Research shows that high taxes harm economic growth
Even with a forecast budget surplus of $17.6 billion over the next budget biennium, the DFL leaders in St. Paul are proposing to raise a range of taxes. There are…
Set aside the hype: Minnesota lags national averages in a wide range of economic indicators, exposing deep vulnerabilities for the future.
Minnesota’s economy continues to surface in national debates over which public policies best promote economic growth and prosperity. Many people claim that Minnesota’s economy performs well above average, so well that other states should emulate Minnesota’s policies on taxes, regulation, and public programs.
President Obama made such claims last year in La Crosse, Wisconsin. He argued Minnesota is winning the border battle with Wisconsin and directly attributed Minnesota’s success to a raft of recent liberal policies, including tax increases on top earners, a minimum wage hike, and Medicaid expansion.
Political rhetoric aside, Minnesotans do seem to view the condition of their state’s economy more positively than residents of other states. Gallup polling ranks Minnesota as the sixth most confident state on its State Economic Confidence Index, just behind Utah, North Dakota, Texas, Nebraska, and Colorado.
This positive view, however, does not square with Minnesota’s actual economic performance. With respect to the measures that matter most to people living in the state—economic growth, incomes and jobs—Minnesota’s economy during the current century has been mediocre at best.
This disconnect between perception and reality presents a real danger to Minnesota’s future. Misplaced confidence in the state’s economy will lead to complacency, which will undermine any effort to advance the pro-growth policies Minnesota needs to regain its competitive footing.
Understandably, most Minnesotans don’t have a good frame of reference to compare Minnesota. Most people don’t regularly travel to places like Seattle, Dallas, Charlotte or Atlanta to see the construction cranes foresting those urban landscapes. Nor do they pore over economic data.
To help align Minnesotans’ perceptions with reality, Center of the American Experiment recently set in motion a strategy to educate people on how well Minnesota’s economy actually performs. As a first step, American Experiment commissioned Joe Kennedy—a former Chief Economist at the U.S. Department of Commerce—to assess Minnesota’s recent economic performance and provide insights into where the state is heading.
While various organizations and state agencies regularly report on Minnesota’s economy, Kennedy’s report offers the most comprehensive assessment of recent trends and sets an important baseline for understanding the state’s economy moving forward.
This systematic review shows that Minnesota’s economy has been average, at best, over the past 15 years. Worse, leading indicators are nearly all pointing downward. If nothing changes, Minnesotans can expect their economy to perform consistently below average in the years to come. Indeed, this is exactly what the state’s own agencies currently project.
Minnesota should be held to a high standard
Minnesota’s economic performance should be held to a high standard. Anyone who lives in Minnesota knows the people of Minnesota top the nation on a wide range of factors that contribute to both a high quality of life and a productive workforce. Minnesota ranks among the top states for educational attainment, health, family cohesion, public safety, workforce participation, civic engagement and access to cultural amenities.
Among these strengths, family cohesion is worth highlighting if only because Minnesota’s advantage here is less recognized. People are well aware the average Minnesota student achieves among the highest scores on standardized tests in the nation. But how many people know Minnesota ranks second nationally behind Utah on the rate of teenagers living with both of their married biological parents?
Positive perceptions of the state’s economy are no doubt linked to these very positive attributes. The media and politicians regularly remind Minnesota residents that their state tops various national lists. Most recently, the Mayo Clinic regained the top spot on US News & World Report’s Best Hospitals Honor Roll, which triggered plenty of local news stories and a tweet from the Minnesota Department of Employment and Economic Development. Minnesotansunderstandably presume these top rankings reflect stronger economic performance.
For much of Minnesota’s history, the state’s economy
met a higher standard. Setting aside the farm crisis that hit Minnesota particularly hard in the 1980s, Minnesota’s economy consistently reported stronger than average growth in economic output, per capita income and jobs from the 1950s through to the 1990s.
Unfortunately, Minnesota’s lofty rankings do not guarantee lofty economic performance. American Experiment’s new report reveals Minnesota’s economic performance over the past fifteen years has been, at best, average.
Minnesota is underperforming
Measures of state-level economic performance generally fall into three main categories: output, income and jobs. Minnesota’s economy shows strengths when viewed from certain angles, but overall these data reveal that Minnesota’s economy is underperforming and even weakening.
