The Minnesota Governor’s 21st Century Tax Reform Commission testified to the Minnesota Senate Tax Committee on February 25, 2009. Here is the video of the hearing: Minnesota Governor\’s 21st Century Tax Reform Commission Senate Hearing 2009
Here is a summary of the 21st Century Tax Reform Commission’s Recomendations.
I testified about “The Economics of Taxation and Dynamic Scoring” to the Minnesota Senate Tax Committee on March 3, 2011.
Here are my PowerPoint slides for the hearing: Economics of Taxation and Dynamic Scoring
The video of the hearing: Minnesota Senate Tax Committee Hearing on Taxation and Dynamic Scoring
I testified about “The Economic Effects of the Minnesota Corporate Income Tax” to the Minnesota Senate Jobs and Economic Growth Committee on March 1, 2011.
My written testimony: Statement of John Spry, Senate Jobs and Economic Growth Committee March 1 2011
The video of the hearing: Minnesota Senate Jobs and Economic Growth Committee Hearing March 1, 2011 (My testimony runs from 23:00 to 52:45).
By John Spry
St. Paul Pioneer Press (MN) – Sunday April 1, 2012
The United States now has the highest statutory corporate income tax rate in the industrialized world since Japan, as of April 1, has cut its rate to 35 percent.
That’s not an April Fool’s Day joke, but it is a foolish tax policy.
Our 41.4 percent combined-federal-plus-Minnesota corporate income tax rate is 66 percent higher than the average rate in other industrialized nations.
That large, uncompetitive tax gap hurts American workers through “reduced employment opportunities and lower wages” according to President Obama’s Job Council.
Yet, U.S. corporate tax revenue is below average, compared to the size of the economy, because the high rate discourages taxable investments and because of the many special tax credits, deductions and exclusions in the tax code.
Each dollar of corporate income tax revenue costs the private sector around $2 in economic damage, according to economist Jane Gravelle of the Congressional Research Service.
Over $40 billion a year is wasted filing and auditing corporate tax forms. We are completely wasting resources that could go toward productive, job-creating investments.
The United States has an indefensible corporate income tax code because Washington has paid too much attention to special tax preferences for specific firms and industries and too little attention to the changing world economy.
“In a global economy in which capital can move easily across borders, differences in corporate tax rates have a growing influence on where multinational companies decide to invest,” says the President’s Job Council. “Yet while most of our competition has reduced their rates significantly over the past three decades, corporate income taxes in the U.S. have changed very little. Broadening the tax base would simplify the tax code and enable the U.S. to lower the corporate income tax rate to internationally-competitive levels,” according to the President’s Job Council.
The current tax code foolishly favors debt financing over equity financing. It imposes a double tax on equity first at the corporate level and again when dividends are paid. Yet, interest is tax-deductible.
The effective corporate tax rate on equity financed investments is slightly higher than the statutory rate, while the effective tax rate on debt-financed investment is negative.
The history of Northwest Airlines provides a case study of the problems with subsidizing debt. Al Checchi saddled Northwest with massive debt in his 1989 leveraged buyout. Northwest got the tax benefit of deducting the increased interest payments, while using the threat of bankruptcy due to the new, staggering debt to win lower wages from its workers and a large bailout from the State of Minnesota.
Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank, suggests broadening the tax base by “replacing the corporate interest tax deduction with a lower corporate income tax rate. The lower corporate income tax rate would encourage business investment without simultaneously providing incentives for corporations to acquire leverage.”
The United States should lower its corporate income tax rate below the international average of 25 percent, while ending tax preferences for politically favored activities. The tax code should raise necessary revenue to run the government while imposing the smallest possible administration, compliance, and efficiency costs on people.
Corporate tax reform is about more than just equalizing tax rates for different types of business investment or making life simpler for accountants and auditors. Ultimately, tax reform is about the fundamental relationship between citizens and the government.
When the government picks winners and losers through the tax code, the political establishment wins more power over the private sector economy. The Washington, D.C., area becomes more prosperous than the nation as whole. The free enterprise system is replaced by the soft corruption of crony capitalism. People start to question whether financial success is due to successful competition to serve customers or the result of special favors from the government.
The politics of tax reform are challenging since every lobbying group with a sweetheart deal in the tax code, from heavily indebted industries to the green energy lobby, will fight hard to defend their group’s tax preference.
Only a focus on the real costs to people from our uncompetitive tax code has a shot of making tax reform possible. As we better understand the lower wages and lost job opportunities caused by our current tax code we increase the odds of reforming the tax code.
John A. Spry is an associate professor in the Department of Finance at the University of St. Thomas. Find him online at twitter.com/johnspry
By John Spry
St. Paul Pioneer Press (MN) – Sunday June 20, 2010
Rhode Island is passing Minnesota in the race for mobile workers, entrepreneurs, and job-creating investments. Its decision to do so could provide a roadmap for a major tax reform in Minnesota.
