Low Taxes on Manufacturers Push Minnesota Economy Ahead of Wisconsin

The other week I brought two basic facts to bear on the debate over whether Dayton’s liberal, high tax policies are beating Scott Walker’s lower tax approach to the economy.  First, Minnesota’s economy pulled ahead of Wisconsin’s before Dayton and Walker took office and so whatever lifted Minnesota’s economy predates both governors.  Second, though the Minnesota economy might beat Wisconsin, both Minnesota and Wisconsin lost ground to the U.S., which shows Minnesota can do better. 

How can Minnesota do better?  Contrary to contentions that Minnesota’s high taxes somehow don’t matter, a closer look at economic data strongly suggest lower taxes are part of what pushed the Minnesota economy ahead of Wisconsin and, more importantly, can be part of strengthening Minnesota’s economy in the future. 

Though Minnesota and Wisconsin are both high tax states, they tax different types of individuals and businesses differently.  This means that some businesses in Minnesota pay more taxes and some pay less compared to their equals in Wisconsin.  It also means some businesses in either state can pay relatively low taxes compared to the rest of the country, despite operating in a “high tax” state.   

As it turns out, many Minnesota manufacturers pay relatively low taxes.  In fact, according to one measure, Minnesota’s capital-intensive manufacturers pay the second lowest taxes in the country.  It also turns out that growth in the Minnesota manufacturing industry led the state’s economic growth over Wisconsin.  The rise of Minnesota’s lowest taxed industry strongly suggests taxes do matter.   Here are the details. 

Historically, Minnesota and Wisconsin are High Tax States

At the outset, it’s important to note that Wisconsin has always been among the higher tax states in the country right along with Minnesota.  In this tale of two states, this is an important point to dispel any misconception that Minnesota taxes have always been higher than Wisconsin taxes.  In fact, the table below shows Wisconsin’s tax burden ranking has regularly been higher than Minnesota’s based on one common measure—state and local tax collections as a percent personal income.  Though, on a per capita basis, Minnesota’s tax burden regularly ranks higher than Wisconsin.

Tax Burden Rankings
	State and Local Tax Collections
	Percent of Personal Income		Per Capita
	MN Rank	WI Rank	MN Rank	WI Rank
1995	5	4	7	9
2000	8	5	7	9
2005	17	11	12	16
2010	14	10	13	17
2012	11	13	10	16

Now recall from the last blog post how Minnesota’s economy pulled ahead of Wisconsin’s between 2000 and 2005 and has remained ahead ever since.  The above table shows each state imposed a fairly similar tax burden.  And so it would be tempting to discount the role taxes might have played during this period.   But, as shown below, that would be a mistake. Digging deeper into what drove Minnesota’s growth ahead of Wisconsin offers important evidence to make the connection between taxes and economic growth.

Manufacturing Industry Led Minnesota Growth over Wisconsin

As already noted Minnesota’s manufacturing sector led the Minnesota economy ahead of Wisconsin.  Between 1999 and 2005—a period when Minnesota GDP grew from roughly the same size as Wisconsin to 6.5 percent larger—Minnesota added $14.6 billion (real 2009 dollars) more to its economy than Wisconsin.  Growth in Minnesota’s manufacturing industry led the way and beat Wisconsin growth by $6.2 billion.  The next closest industry was “finance, insurance, real estate, rental, and leasing,” which beat Wisconsin growth by $3.7 billion.  Extending the period to 1997 to 2014 (the full period of available, comparable data), Minnesota manufacturing sector growth exceeded Wisconsin by $8.5 billion. 

In percentage terms, Minnesota’s manufacturing sector grew by 37.8 percent between 1999 and 2005, compared to 8.6 percent for Wisconsin and 17.7 percent for the nation.  And looking to the longer period between 1997 and 2014, the Minnesota manufacturing sector grew by 66.7 percent, compared to 18.1 percent for Wisconsin and 41.0 percent for the nation.  All of this goes to show Minnesota’s manufacturing sector consistently outperformed the U.S. and Wisconsin in recent years.

So why is Minnesota’s manufacturing sector experiencing stronger growth than Wisconsin and the U.S.?

Rust Belt a Piece of the Puzzle but Fails to Explain Difference between Minnesota and Wisconsin

One answer might be that Minnesota was never part of the so-called “Rust Belt,” the regional belt of more labor-intensive manufacturing extending from Utica, New York to Milwaukee, Wisconsin that has struggled against automation and cheap global labor.  On this theory, Minnesota’s economy has not been weighed down by the contraction of Rust Belt manufacturers nearly as much as Wisconsin and the U.S.  With fewer manufacturers contracting, Minnesota should be experiencing stronger rates of economic growth and lower rates of job losses in the manufacturing sector.

