clothing tax that adjusts for both income and family size.
• A sales tax exemption for local governments, breaking the illogical cycle of local governments taxing property owners to pay state sales taxes so that the state in turn can provide local property tax relief. Business purchases of capital equipment are also made exempt from sales taxes at the time of purchase, rather than via a clumsy and costly refund.
• A sales tax collection requirement for more online sellers. States have limited ability to force online retailers to collect the sales taxes owed on their sales. But where Minnesota can act, it should.
• A lower corporate tax rate. Few Minnesota corporations pay the state’s full 9.8 percent corporate income tax rate, but those that do are paying the third-highest state corporate rate in the nation. Rest would take the rate to 9 percent, which would tie Minnesota with three other states for fifth-highest rate, according to the Tax Foundation.
• Smarter corporate tax policy. Under Rest’s plan, the foreign-operations deduction and foreign-royalty subtractions that have been decried as a tax dodge would be eliminated. In their stead would be a bigger credit for Minnesota-based research and development operations. That would reward job creation at home rather than abroad.
• A tobacco tax increase that would deter smoking, especially among teens. The proposal would add 94 cents to the price of a pack of cigarettes — a position Dayton shares.
Rest said her aim is to eliminate aspects of the tax code that distort economic behavior and to “stop the chatter” about Minnesota’s uncompetitively high sales and corporate tax rates. That chatter isn’t just annoying: It’s damaging to Minnesota’s brand as it seeks to keep and attract investment.
But if that’s true for sales and corporate taxes, it true in spades for the piece of the Senate’s tax puzzle that has not yet appeared, the personal income tax. It’s clear that the Senate’s DFL majority contemplates an income tax increase for Minnesota’s top earners to end a decadelong cycle of deficits and improve investment in education. What’s not clear is how many top earners will be affected, and how much they’ll be asked to pay.
Senators and their House counterparts, who are due to release their tax ideas this week, would do well to apply the standard tax reform formula — “broaden the base, lower the rate” — to their income tax ideas as well. Dayton has proposed a steep, top-tier income tax rate — 9.85 percent — to only that portion of taxable income that, for married joint filers, exceeds $250,000. That’s the top 2 percent of the state’s income tax filers. Broaden its reach only a little, say to the top 5 or 6 percent of filers, and a rate closer to 9 percent would raise the same amount of revenue without as much competitive sting.
Dayton is keen to spare middle-class Minnesotans from higher taxes. But with median household income in the state pegged at $56,954 in the latest U.S. Census reckoning, it’s clearly possible to slightly expand the reach of an income tax increase for upper-earners and still shield the middle class. What should be clear is that if lawmakers raise taxes in a way that diminishes this state’s future prosperity, no Minnesotan will be shielded from the consequences.