How the Democrats tax proposal affects Minnesota
On Monday, Sept. 13, House Democrats released their tax proposal, which is supposed to pay for their $3.5 trillion spending plan. Among other things, the proposal raises the corporate tax…
Minnesota is losing taxpayers and their income to lower-tax states
Connecticut’s dismal economic performance and present budget crisis offer a harsh lesson on the limits and consequences of a state raising taxes too high. Data from the IRS that tracks the state-to-state movement of taxpayers and their income shows Minnesota is headed down the same taxing path as Connecticut. Like many states, Connecticut immediately turned to tax increases to balance the severe budget shortfalls nearly every state experienced in the midst of the Great Recession. The state raised taxes by $900 million in 2009, then by $2.6 billion in 2011 and, most recently, by nearly $2 billion in 2015.
Even after all those tax increases Connecticut’s budget faces a deficit. In facing their current budget crisis, Connecticut lawmakers now accept another tax increase is not only out of the question, but that prior tax increases are part of the problem.
Connecticut Governor Malloy discussed the problem with the state’s reliance on tax increases at a town hall last March. He explained, “We have raised taxes previously in my administration twice, in the prior administration once before she left office as well. We know it’s having an impact on our ability to attract business and jobs, which after all ultimately pay taxes and allow us to pay for the services that we want to acquire for our citizens.”
Later during the town hall, Malloy put the problem more bluntly: “I’ve raised taxes multiple times. You know, it’s not working and it’s come up a cropper. And you know you can’t go back to the well. We’re already losing jobs. So, you know, what’s the right balance?” The wake-up call for Connecticut
lawmakers was likely the January announcement that GE will move
its headquarters along with 800 jobs from Fairfield, Connecticut to Boston, Massachusetts.
GE executives made their frustration with Connecticut’s tax increases very clear. Reuters reports how in the same month Connecticut raised taxes in 2015, GE CEO Jeffrey Immelt “said in an email to employees that he asked a team to examine the company’s options to relocate the headquarters to a state with a ‘more pro-business environment.’”
Minnesota is on Connecticut’s downward path
Is the same shrill wake-up call on Minnesota’s horizon?
Like Connecticut, a DFL-controlled legislature worked with Gov. Dayton in 2013 to raise taxes by over $2 billion. Much of this 2013 tax increase falls on high-income earners. After raising the income tax rate on top earners from 7.85 to 9.85 percent, Minnesota now has the fourth highest rate in the country.
Internal Revenue Service (IRS) data analyzed in the American Experiment report, Minnesotans on the Move 2016, may offer Minnesota the wake-up call it needs to avoid hitting the economic lows Connecticut is experiencing today. The data shows Minnesota is not competing well on one very important metric: the willingness of people to move into, and out of, the state.
The IRS has been tracking the state-to-state movement of tax filers and their income since 1992. For the 2013 to 2014 period, Minnesota, on net, lost nearly $1 billion in adjusted gross income (AGI). The net loss amounted to exactly $948 million, which represents a dramatic rise from just three years ago when the state lost $490 million.
A nearly $1 billion net loss in income might be the most eye-popping data point, but there’s much more in the IRS data that should wake people up to the importance of a more balanced, pro-growth tax policy.
After a decade of attracting people to Minnesota in the 1990s, Figure 1 shows the net domestic migration of people (taxpayers and their dependents) into Minnesota turned negative in 2002 and has remained negative ever since. Comparing the decade of the 1990s with the 2000s, IRS data shows Minnesota experienced a net gain of 67,504 people in the 1990s and a net loss of 52,944 in the 2000s.
Data show movement by age and income
The IRS released new data in 2015 that now provides information on who is moving by their age and income. These data deliver important new insights into migration patterns that dispel some misperceptions, possibly the insights necessary to wake people up.
The new data shows the most active movers are young and low-income. Despite being more active movers, tax-filing households headed by young and lower-income Minnesotans represent a smaller portion of the net change in both population and income movement. Their larger migration flows in and out of Minnesota tend to balance out more.
When talking about the migration of young people, it’s important to note here that the IRS data only tracks tax filers and their dependents. Many young adults in college do not file taxes. Census surveys tracking the movement of students show Minnesota does, on net, lose substantial numbers of students—around 8,000 each year.
Among tax filers, the largest migration impact on Minnesota’s population comes from a net loss of people in households headed by taxpayers in their prime earning years and making higher incomes.
Between 2011 and 2014, as shown in Figure 2, people from households headed by 45 to 54 year olds represent the largest net loss. Minnesota lost 5,827 people from these households and lost another 4,920 people from households headed by 35 to 44 year olds. These two age categories account for nearly 58 percent of the net loss for the 2011-14 period.
Looking at Minnesota’s population change by income, Figure 3 shows the largest net change for the 2011 to 2014 period results from losses of people in higher income households. On net, higher-income Minnesotans earning more than $100,000 account for the largest share of the population loss. This shows quite clearly that Minnesota is less attractive to higher income people.
