As Minnesotans feel the bite from higher taxes, they look to reduce their tax burden

“Incentives do make a difference”. So said our former Governor, Mark Dayton, when discussing how to attract investment to Minnesota. He was right.

The 2017 Tax Cuts and Jobs Act capped the deduction which taxpayers who itemize can make for their state and local tax payments at $10,000. This was liable to impact tax revenues in high tax states. As I wrote at the time,

The deduction essentially works as a subsidy from Washington DC to state governments. The Tax Policy Center estimates that “Federal tax subsidies through the SALT deduction and the federal tax exemption for state and local bond interest provided an additional $135 billion (annually) in implicit federal support for state and local governments.” By subsidizing local and state governments, the SALT deduction insulates voters in high tax states like Minnesota from the full fiscal consequences of their decisions. By passing some of the burden onto the Federal treasury, lawmakers in St. Paul can get $1 in state income-tax revenue at a real cost to their taxpayers of less than $1.

Capping the deduction removed a lot of this insulation. Andrew Cuomo, the governor of high tax New York state, called it to an “economic civil war” that “literally restructured the economy to help red states at the cost of blue states” in a “diabolical, political maneuver.” Gov. Cuomo is now staring down a $2.3 billion shortfall, and he has been forced to admit “Tax the rich, tax the rich, tax the rich and now what do you? The rich leave”

That is not all they can do. They can reduce their tax burden by buying municipal debt. These securities pay interest that’s exempt from federal and state taxes. Investors from New York and California have helped drive a $20 billion influx of cash into municipal mutual funds in 2019. But, as Bloomberg reports,

It’s not only residents of high-cost coastal states that are plowing into municipal bonds as a haven from the new deduction limits. It’s happening in Minnesota, too.

…

Minnesota had the fourth-highest top state income-tax rate in the country last year at 9.85 percent, according to TurboTax. That’s driven more interest in Eaton Vance’s $135 million Minnesota Municipal Income Fund, said Craig Brandon, co-director of state and local government bond investments at Eaton Vance Management. Of the company’s 17 state-specific municipal mutual funds, 16 have seen positive net inflows in 2019.

“Municipals are almost like the last great tax haven left,” he said.

Doug White, co-manager of the Columbia Minnesota Tax-Exempt Fund, said he’s seeing more interest in municipals from Minnesota residents. That could “powerfully” increase as more people complete their taxes and realize the impact of the limit on deductions, he said.

“A state like Minnesota with a low population doesn’t make the news, but we’re a very high-tax burden state and there’s always been a strong demand for munis as a result,” he said.

Eaton Vance and Columbia declined to break out flow figures into their funds. Minnesota state open-end and exchange-traded municipal funds have pulled in $90 million in the first two months of 2019, far more than the $17.6 million they attracted in the same period of 2018, according to data compiled by Morningstar.

They’ve even attracted more than municipal funds focused on New Jersey and Connecticut, both high-tax states that are affected by the limit on state and local tax deductions.

There are two lessons for policymakers here.

One, is that taxes are incentives. If you change the tax rate you change the incentives and people modify their behavior accordingly.

The other, is that nobody is better at altering their exposure to tax than the rich. This is why countries with high tax burdens than the US manage that, not by taxing ‘the rich’ more heavily, but by taxing the middle class more heavily.

John Phelan is an economist at the Center of the American Experiment.