Rhode Island’s legislature unanimously voted to reduce its highest income tax rate from 9.9 percent to only 5.99 percent. That’s a 40 percent reduction. It will move Rhode Island from the nation’s fourth-highest income tax rate this year down to 25th place next year. Policy-makers believe it will help make Rhode Island much more competitive in attracting businesses — and jobs.
Rhode Island’s reasoning and the structure of its reforms could be instructive for Minnesota, which currently has the ninth-highest personal income-tax rate in the nation (7.85 percent).
The new Rhode Island tax code has a larger standard deduction of $7,500 for individuals, $15,000 for married couples; a $3,500 personal and dependent exemption; and three tax brackets: below $55,000, 3.75 percent; $55,000 to $125,000, 4.75 percent; over $125,000, 5.99 percent. It eliminates the state alternative minimum tax. The deduction and exemptions are phased out for higher income taxpayers.
Rhode Island pays for the reduction in tax rates and increase in the standard deductions by widening the income tax base. Rhode Island’s reform eliminates itemized deductions and limits tax credits. It keeps only eight tax credits, including a property tax credit and the earned income tax credit for lower income families. The number of tax brackets is reduced from five higher tax brackets to three lower brackets.
Eliminating itemized deductions makes the tax code more “transparent, easier to administer, and easier for taxpayers to understand,” according to Rhode Island Senate President M. Teresa Paiva Weed, a Democrat.
Many itemized deductions, like the home-mortgage interest deduction, seem politically popular. However, Rhode Island’s 68-to-0 House vote and 35-to-0 Senate vote demonstrate that lower tax rates can be more important than maintaining tax preferences.
Rhode Island’s unanimous tax reform shows how a coalition can be assembled to lower tax rates by widening tax bases. Every Democrat in the Rhode Island legislature was willing to support significant pro-growth reduction in tax rates because he or she recognized the benefits of lower tax rates in today’s competitive economy. “We are living in a mobile global economy. There are those people who will embark upon entrepreneurship … and they will shop around,” said Democratic State Sen. Daniel DaPonte.
House Speaker Gordon Fox, also a Democrat, commented, “This significant tax-reform legislation sends a loud and clear message to all other states that Rhode Island is aggressively seeking to attract business, create new job opportunities and ensure that our economy is moving in a positive direction. Combined with other bills we have passed this session to streamline our regulatory and permitting process, we have taken major steps toward becoming a business-friendly state.”
Republican Gov. Donald Carcieri and every Republican in the legislature were willing to end tax deductions in order to achieve significant reductions in tax rates. Gov. Carcieri called it “a clear message to our citizens, businesses, and neighbors that we are serious about improving our tax competitiveness.”
Will Minnesota follow Rhode Island’s lead by cutting our tax rates while simplifying the tax code by eliminating tax preferences?
Minnesotans face a choice about taxes in the fall election campaigns. The decision involves both tax rates and tax bases. Are Minnesota’s tax rates too high or not high enough? Are lower tax rates worth eliminating tax deductions? Or should we raise tax rates and create new tax loopholes? Is it better to pick winners and losers through the tax code or follow the example of Rhode Island’s tax reform?
Candidates should clearly explain their position on these issues. They should also explain how their tax policies would create an environment for job creation and economic growth.
Perhaps Minnesotans will agree with Democratic Rhode Island State Rep. Steven Costantino: “This is the moment that we can change our reputation” as a high-tax state. “Let’s tell our neighbors, ‘We are ready to do business.'”
John Spry of St. Paul is an associate professor in the department of finance at the University of St. Thomas.
Example: Single parents with modest incomes in Minnesota can face ‘effective marginal tax rates’ over 100%
By John Spry
St. Paul Pioneer Press (MN) – Sunday May 9, 2010 – Page B9
Are we still a society that values honest work?
Our state and federal laws provide an unpleasant answer. Our tax code imposes punishing tax rates on work. Working more to increase pre-tax income can actually reduce a family’s take home pay.
The “effective marginal tax rate” is a technical term for the fraction of an additional dollar earned that is lost to taxation. It is a measure of the bite that taxes take out of your paycheck when you work a little more.
Too many Minnesotans face effective marginal tax rates that approach and even exceed 100 percent because of compounded taxes on top of other taxes and a mish-mash of social service programs.
High marginal tax rates create a disincentive to earn by reducing the rewards for work. Over time, these high effective tax rates debase our culture by undermining the virtue of hard work.
How can working more actually reduce take-home family income?
There are at least 16 federal and state programs in Minnesota to transfer cash and non-cash benefits to households with low or moderate incomes. Each of these programs has its phase-outs that “claw back” benefits as these households work more and increase their pre-tax income.