Figure 3 also shows that we are attractive to low-income earners who make less than $25,000. Thus, Minnesota is losing the people who pay taxes and gaining the people who place demands on public welfare programs.
As already noted, this net loss of people resulted in a net loss of income approaching $1 billion between 2013 and 2014. Not surprisingly, Figure 4 shows income losses from high-income tax filers account for most of this net loss in income. 68 percent ($667 million) of Minnesota’s net loss of income is from tax filers with incomes larger than $200,000 and another 17 percent ($168 million) of the loss comes from people earning between $100,000 and $200,000. The remaining income categories account for 15 percent of the loss. Though just 15 percent, this still amounts to a substantial loss of $149 million in AGI.
Before the IRS released the new data tracking the age and income-level of movers, some people dismissed Minnesota’s substantial yearly loss of AGI as a product of retirement patterns. But retirement is by no means the only or even the principal factor behind the state’s net loss of AGI. A majority of the loss comes from working-age people. Altogether, as shown in Figure 5, working-age people under 65 account for 75 percent of the net loss in AGI for 2011-12, 86 percent for 2012-13 and 71 percent for 2013-14.
Minnesota is among the least attractive states for top earners
How do Minnesota’s migration patterns compare to other states?
The new IRS migration data can be used to compare a state’s attractiveness to taxpayers by age and income by calculating the net migration rate for returns, exemptions and income. The net migration rate shows how much population or income a state gains or loses relative to the state’s population or income that existed at the start of the period.
For the 2013-14 period, Minnesota’s net migration rate performs below the median state across nearly every age and income range. Overall, the state’snet migration rate for tax filers ranks 31st and the rate for income ranks 43rd.
Comparing Minnesota’s net income migration rate for top earners—people making more than $200,000—reveals another eye opening data point.Between 2013 and 2014, Minnesota’s net migration rate for these high earners was a negative 1.42 percent, ranking behind 46 states and ahead of only New Jersey, Illinois, Vermont and the District of Columbia.
All of these numbers demonstrate one thing very clearly: Minnesota is overall a less attractive place for Americans to move. Minnesotans need to wake up to this reality.
Making Minnesota more attractive is key to growth
In light of this reality, a 2015 report by Minnesota’s State Demographer offered this advice:
Minnesota leaders should work to stem and reverse domestic losses, redouble efforts to attract and integrate new residents, especially young adults, and seek to retain its current resident population. Positive migration is key to fueling our economy and maintaining a high quality of living in Minnesota in the years to come.
Making Minnesota a more attractive place for people to live and work is more important than ever before due to, as the state demographer explains, the “new demographic era” Minnesota is entering “where migration’s relative influence on our total population will rise.” Baby boomers are already leaving the workforce and deaths are projected to outpace births in coming decades. Without more births, migration is key to the state’s growth.
How can Minnesota’s leaders make the state more attractive?
Of the policy levers available to Minnesota’s leaders, lower taxes offer the most promise.
Evidence shows taxes influence where people move
While many on the left continue to deny it, at least outside the state of Connecticut, the weight of the evidence shows taxes do influence migration.
The evidence starts with academic studies. Economist Mark Gius’s review of the academic literature concludes “most of the prior research found that taxes had a negative effect on migration; in other words, the lower the taxes in a person’s home state, the less likely they will migrate.”
Recent research investigates the movement of highly paid athletes. These studies find star NBA basketball players and European footballers move to lower tax locations. A similar study on star scientists likewise “uncover[s] large, stable, and precisely estimated effects of personal and corporate taxes on star scientists’ migration patterns.” Another study on inventors finds that “superstar top 1% inventors are significantly affected by top tax rates when deciding where to locate.”
Adding to this academic evidence, the migration patterns revealed in the IRS data show people tend to move to lower tax states. Of the ten states to which Minnesota loses the most income, eight are lower tax states in the bottom half of tax burden rankings, as ranked by the Tax Foundation. Seven of ten states from which Minnesota gains income are higher tax states in the top half of the rankings. Notably, five of the top ten states to which Minnesota loses income impose no income tax.
High tax states nationwide show similar migration patterns. Taxpayers with the highest incomes, of course, have the largest incentive to move to low tax states to avoid taxes. Analysis of income migration for top earners across the nation shows a clear national pattern of movement out of higher tax states and into lower tax states. The map in Figure 6 shows net income migration rates of taxpayers earning more than $200,000 for the 2013-14 period. It shows which states are proportionally gaining and losing the most income in proportion to their size. The red states reflect the net gaining states and the blue states reflect the net losing states.
One fact immediately stands out in the map. The low tax states in each region tend to attract top earner income, including New Hampshire in the Northeast, South Dakota in the Midwest, Nevada in the West, and Tennessee and South Carolina in the South. Except for South Carolina, these are all states with no income tax.