The chart below suggests there may be some truth to this theory when comparing Minnesota to the U.S.  Relative to the U.S., between 1997 and 2014 Minnesota manufacturing output is clearly experiencing higher growth (66.7 percent in MN versus 41.0 percent in the U.S.) along with lower job loss rates (20.2 percent in MN versus 30.4 percent in the U.S.).

Change in Real GDP and Employment	1997	2014	Change
US Mfg GDP (millions of chained 2009 dollars)	1,365,083	1,924,325	41.0%
US Mfg Employment	17,502,700	12,175,300	-30.4%
MN Mfg GDP  (millions of chained 2009 dollars)	24,754	41,268	66.7%
MN Mfg Employment	391,200	312,100	-20.2%
WI Mfg GDP  (millions of chained 2009 dollars)	43,981	51,963	18.1%
WI Mfg Employment	579,200	464,800	-19.8%

But when comparing manufacturing employment in Minnesota to Wisconsin, the states are nearly identical (so identical that the dotted lines are on top of of each other throughout the period).  In fact, manufacturing employment declined a touch less in Wisconsin (19.8 percent) than Minnesota.  If employment contractions are a good indicator of being hit by Rust Belt problems, Minnesota and Wisconsin are being hit the same.  So, the Rust Belt experience does not provide a satisfying answer for what separates Minnesota and Wisconsin manufacturers.  Something else must be going on. 

Minnesota’s Manufacturing Sector is More Dynamic

Hidden within the contraction of manufacturing industry establishments and employment continues to be a dynamic process of establishments starting up and closing, employees being hired and laid off.   Though on net the number of establishments and employment is declining across the country, there are still entrepreneurs building new and productive manufacturing businesses within the shadow of that decline.  And the above chart shows that these new and expanding businesses are increasing the economic output of the manufacturing sector even as employment drops.   

Taking a closer look at the decline in manufacturing establishments and employment shows Minnesota’s manufacturing sector is more dynamic than Wisconsin’s.  Business dynamism is incredibly important to sustained economic growth.  According to Ian Hathaway and Robert Litan, “Business dynamism is the process by which firms continually are born, fail, expand, and contract, as some jobs are created, others are destroyed, and others still are turned over.”  Writing for the Brookings Institution, they go on to explain how dynamism promotes growth.

Business dynamism is inherently disruptive; but it is also critical to long-run economic growth. Research has established that this process of “creative destruction” is essential to productivity gains by which more productive firms drive out less productive ones, new entrants disrupt incumbents, and workers are better matched with firms.  In other words, a dynamic economy constantly forces labor and capital to be put to better uses.

The chart below shows Minnesota’s manufacturing sector consistently has a higher rate of establishment births and deaths than Wisconsin.  So, despite having about the same rate of manufacturing establishment losses over the period covered in the chart below, on average Minnesota annually experienced a little more than a percentage point higher rate of both births and deaths.  Minnesota also experienced a slightly higher rate of employment gains due to births and expansions and losses due to deaths and contractions.

This demonstrates there’s a higher level of manufacturing entrepreneurism in Minnesota than Wisconsin.  Though each state ended the period with relatively the same rate of loss in establishments, more companies made a go of it in Minnesota—about 1,000 additional companies, assuming Minnesota were to have a comparable rate as Wisconsin.  Many of these startups likely displaced underperformers across the country.

Minnesota Manufacturers Pay Far Lower Taxes

Okay, so Minnesota’s manufacturing sector is more dynamic than Wisconsin’s. What explains the dynamism? And is there anything else spurring higher growth rates in Minnesota?

Part of the answer to both questions is almost certainly low taxes. 

Though Minnesota and Wisconsin are both higher tax states, the specific state tax burden for a taxpayer—the amount people and businesses actually pay—can vary quite substantially across income levels and business sectors.  Simple comparisons of per capita tax burdens or corporate tax rates fail to account for what a business actually pays. 

Indeed, different types of businesses can pay very different tax amounts depending on the type and value of their property, the proportion of sales sold in-state, unemployment insurance tax rates, sales tax rates and whether they apply to business inputs, and various tax incentives offered to new and expanding businesses.

To help understand what actual businesses pay in taxes from state to state, the Tax Foundation in collaboration with accounting firm KPMG developed an apples-to-apples comparison of business tax costs by state.  Tax Foundation economists developed 7 model firms and KPMG then established what these firms would pay in taxes depending on whether they were mature firms or new firms.  Of the seven firms, one was a capital-intensive manufacturer and another was a labor-intensive manufacturer.

The results: Minnesota tax burdens ranked very high for four of the seven mature firms (see table below). The four high tax firms included corporate headquarters (48th), retail store (49th), call center (45th), and distribution center (42nd). 

But despite its high tax reputation, Minnesota ended up being the 13th lowest tax state for an R&D facility and the 17th lowest tax state for labor-intensive manufacturing.  But here’s where Minnesota really stood out: The state imposed the 2nd lowest tax burden on capital-intensive manufacturers.  Yes, despite Minnesota imposing the third highest corporate income tax rate in the country, the actual taxes paid by capital-intensive manufacturers are the 2nd lowest in the country.  