Phase-outs increase effective marginal tax rates. So the cumulative effect of households facing several program and tax phase-outs simultaneously can create what effectively is a tax rate of over 100 percent on additional income.
A study by the non-partisan Minnesota Taxpayers Association (MTA) provides a concrete example. Consider a single parent of two children who works more to increase gross family income from $33,000 to $34,000. The effective marginal tax rate from the federal and state earned-income tax credit phase-outs are about 21 percent and 10.3 percent, respectively. These rates reduce the family’s tax credits — in effect, its income — by about $210 and $103. In addition, benefits from the Basic Sliding Fee child-care program are reduced by $1,692 because of the sliding fee.
Thus, the reward for earning an additional $1,000 in gross wages is a reduction in take-home family income of $1,005 because of the combined effects of these three programs.
High tax rates are unfair to people seeking to help their family by working harder. A Minnesota House Research study found that — given the intersection of our tax system with various social programs — the average effective marginal tax rate for a single parent with two children and income between $23,500 and $41,700 was 104 percent. On average, working overtime to earn an additional $1,000 in gross income reduces household after-tax income by $40.
These programs and the tax code were created over time by different committees in St. Paul and Washington, D.C. There was no attempt to measure the compound effect of different sections of the tax code and the phase-outs of various programs on the incentives of real people to work. These disincentives to work are a barrier to opportunity and social mobility because working more or getting a better paying job means higher tax payments instead of higher after-tax income.
A rededication of society to the simple principle that work should pay is the start of a solution to the disincentive-to-work problem.
If society values work, then we should reward work by reducing effective marginal tax rates. This will require tax reform to broaden tax bases by ending tax loopholes while lowering tax rates. It also will require an overhaul of our social service programs. We need to examine Minnesota’s social programs as a whole system. A redesign of social programs could lower effective marginal tax rates for everyone below 50 percent.
Everyone should benefit from their own hard work by keeping the fruit of their labor.
John Spry of St. Paul is an associate professor in department of finance at the University of St. Thomas. Background on this subject can be found on the Web at: www.taxadmin.org/fta/meet/06re_data/pres/Wilson_low-income.pdf and at http://www.mntax.org/cpfr/disincentives.php
St. Paul Pioneer Press (MN) – Thursday, February 4, 2010
Author/Byline: John Spry
Edition: St. Paul
Section: Editorial
Page: B9
We should all agree that we want a more prosperous Minnesota. Here are two specific reforms that will strengthen Minnesota’s economy
— End the state income tax exemption for interest on Minnesota municipal bonds.
— Use the revenue from closing this wasteful tax loophole to cut our high state corporate income tax rate.
Understanding how these reforms will make Minnesota more prosperous is just as important as the ideas themselves. The path to a more prosperous future begins with understanding the process of wealth creation.
Wealth is created when lower-value resources are combined to create a product or service that is worth more than its cost of production.
In the private sector, workers, investors, inventors and businesses combine their resources, knowledge, and effort to supply consumers with a cornucopia of products and services. Competition forces businesses to create value for society. If a business cannot sell its product at a price that covers its costs, it will not survive in the marketplace.
The free enterprise system is dynamic and decentralized. It spontaneously produces and rewards innovations that improve product quality or reduce costs. New inventions and production methods replace dated ideas and organizational structures in the private sector. This constant innovation, spurred by competition, is a major source of economic growth.
The public sector can also create wealth when it takes resources and combines them to produce more value than the cost of the public expenditure. For example, local governments combine a system of sirens with information about severe weather threats from the federal National Weather Service to provide life-saving warnings.
Unfortunately, the public sector is not nearly as nimble and dynamic as the private sector. Government policies that destroy wealth for Minnesotans can persist for decades.
Both the Minnesota municipal bond interest exemption and the state corporate income tax waste valuable resources for Minnesotans. These policies make us poorer by providing tax incentives to divert precious investment dollars away from more socially productive projects.
The Minnesota municipal bond income tax exemption creates a balkanized market for Minnesota state and local bonds because the tax exemption applies to only some of the potential investors in Minnesota municipal bonds. This loophole provides an incentive for investors to divert capital away from the private sector. It also encourages local governments to issue debt inefficiently just to capture some of the implicit state subsidy from the municipal bond exemption.
Economists Mary Lovely and Michael Wasylenko find that Minnesota gives up approximately $1 in lost state income tax revenue from this loophole for each 50 cents in reduced government borrowing costs.
There are good legal reasons to phase out the municipal bond exemption when new bonds are issued to honor the commitments Minnesota made when issuing existing debt. The revenue raised from phasing out this loophole can fund a reduction in the Minnesota corporate income tax rate.
A corporate income tax acts to throw sand into the gears of private sector. As the non-partisan Congressional Budget Office notes, “The domestic distortions that the corporate income tax induces are large compared with the revenues that the tax generates … The corporate income tax has the potential to distort economic incentives and generate inefficiency in at least six ways.”
