John Spry's Blog

St. Paul Pioneer Press (MN) – Sunday, January 27, 2013

Gov. Mark Dayton wants to tax the sale of food, clothing, and just about everything else you buy in the worst possible way.

His budget proposes a $2.1 billion, or 20.7 percent, sales tax increase.

Since everyone pays sales tax, everyone will pay Dayton’s sales tax increase.

But it’s worse than that.

Dayton’s tax plan violates the basic principles of tax reform.

It intensifies the pain of taxation by imposing hidden taxes on intermediate business purchases. This causes “tax pyramiding,” which is a big mistake.

According to non-partisan legislative researchers, “Standard tax policy principles argue that intermediate business purchases should not be subject to consumption taxation. This follows from the purpose of the tax, to tax consumption, and the principle of horizontal equity — i.e., to tax taxable consumption on an equal basis or only once.”

Dayton’s proposal to tax business services would hurt all Minnesota households by causing the sales tax to apply at several levels of a supply chain.

The same non-partisan researchers explain: “The result of this typically would be to pass the tax along in higher prices at the next level of production (e.g., a manufacturer who sells to a wholesaler). The tax burden ‘pyramids’ or cascades at each level, so that the total burden on the consumer is higher than the statutory or nominal rate.”

For example, a 5.5 percent sales tax on auto repair that pyramids twice would result in an 11 percent effective sales tax rate, but the consumer would only see a 5.5 percent sales tax rate on the receipt. The other part of the sales tax is hidden as higher consumer prices.

Dayton’s tax plan is harmful for small business and the people who will lose their jobs at Minnesota’s small businesses.

Large, vertically integrated businesses will not have to pay sales tax on legal, accounting and other in-house services. Small businesses using independent law firms or CPAs will have to pay sales tax on the same business functions. This inequity violates basic fairness.

It also makes Minnesota’s employers less competitive in a competitive, global economy.

Minnesotans will also lose their jobs to competitors in other states that don’t levy sales taxes on business-to-business services.

Dayton’s sales tax proposal would add more complexity to the tax code. It also would create new administrative and compliance costs. Yet, Gov. Dayton has not addressed how much it would cost to enforce his new business-to-business sales taxes.

Economist Alan Viard also warns, “The tax on inputs pyramids into the price of the final goods in an uneven manner, causing effective tax rates to vary across goods subject to the same statutory tax rate, which can distort consumers’ choices between different goods.”

Dayton’s sales tax proposal would add new sales taxes to the price of food in the grocery. The hidden taxes paid by all of the businesses from the farm to the store will be baked into price of every loaf of bread that you buy, even though food would be nominally exempt from sales tax.

Dayton’s budget creates new hidden taxes throughout the Minnesota economy.

Visible taxes make the tax burden clear so that citizens can compare the costs of taxation to the benefits of government services funded by taxation. Hidden taxes allow elected officials to camouflage the true cost of taxes.

Increases in hidden taxes are an implicit admission that greater spending might not pass a cost/benefit test unless the costs of the higher taxes are camouflaged.

As the Legislature considers the budget, they should ask whether each dollar of spending is worth imposing higher, visible taxes on all of their constituents.

St. Paul Pioneer Press (MN) – Sunday, May 19, 2013

Gov. Mark Dayton wisely urged Minnesotans to use facts in the budget debate in a speech to the Chamber of Commerce. Despite this sage advice, he continued to rely on a flawed analysis as an important rationale for his budget’s higher taxes.

“If the lowest taxes equaled the highest job growth and the highest per capita income, public policy would be clear and simple,” Dayton told the Chamber. “In fact, however, the opposite is true. If you look at the last chart, two pages of your handout, people living in the states with the lowest taxes generally have among the lowest per capita incomes. And those states have inferior job growth,” he stated.

Gov. Dayton’s data analysis has multiple statistical mistakes. One critical error is selection bias. He looks at a small subsample of the available evidence that was carefully cherry-picked, instead of drawing a conclusion from all of the available evidence.

Dayton showed data from only six states in one table and from only eight states in a second table before drawing the specious conclusion that these cherry-picked numbers prove that lower taxes equal lower job growth and lower per capita income.

