A new Minnesota Department of Revenue analysis showing how folks in the bottom half of the income ladder would bear the biggest tax increases under a proposal from Gov. Tim Walz turned out to be a big story last week, although it couldn’t have been news to anybody involved in tax policy.
That’s because a big piece of the governor’s plan is boosting taxes on gasoline to fund transportation improvements. A gas tax is really a textbook example of a form of tax that economists call regressive, meaning it takes a bigger bite out of the incomes of lower-income people than the well-off.
Before launching into a heated argument over how that could be fair, it might make sense to step back and first appreciate how Minnesota has one of the most progressive systems right now. That will still be true however this legislative session finally concludes.
Tax fairness seems to come up a lot in the spring, and not just because it’s when the state Legislature convenes. Every April I get at least one caller who suggests an article about the injustice of letting half of all Americans get away without paying any taxes at all.
That’s not really the case, of course, but people who call newspaper offices typically aren’t the type easily talked out of what they think they know for certain.
This notion comes from the federal income tax system, and as of the latest from the Tax Policy Center, about 44% of American “tax units” likely paid nothing in income tax last year. They simply didn’t make enough, though if they worked they still would have paid payroll taxes toward Social Security and Medicare.
The federal income tax system is what’s called progressive, meaning there are higher tax rates as a taxpayer moves up the income ladder.
That’s the distinction, whether or not a proposed tax is progressive, that seems to inform a lot of the argument about tax fairness.
And while the federal income tax system is progressive by design, things like state sales taxes and local property taxes are not. Some states have tax systems that seem designed from the get-go to make lower-income people pay the most.
Traditionally “low tax” states like Texas and Florida are high on the list of states with the most deeply regressive tax systems, at least as ranked by the Institute on Taxation and Economic Policy. But topping the list is actually the state of Washington.
The 20% of Washington taxpayers who make less than $24,000 a year pay nearly 18% of their incomes in state and local taxes. Taxpayers at the other end, the tiny sliver of all taxpayers making more than $545,000 a year in income, only pay about 3%. It’s hard to imagine a legislator, in Washington or anywhere else, standing up in a floor session to praise the fairness of a system that produces that kind of result.
The most burdensome tax for low-income people in Washington turns out to be a tax on businesses.
If that seems weird, welcome to the world of tax incidence research. This is an area that involves trying to figure out who actually bears the true cost of a tax, which is not always the person who files the tax return and sends the money to the state.
Those who push for higher taxes on businesses should consider that there’s a good chance a new tax will lead to lower worker wages, so it’s workers who are actually paying, or higher prices for consumers, making them really pay the tax.
In the case of a tax on things or activities rather than something like income, how customers react to higher prices once the tax is applied really matters.
If the price goes up and demand for the product dries up, then producers have to keep down any price increases to keep up sales. That means they are really paying for the tax.
On the other hand, if a new or higher tax drives up the price and customers keep buying anyway, then they are really paying.
By now you have already guessed how a gas tax lands. If the only practical way to get to work is by driving a car, the worker is going to buy the same amount of gas whether a tankful costs $2.80 per gallon or $3 per gallon.
It has been shown repeatedly that even though consumers may lap up every word written about gas price changes in the newspaper, the fact is prices really don’t matter. Consumer behavior barely budges.
And a gas tax is certainly regressive. If the executive chairman of Minnesota’s biggest company, UnitedHealth Group, paid as big a share of his income in gasoline taxes every year as I do, he would have to buy enough gas to drive the 3,800-mile round trip from the Twin Cities to Los Angeles four times every day.
It’s not just the gas tax in the governor’s plan that ends up being regressive, but it’s fair to point out that proposed changes to the income tax and estate tax push in the opposite direction, of making the system more progressive.
One thing that might be helpful for policymakers is to glance at another report released just last week on Minnesota’s tax policies, from the Minnesota Center for Fiscal Excellence. It described Minnesota’s as the most progressive income tax system in the nation, based on its analysis of the income tax situations of taxpayers with $20,000 of income vs. those with $1 million.
Arguments about tax fairness in St. Paul seem to have gotten out of hand, the center’s Mark Haveman said last week. Among other things that should also be considered in making tax policy is who benefits, he said, like how a well-maintained transportation system seems to be good for all payers of a gas tax.
And Haveman correctly recognizes that the context for choices like bumping the gas tax here also matters.
All forms of individual taxation paid by the taxpayer are by design progressive in Minnesota, he said, enough to offset the regressive impact of taxes on things like liquor and gas.
“That is a remarkable fairness accomplishment that this state has achieved with its tax system,” Haveman said, “that nobody recognizes.”