My cautious review of the academic literature reveals that each dollar of state corporate income tax revenue reduces payrolls by approximately $2. There is not a consensus on the exact size of the reduction in wages and payrolls caused by a marginal dollar of corporate income tax revenue. There are some papers in the literature with estimates of greater harm to workers from high state corporate income taxes. Recent research by economists Alison Felix and James Hines estimates that high state corporate income taxes reduce union wages more than non-union wages.
Combined, these two policies cost Minnesota workers approximately $4 of reduced payrolls for every $1 of benefit provided to Minnesota local governments. Ending this waste should appeal to citizens across the political spectrum.
Admittedly, these two inefficient policies are just the tip of the iceberg. Numerous tax loopholes and government programs need reform. State government should eliminate policies that make Minnesotans poorer, policies that first take resources from where they would be more useful and then squander them.
John Spry, Ph.D, is an associate professor in the finance department of the Opus College of Business at the University of St. Thomas. References to materials he drew on while writing this piece are online at www.twincities.com/opinion. Look for “Two reforms for a more prosperous Minnesota — links to more information.”
Congressional Budget Office. “Corporate Income Tax Rates: International Comparisons. Congressional Budget Office.” 2005. (http://www.cbo.gov/ftpdocs/69xx/doc6902/11-28-CorporateTax.pdf)
Dahlby, Bev and Ergete Fededeb. “Tax Cuts, Economic Growth, and the Marginal Cost of Public Funds for Canadian Provincial Governments.” 2008. Working Paper Department of Economics, University of Alberta, Edmonton, Canada. (http://www.uofaweb.ualberta.ca/economics2/pdf/WP-Dahlby-Ferede-Tax-Cuts-Economic-Growth-July08.pdf)
Felix, Alison. “Do State Corporate Income Taxes Reduce Wages?” Federal Reserve Bank of Kansas City Economic Review. 2009. 77-102. (http://www.kc.frb.org/PUBLICAT/ECONREV/PDF/09q2felix.pdf)
Felix, Alison and James R. Hines, Jr. “Corporate Taxes and Union Wages in the United States.” National Bureau of Economic Research Working Paper 15263. 2009. (http://www.voxeu.org/index.php?q=node/4363, http://www.frbkc.org/Publicat/RegionalRWP/RRWP09-02.pdf and http://www.nber.org/papers/w15263.pdf)
Gyourko, Joseph and Joseph Tracy. “The Importance of Local Fiscal Conditions in Analyzing Local Labor Markets,” Journal of Political Economy 97: 1208-1231, 1989. (http://www.fednewyork.org/research/economists/tracy/jpe1989.pdf)
Hines, James R. Jr. and Lawrence Summers. “How Globalization Affects Tax Design.” National Bureau of Economic Research Working Paper 14664. 2009. (http://www.nber.org/papers/w14664)
Johansson, Åsa , Christopher Heady, Jens Arnold, Bert Brys and Laura Vartia. “Tax and Economic Growth.” OECD Working Paper 620. 2008. (http://www.olis.oecd.org/olis/2008doc.nsf/LinkTo/NT00003502/$FILE/JT03248896.PDF)
Lovely, Mary E. and Michael J. Wasylenko. “State Taxation of Interest Income and Municipal Borrowing Costs,” National Tax Journal 45: 37-52, 1992. (http://ntj.tax.org/wwtax/ntjrec.nsf/175d710dffc186a385256a31007cb40f/962954034c3ad6548525686c00686df9/$FILE/v45n1037.pdf)
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/).
The Macroeconomics rap battle video “Fear the Boom and Bust” has been released.
I enjoyed the world premier at the American Economic Association conference in Atlanta, Georgia at the beginning of 2010.
Tagged TeachingThis paper in the Eastern Economic Journal (co-authored with Jocelyn Crowley) examines the effects of the government created monopolies at service areas along New Jersey’s Toll Roads.
An earlier working paper version of this paper resulted in a brief story in the New York Times. I am not sure if the reporter grasped the main point about the size of the inefficiency and waste from the state creating monopolies selling gasoline and food along the toll roads.
Tagged Deadweight Loss, Monopoly, New JerseyA study by two Rutgers professors confirms what is probably obvious to New Jersey toll-road drivers: motorists pay more for gas and food there than they would if they got off at the nearest exit. Jocelyn Crowley and John A. Spry did first-hand research May 17 through May 21 and found gas prices to be at least five cents per gallon higher on the New Jersey Turnpike, Atlantic City Expressway and Garden State Parkway than at the nearest off-highway gas stations. Similarly, food prices tended to be much higher on the toll roads. Ms. Crowley recommended allowing off-road establishments to advertise on the toll highways and putting more, competing vendors in rest areas.