State Tax Burden and Rank Across Seven Model Firms
	Minnesota				Wisconsin
	Mature		New		Mature		New
	Rate	Rank	Rate	Rank	Rate	Rank	Rate	Rank
Corporate Headquarters	21.5%	48	25.0%	47	16.5%	40	7.7%	8
Research & Development Facility	8.2%	13	10.7%	20	10.5%	20	2.5%	8
Retail Store	2.4%	49	40.0%	43	19.9%	42	40.0%	43
Capital-Intensive Manufacturer	4.0%	2	4.6%	9	16.5%	46	9.8%	33
Labor-Intensive Manfucaturer	7.2%	17	9.8%	27	13.0%	42	7.7%	17
Call Center	26.8%	45	38.0%	49	19.1%	23	3.0%	4
Distribution Center	38.4%	42	45.6%	42	26.9%	26	37.4%	33

Low Taxes Due to Single Sales Apportionment and Throwback Rule

The main reason Minnesota manufacturers pay such low taxes is largely because Minnesota applies a single sales apportionment factor formula and no “throwback rule” to corporate taxes.  States used to apportion corporate taxes based mainly on the location of property and payroll.  For instance, if 50 percent of a business’s property and payroll is in the state, then the state would tax 50 percent of the corporation’s profits.  If 100 percent is in state, then 100 percent of profits are taxed.

Today, Minnesota applies the corporate tax based entirely on the apportionment of sales, not property or payroll.  Thus, a manufacturer with 10 percent of sales to Minnesota customers will only pay taxes on 10 percent of profits.  This is a huge tax advantage to businesses that sell a large proportion of their products out of state, such as General Mills, 3M and Medtronic. 

Furthermore, Minnesota does not apply a “throwback rule.”  Some states will tax sales to another state if the other state does not tax the sale.  In effect, the sale is “thrown back” and taxed in the originating state as if it was sold in the originating state.  For tax purposes in Minnesota, Count Chocula, post-it-notes and pacemakers sold to Vegas, stay in Vegas.

Across the border, Wisconsin’s tax burden on capital-intensive manufacturers ranks 46th and, at 42nd, its rank for labor-intensive manufacturers isn’t much better.  According to the report, the “main factor” behind Wisconsin’s rank “is the nation’s fifth highest corporate income tax burden for this firm type, in large part due to a throwback rule which exposes all of the operation’s income to in-state taxation and the disallowance of the state’s manufacturing deduction for mature firms.”

Though taxes are only one part of a firm’s decision to open or expand, taxes strongly favor opening or expanding a manufacturing business in Minnesota versus Wisconsin.  Based on the model firm presented in the Tax Foundation report, the actual tax burden for a mature capital-intensive manufacturer is 4.0 percent in Minnesota versus 16.5 percent in Wisconsin.  New manufacturers can expect a 4.6 percent rate in Minnesota versus a 9.8 percent rate in Wisconsin.  No business can ignore a 12.5 percentage point difference or even a 5.2 percentage point difference in tax rates.

Shutterfly Would Likely Choose Minnesota over Wisconsin Even Without Special Incentives

To put a face on all these numbers, a couple years ago Shutterfly was in the news because it chose to locate a new manufacturing facility for its products in Shakopee, Minnesota, bringing up to 1,000 full and part-time jobs to the state.  Shutterfly wanted a Midwest facility close to Midwest customers and the choice largely came down to Minnesota versus Wisconsin.  According to Gov. Mark Dayton, “The plant would be developing in Wisconsin rather than Minnesota if it were not for incentive financing.” And nearly every news outlet dutifully reported on how a $1 million grant from the state and $1.5 million in tax breaks from Scott County lured Shutterfly to Minnesota. 

News outlets, however, completely neglected the most important tax difference between Minnesota and Wisconsin—Minnesota’s lack of a throwback rule. One must wonder if Shutterfly executives were laughing all the way to bank.  Would the company really have opened a plant in Appleton, Wisconsin when the sale of photo books, cards, calendars and photo gifts to customers in other Midwestern states would be thrown back to Wisconsin and taxed?  Very, very doubtful.

Shutterfly opened and will thrive in Minnesota in no small part to Minnesota’s low tax burden on this particular industry.  No doubt other manufacturers are doing the math and choosing Minnesota over Wisconsin and other states as well.

But manufacturing is just one sector of Minnesota’s economy.  Other industries face among the highest tax burdens in the country.  Take away manufacturing and the rest of Minnesota’s economy consistently underperforms the U.S.

Minnesota’s economy can do better.   

In the end, a closer look at Minnesota’s border battle with Wisconsin actually shows how taxes matter and how low taxes promote growth.  Low taxes on Minnesota’s manufacturing sector help spur strong growth and it’s long past time the state gives other industries the same low-tax advantage to grow.