The IRS data also show a substantial increase in Minnesota’s net loss of income immediately after the legislature and Governor Mark Dayton enacted a large income tax increase in 2013. The following year, Minnesota’s net loss of adjusted gross income leaped from $697 million (2012-2013) to $948 million (2013-2014). The nearly $1 billion loss sustained in 2014 is well above anything previously recorded. While a number of factors likely contribute to the larger loss, the timing suggests an immediate migration response to Minnesota’s 2013 tax increase.
Tax changes usually elicit a lagged response that can be hard to identify and it’s not likely the 2013 tax change spurred many people to immediately leave Minnesota. However, many Americans were already in the position of making an immediate decision to move for a job or other reasons in 2013 and 2014. The IRS data confirm Minnesota’s much larger net loss in income for the 2013 to 2014 period was, in fact, due to the state attracting fewer taxpayers and less income. Thus, it’s very plausible Minnesota’s 2013 tax change spurred many Americans, who were already considering a move, to opt for a lower tax state.
Possibly the most important Minnesota-specific evidence comes from surveys of accountants and attorneys who advise wealthy clients. These people see firsthand how taxes influence decisions to move assets or residency to another state.
The Minnesota Society of Certified Public Accountants surveyed its members after the 2013 tax increase and found that “more than 86 percent of respondents said clients had asked for advice regarding residency options and moving from Minnesota.” Ninety-one percent said the number of clients asking about moving increased from previous years.
More recently, Twin Cities Business surveyed wealth managers, accountants, attorneys and other professionals who advise high-income Minnesotans. These advisers report an average of 10 percent of their clients changed or began changing their residency in the past two years. Of these movers, “72 percent, or 2,231 of these clients, moved or are moving due to taxes or [tax] policies.”
Key indicators show Minnesota is underperforming
Despite all this evidence, many on the left continue to deny state taxes have any meaningful influence over where people choose to live. In a Star Tribune commentary responding to the Center’s report, the commissioner of the Minnesota Department of Revenue wrote “few people make a decision as important as moving their family based on taxes alone.” She then went on to argue Minnesota “is an attractive state to move to,” citing various quality of life rankings.
Minnesota certainly boasts many attractive qualities. But facts are facts. And there can be no denying the fact that Minnesota consistently fails to attract more people and income than it loses to domestic migration. Considering Governor Dayton ran on a policy to tax the rich, it’s not surprising that his revenue commissioner denies the mounting evidence on how Minnesota taxes are now driving those people away. But will Minnesota need to hit bottom like Connecticut before realizing some balance must be maintained in how the state taxes residents and businesses?
When Connecticut increased taxes, they did not have the benefit of the new and improved IRS data set that shows who is moving and provides a full measure of the income loss.
Minnesota now has that data and it shows the state is headed down Connecticut’s path. Both Connecticut and Minnesota rely heavily on income taxes on high earners for revenue. And both Connecticut and Minnesota rank among the worst states for attracting high earners making more than $200,000 per year. The Minnesota rate was actually worse than Connecticut for the 2013 to 2014 period.
Many people believe Minnesota’s economy remains strong and steady, but key economic indicators show otherwise. Over the past ten years, growth in the state’s gross domestic product and jobs lagged the national average. Looking forward, state economic forecasts predict Minnesota will continue to lag the nation on these indicators. While Minnesota is not performing as poorly as Connecticut, it is underperforming.
Recent revenue data suggest Minnesota income tax collections are also underperforming. Growth in state revenue from the personal income tax lagged the nation between FY2014 and FY2015. And income tax revenue reported in the latest Revenue & Economic Update shows actual collections for February and March 2016 were down nearly $70 million (6.5 percent) from projected collections.
Opportunities to align taxes with growth
Though the immediate chances of reducing Gov. Dayton’s signature income tax hike are zero, there are other opportunities to make Minnesota’s tax system more attractive. Reducing the estate tax would be the best place to start. The estate tax makes the least sense of all the taxes imposed on wealthy Minnesotans. The tax collected $145 million in FY2015— only 0.7 percent of state revenue—yet it imposes a substantial burden on those who pay it. This burden creates strong incentives for taxpayers to distort their behavior to avoid or reduce the tax. These distortions tend to reduce or remove economic activity in the state and this lost economic activity then translates to lost state and local revenue tied to the activity. It’s entirely possible these revenue losses are greater than the gains from the estate tax.
By the time this magazine is published, state lawmakers may already have reduced the estate tax. The current omnibus tax bill in the House would increase the estate tax exemption amount to the federal level and the Senate gave the policy serious consideration in a committee hearing.
While a good first step, much work will remain to align Minnesota’s taxes with economic growth. The Center’s broad recommendations to redesign Minnesota’s tax system released with the Minnesota Policy Blueprint in January 2015 will remain just as relevant and sound in January 2017.