Estate tax is an incentive to leave Minnesota

This op-ed appeared April 17, 2018 in the Rochester Post Bulletin

“Incentives do make a difference.” So said Gov. Mark Dayton recently, discussing what state governments can do to attract investment.

He’s right, and this insight applies across public policy making. When Dayton raised taxes on cigarettes in Minnesota, his explicitly stated aim was to incentivize people to stop smoking.

For some reason, though, when it comes to other public policy interventions, this logic goes out of the window. So, while Dayton hikes taxes on smoking to change people’s behavior, he seems to think that hiking taxes on estates won’t have any impact on people’s behavior.

Applying this logic consistently shows why the governor’s proposal to freeze the estate tax exemption level at $2.4 million instead of the scheduled $3 million is such a bad idea.

Minnesota taxes estates more heavily than most states. It is one of only 14 states plus the District of Columbia to levy an estate tax. Eight of those 14 states and the District have a higher exemption. The state’s starting rate of estate taxation—12 percent—is higher than any of the other jurisdictions that levy one. Its top rate is 16 percent. Only the state of Washington has a higher top rate.

This gives individuals an incentive to take steps to lower or eliminate their liability and there are many legal avenues open to those who wish to do so. Ultimately, they can leave the state for a jurisdiction with a lower rate or no estate tax at all. There’s evidence that a significant number of wealthy Minnesotans do just this.

But what is the impact in dollar terms on state government revenues of people leaving Minnesota to avoid the state’s heavy estate taxes? To know this we need to know 1) the revenue the tax brings in (the revenue effect) and 2) the revenue from other taxes lost when people leave (the incentive effect).

The revenue effect is straightforward. According to official data, Minnesota’s estate taxes brought in $183.2 million in revenue in 2016, 0.8 percent of the state’s total revenue. Over the previous decade, when the exemption was lower, the average revenue was just $149.4 million annually.

But how about the incentive effect? Using survey evidence and official data in our report, we are able to estimate the value of current and future income tax and sales and excise tax revenue that the state loses when people leave to avoid the estate tax. Assuming that two-thirds of 55- to 65-year-olds and 80 percent of those over 65 who leave Minnesota because of its taxes leave because of the estate tax, then the tax has been a revenue loser in three of the last five years.

Ideally, taxes are levied at low rates on broad bases. Neither is the case with Minnesota’s estate tax. And, with the increase in the federal estate tax exemption in the recent tax bill, the incentive for Minnesotans to leave the state has grown. In this context, Dayton’s budget proposal to freeze the estate tax exemption level is dreadful policy that will cost the state government revenue.

Remember, “Incentives do make a difference”.

Policymakers in St. Paul ought to be consistent from cigarettes to estates. The estate tax exemption should be raised to at least the new federal level. Better still, our state should follow other states in recent years and eliminate this inefficient and costly tax completely.

John Phelan is an economist at Center of the American Experiment, a Twin Cities public policy organization that advocates for conservative and free-market principles.