St. Paul Pioneer Press (MN) – Thursday, May 14, 2009
Author/Byline: John Spry
Edition: St. Paul
Section: Editorial
Page: B8
Minnesota has the third-highest statutory corporate income tax rate in the industrialized world. If the DFL tax plan the governor vetoed were to become law, Minnesota would have the fourth-highest personal income tax rate in the nation. A majority of the Legislature wants to raise tax rates. Economic principle points to a better way.
Rather than raise taxes, Minnesota should reform its tax code by eliminating some inefficient taxes altogether and cutting rates on other taxes, while broadening the tax base (for example, removing some sales tax exemptions) to deliver revenue-neutral tax reform. Reforming the Minnesota tax system based on economic principle will deliver a more stable stream of revenue and strategically position Minnesota for economic growth in the hyper-competitive world economy.
A pro-growth tax code raises necessary tax revenue with minimal interference in the economic decisions made by individuals and businesses. The private sector is more productive when personal and business decisions are made for sound common-sense reasons, not distorted to minimize tax liability.
Tax distortions or bad tax-induced decisions are proportional to the square of the tax rate and the responsiveness of the tax base to taxation. This concept is routinely taught in undergraduate economics courses but largely unknown at the Legislature. This means that an incremental tax rate increase on already high tax rates creates more market distortion than the same aggregate tax increase spread over a broader base. High tax rates shrink the size of the state’s economic pie.
Raising additional revenue through higher tax rates on mobile taxpayers shrinks the private sector by significantly more than the revenue collected. Eliminating tax exemptions reduces distortions and opportunities for tax avoidance. Broader tax bases raise revenue at a lower cost to the tax-paying private sector.
The current combination of a 35 percent federal tax rate, 7.85 percent Minnesota tax bracket, and 2.9 percent payroll tax yields an effective tax rate after federal deductions of 43 percent. The Legislature recently voted to raise the highest Minnesota income tax rate to 9.0 percent.
A taxpayer facing a 43 percent marginal tax rate keeps only 57 percent of each incremental dollar of income. Such high tax rates discourage work, saving, investment, on-the-job training and continuing education. High tax rates penalize all of those socially desirable actions.
Our outdated system of a 53 percent rate of double taxation on corporate income has failed. (A corporation is taxed on its earnings and then individuals are taxed on their dividends by the federal and state governments.) Despite an uncompetitive 9.8 percent state rate, Minnesota’s budget forecasts only $450 million of corporate tax revenue for the next fiscal year. A high tax rate yielding a relatively low level of volatile revenue is the hallmark of a fatally flawed tax.
Further, the corporate income tax has the highest administrative cost relative to state receipts of any tax — yet those costs are dwarfed by the compliance cost for business. Compliance costs are particularly burdensome for small and medium-sized corporations. Ninety-six percent of Minnesota C-Corporations are small businesses with payrolls of less than $5 million.
A bit more insidious, the corporate income tax imposes hidden taxes on every Minnesotan. It is a tax the progressive think tank Growth & Justice recognizes as regressive. More than 90 percent of the net tax burden from the corporate tax is shifted onto the backs of Minnesota workers and consumers.
The corporate income tax already explicitly places a tax on the sale of food, clothing, prescription drugs, and medical devices produced and sold by Minnesota corporations. The current corporate income tax code involves multiplying corporate sales in Minnesota by the 9.8 percent tax rate. Eliminating the corporate income tax eliminates these hidden taxes. Expanding the visible state sales tax is more transparent and honest.
The current Minnesota sales tax statute exempts most consumer purchases of services despite the service sector growing to become 80 percent of Minnesota’s economy. More than 60 percent of Minnesota consumer purchases are currently exempt from the sales tax. The narrow tax bases and high tax rates in the current tax code are an outdated drag on economic growth.
Broader tax bases can finance tax rate reductions. Recognizing the growth of the service sector, the Legislature can make Minnesota’s tax system simpler with less distortion by reducing sales tax exemptions. Minnesota can collect necessary revenue without higher tax rates on hard work, productivity and investments in education and training.
Minnesota should reform its antiquated tax code to reflect our 21st-century economy. Eliminating the state corporate income tax and refraining from raising individual income tax rates would position Minnesota to compete globally.
John Spry is an associate professor in the Opus College of Business at the University of St. Thomas and a member of the Governor’s 21st Century Tax Reform Commission (www.taxes.state.mn.us/ mntaxreform/).