New Hampshire, for instance, was clearly picked for one table to “prove” that New Hampshire’s low taxes lead to New Hampshire being 46th in job growth in 2012, while New Hampshire’s high per capita income failed to appear in the other table. Similarly, Dayton’s tables suggest that North Dakota’s job growth comes from its high tax collections, instead of the Bakken oil boom that has led to both North Dakota’s job growth and a gusher of energy-related tax revenue.

Dayton’s analysis also suffers from a tiny sample, a lack of statistical hypothesis testing, and the omission of any control variables. These serious statistical flaws mean that Dayton’s inference that higher taxes equal higher incomes and job growth is not supported by his methodology.

Most peer-reviewed research examining the aggregate effect of state taxes finds “a negative relationship between taxation and growth,” while a few papers “do not detect any significant negative impact of taxes on growth” according to a careful literature review by economists Ergete Ferede and Bev Dahlby in last September’s National Tax Journal. This literature review does not find a robust positive relationship between aggregate state taxes and income growth.

Research on the aggregate effects of taxes is complicated by several technical issues of data quality. Aggregate measures of taxes mix more- and less-distortionary types of taxes. Aggregation also conflates productive public expenditures with wasteful public expenditures.

Even careful analysis of the aggregate effects of typical state tax and spending patterns doesn’t provide the best guidance about the economic consequences of specific increases in taxes and spending.

A better way to understand the effects of higher taxes and spending is to consider each tax hike and spending program on a case-by-case basis.

Each dollar of government spending costs the private sector both the dollar taken from people in the private sector plus the economic damage from all the ways taxes distort decision-making.

People change their behavior in response to changes in taxes. Higher income tax rates are a disincentive to work, work overtime, or work multiple jobs. Higher income tax rates penalize education and on-the-job-training by lowering the after-tax rewards for investment in productive human capital.

At low tax rates, this economic damage from taxes is small. But at higher tax rates, these negative effects of taxes are larger.

The tax bills in St. Paul would increase effective marginal income tax rates above 50 percent for some primary earners and above 60 percent for affected secondary earners. In other words, these taxpayers would gain less than the government from additional hard work to earn another dollar of pre-tax wages.

At the proposed federal plus Minnesota income-tax rates, each extra dollar of government spending is likely to cost the private sector around $1.25 to $3. I applied standard economic formulas and the proposed tax rates to a range of estimated behavioral responses from other economists’ research to produce this imprecise estimate.

The logical case for higher taxes and spending requires explaining why the private sector should shrink by more than a dollar for each additional dollar spent by the public sector.

Gov. Dayton should lead elected officials from both parties to eschew flawed analysis in favor of careful enumeration and consideration of the real costs of additional taxes and the benefits of each spending program based on the best possible analysis.

John Spry of St. Paul is an associate professor in the Department of Finance at the University of St. Thomas. He’s on Twitter at @JohnASpry .

Did you know Minnesota is considering a 12.49% state income tax rate?  Or that some Minnesotans would face marginal income tax rates over sixty percent?

Let’s look at the numbers of how layers of taxes add up to effective marginal income tax rates over 60%:

Federal income tax rate             39.6%            (top tax bracket)

Federal FICA                            15.3%             (combined FICA tax rate up to $113,700 of each individual’s earnings)

Minnesota income tax               12.49%           (Revenue Estimate of a 8.49% tax rate + 4.0% surtax for the 2013 and 2014 tax years)

The combined effective marginal tax rate on secondary earners would almost never be equal to the simple sum of 39.6% + 15.3% + 12.49% = 67.39%.

This is because these hard-working taxpayers would better of deducting their Minnesota state income tax as itemizers on their federal taxes and because some of the FICA contributions may also be tax deductible.  However, even considering deductibility, the effective marginal tax rate would still be over 60%.

The type of taxpayer who would face effective marginal tax rates over 60% would be the secondary earner, filing jointly with their spouse who earned sufficient income to put the couple in the top federal tax rate, but as an individual makes under the FICA limit of $113,700.  For example a teacher, nurse, or home day-care provider filing jointly with a surgeon or successful owner of a business could have individual income below the $113,70 FICA limit, but enough joint income to be in the highest federal and Minnesota tax brackets.

Of course, the combination of several layers of taxes and phase-outs of government subsidies also produces extremely high effective marginal tax rates that can approach and exceed 100%!

