A better state budget omits services tax

Minnesota can balance the state budget and improve vital public services without socking its service-based businesses with an extraordinary new tax burden. That's the Editorial Board's conclusion from a deep dive into state government balance sheets in the days since Gov. Mark Dayton's State of the State address.

Dayton deserves credit for initiating an overdue debate about tax reform when he advanced a $37.9 billion budget plan for 2014-15 on Jan. 22. But his plan contains an unacceptable flaw.

It would expand the sales tax in a way that would sorely burden businesses that sell services to other Minnesota businesses -- legal, engineering, accounting, advertising, computing and more. (And, yes, the Star Tribune would be among them.)

Dayton's plan would distort markets and put those businesses at risk, while also layering hidden taxes into the price of most things Minnesotans buy.

The DFL governor said on Feb. 6 that he'll entertain alternatives, provided they erase a $1.1 billion deficit in a lasting way and allow for renewed investment in education and infrastructure.

"No one would be happier than me to see a good Plan C," he said.

We take him at his word. Here's how our "good Plan C" would alter Dayton's Plan A while maintaining a progressive approach to taxation that asks more of all Minnesotans:

• Go easier on reducing the sales tax rate. Without the big sales tax base expansion to business services, Dayton's rate cut (from 6.875 percent to 5.5 percent) isn't affordable. A more modest cut, say to 6.25 percent, should still be possible.

• Scrap the $100 threshold on taxable clothing purchases. Tax 'em all, as all but four other states with sales taxes do. Adding clothing to the sales tax makes it less regressive, because average consumer spending on clothing rises with income. It also makes the sales tax a more stable source of revenue.

But shield low-income families with a credit. Sen. Ann Rest has a well-crafted approach that adjusts for family size and, at our 6.25 percent rate, would spare low-income adults from the tax on up to $480 in yearly clothing purchases.

Legislators might make one concession to the Mall of America: a kiosk at the airport that dispenses sales tax rebates to out-of-state customers.

• Scale down and revamp the property tax relief features. Dayton has proposed the most populist of relief plans -- $500 refunds each year for every homeowner. That spreads state money to the deserving and undeserving alike, eases pressure on local governments to constrain spending, and costs the state treasury a whopping $1.44 billion in the next two years. (It wouldn't be that generous to taxpayers, however. They would be obliged to declare the rebate as income for federal tax purposes, and send a sizable portion of it to Washington.)

The circuit breaker could use an upgrade. Taxpayers should not have to wait until August for help paying a bill that comes due in May.

For the sake of property tax constraint, Dayton also beefs up direct aid to cities with a new formula that's beneficial to first-ring suburbs. We like the formula but prefer a price tag about a third the size of Dayton's.

• Slow down the corporate income tax rate reduction. Dayton is right to finally end the preferential treatment of income corporations derive from royalties and operations overseas. That good 1987 policy went bad when businesses learned to use it as a tax dodge.

But a still-unbalanced budget argues for caution in cutting the corporate tax rate from 9.8 percent to 8.4 percent, as Dayton recommends. A 9.4 percent rate would be more affordable for the next two years, and would allow for enlarging a "loophole" that appears to be producing good results -- the tax credit for research and development. Further cuts in this regressive, volatile, hard-to-administer tax should be a goal for future years.

• Add an alcohol tax increase, and up the ante on tobacco. The high public costs associated with tobacco and alcohol use, plus the deterrent effect of higher prices, more than justify an increase in "sin taxes." Dayton recommended a 94-cent-per-pack increase in cigarette taxes; we prefer state Rep. Ann Lenczewski's proposal for a $1.60-per-pack increase.

• Go easier on higher income taxes for the rich. Dayton won the 2010 election saying he would solve the state's fiscal troubles by raising income taxes on the state's top earners. He and his party can claim political justification for a new, high-rate "fourth tier" for that portion of adjusted taxable incomes exceeding $250,000 for married joint filers.

The policy justification for this move is weaker. Dayton correctly notes that top earners pay a lower effective total tax rate than middle earners. But the same is true in most of the states with which Minnesota competes for jobs. A new top rate will put this state at competitive disadvantage in both attracting and retaining talent.

Yet without a boost in the state's only progressive tax this year, the burden of our plan would fall heavily on people who can least afford to pay higher taxes. An income tax increase for those most able to pay is in keeping with Minnesota's history, culture and abiding sense that "we are all in this together."

A recent Citizens League survey of 274 participants in their Common Cents workshop series found them more likely to judge tax fairness on "how much people can afford to pay" than any of seven other criteria.

We propose to reduce Dayton's proposed 9.8 percent top rate to 9.4 percent, matching our plan's corporate rate. Many of those top personal rate payers are actually small businesses. The most successful among them should face the same state income tax rate that larger businesses pay.

A new state budget forecast is due on Feb. 28. If it shows more revenue available in 2014-15, we would reduce both of our recommended corporate and fourth-tier personal income tax rates.

We'd also urge Dayton and the Legislature to seek more ways to apply the standard recipe for tax reform -- broaden the base, lower the rate -- to those competitively worrisome taxes.

---------------------------