Finally, Professor Steven Landsburg at the University of Rochester reminds us that “You Too Could Face 95% Taxation” from multiple layers of taxation on working now to spend when you are older.  (Source: Steven E. Landsburg, ‘‘You Too Could Face 95% Taxation,’’ The Wall Street Journal, March 15, 2011, p. A 22.)

On April 27, 2012, I provided the following written testimony about the Gambling Control Board estimates to the Minnesota Senate Tax Committee hearing on SF 2391: Providing for a New National Football League Stadium.

Dear Chairwoman Ortman and Members of the Committee,

I have been asked to provide some information about the economics of revenue estimates for your consideration by members of the Legislature.  My testimony and all errors are my own.

As Yogi Berra might have said, “forecasting is difficult, especially when it involves the future.”  Yet forecasting the gross and net receipts and change in state revenue from the proposed changes in lawful (charitable) gambling is especially difficult.  It is so difficult that no economist can claim accuracy in forecasting lawful gambling revenue from the gambling behavior of Minnesota consumers encountering new forms of gambling.

Forecasting sales of any new product launch accurately for decades is an impossible challenge.  In this case, it would require knowing how consumers will respond to the novel forms of gambling versus existing gambling.  It also requires knowing how paper lawful gambling receipts and lottery sales will fall due to the newly introduced forms of gambling.

The multiple Revenue Analyses for HF 1486/SF 702 and HF 2810/SF2391 show the difficulty of this estimation because of their wildly different guesses.  In several of the early iterations of Revenue Analyses, the Gambling Control Board said:

This estimate assumes that 50% of paper pull-tabs and tip boards would be eliminated in FY 2012, 75% in FY 2013, and by FY 2014 95% of paper pull-tabs and tip boards would be eliminated.

Then beginning in December 4, 2011 the Gambling Control Board said:

The introduction of electronic pull-tabs and electronic linked bingo will reduce the amount of paper pull-tabs sold by 20%.

There is obviously a large difference in revenue between the Gambling Control Board’s estimate that 95% of paper pull-tabs and tip boards would be eliminated and its estimate that 20% would be eliminated.  One thing we know for sure is that not all of the Gambling Control Board estimates can be close to being correct.

It is hard to understand how the Gambling Control Board estimated that the new forms of gambling would reduce paper lawful gambling but not have any negative effects on lottery sales and state revenue from the lottery.  Perhaps they just didn’t consider effects on the lottery in their estimation process.  This is a significant omission.

I am not able to vouch for the estimates provided to you from the Gambling Control Board.  Those Gambling Control Board estimates are highly uncertain.

In addition, reporters Elizabeth Dunbar, Marlys Harris, and Don Davis quoted me about the uncertainty surrounding forecasting revenue from novel forms of gambling.

The Minnesota Tax Expenditure Review Report (which I co-authored with Marsha Blumenthal, Laura Kalambokidis, P. Jay Kiedrowski, Judy Temple, and Jenny Wahl) agrees with economist Alan Viard’s call for treating state sales taxes as consumption taxes on final consumer purchases of goods and services.  The Tax Expenditure Review Report rejects tax pyramiding:

Economists and public policy analysts generally think of the sales tax as a consumption tax. As such, it should be levied only on sales to consumers, and not on sales between businesses. Taxing intermediate purchases – including capital equipment, office supplies, and building materials – will cause tax pyramiding as one business passes the tax cost along to the next. Ultimately, this creates an additional (and hidden) tax burden on consumers who purchase the final goods and products, as noted in a 2009 presentation to lawmakers:

Pyramiding occurs when a tax applies at multiple levels of business production and distribution. The result of this typically would be to pass the tax along in higher prices at the next level of production (e.g., a manufacturer  who sells to a wholesaler). The tax burden “pyramids” or cascades at each level, so that the total burden on the consumer is higher than the statutory or nominal rate. Pyramiding favors vertically integrated or larger businesses. These businesses can minimize the multiple levels of tax by performing functions – that would be taxable if purchased from a third party – with employees.  Pyramiding also undercuts statutory exemptions (e.g., the sales tax paid by grocers gets passed along in higher grocery prices, despite the exemption for food products) that are intended to reduce regressivity or exempt necessities.