Historically, Minnesota tends to track national patterns
across a broad range of economic indicators. The fact that the state reflects national trends is likely due to the state’s diverse economy, which includes a more even mix of agriculture, natural resource extraction, manufacturing, retail and financial services than most state economies. With this history, the United States presents a good reference point and any prolonged underperformance within a given indicator, especially those linked to incomes, productivity or innovation, presents cause for concern.
GDP settles to the national average. The most fundamental measure of economic performance is a state’s gross domestic product (GDP, also referred to as gross state product or GSP), the basic measure of a state’s total economic output. GDP measures the total market value of goods and services produced within an economy. Prior to 2000, Minnesota’s consistently registered a slightly higher average annual GDP growth rate than the nation. Since 2000, however, Figure 1 shows Minnesota GDP growth has settled down to the national average. Despite playing some catch-up in recent years, state projections forecast Minnesota GDP growth will remain below average in coming years.
Productivity remains below the national average. What matters most for long-term growth is productivity. As workers become more productive, their real wages rise. Though difficult to measure precisely, state productivity can be approximated as state GDP per worker. Since 2000, Minnesota’s productivity has consistently been below the national average. As shown in Figure 2, Minnesota lost ground between 2004 and 2010 and has gained back much of that lost ground since.
Per capita incomes are higher, but growth is average at best. Growth in Minnesota’s per capita income was particularly strong in the 1990s, a time when the state’s labor force participation rate hit peak levels. Since the 1990s, Minnesota’s per capita income has grown in step with the national level. Though Minnesota growth kept pace with the nation, a majority of states still outperformed Minnesota. As shown in Figure
3, Minnesota per capita income growth from 2000 to 2015 ranked 30th overall among the states. It’s important to note that Minnesota’s high taxes take a cut out of personal income. Minnesota’s disposable income—personal income minus taxes—actually grew below the national average and this growth ranked 34th overall.
Average annual wages remain just average. Another important income measure is the average wage earned per job. The average wage provides a more accurate sense of the economic status of the typical worker than per capita income. Income earned from dividends, interest, and rental property is important to a state’s economy, but most people depend on wages they earn at a job for their livelihood. Here, Minnesota tracks very closely to national averages. In 2015, Minnesota’s average wage of $53,519 was just $582, or 1.1 percent more than the U.S. Also, the trend in Minnesota has tracked the national average almost exactly over the last 15 years as the state’s lead in the early years of the decade has all but disappeared.
Job growth just shy of the national average. Since 2000, the rate of job growth in Minnesota has lagged behind the nation as a whole. As Figure 4 shows, Minnesota slightly outpaced the national job creation rate around 2002 and 2003, but fell significantly behind between 2005 and 2008. In each of the last four years, the rate of job growth in Minnesota has been below the national average.
Unemployment rate consistently lower than average. The most positive aspect of Minnesota’s economy is the fact that Minnesota’s unemployment rate has generally been lower than the national average. In May 2016, Minnesota’s unemployment rate of 3.8 percent was well below the national average of 4.7 percent (although above North and South Dakota’s rates of 3.2 and 2.5 percent, respectively). Minnesota’s lower unemployment rate means there are fewer idled workers who would otherwise pose demands on public services. However, Minnesota maintains a low unemployment rate while at the same time recording below average job growth. Though low unemployment generally reflects efficient utilization of labor, the tightness of the state’s labor market might also reflect fewer people participating in the labor market.
Overall, the measures of economic performance reviewed here show that, so far this century, Minnesota’s economy does not rank among the country’sstrong performers. Over the past 15 years, Minnesota GDP—the most comprehensive measure of economic performance—grew below the national average. The state’s per capita personal income might be higher, but growth is just average and this middling growth falls below average when adjusted for Minnesota’s high taxes. Growth in wages and jobs is also just average. The state’s economy is by no means in the doldrums, but the sum of these measures points to average economic performance at best.
Findings of average performance is consistent with other sources
The data presented in the report may seem surprising to Minnesotans accustomed to hearing their state’s economy described in glowing terms. In fact, however, there should be nothing controversial about the fact that in recent years, Minnesota’s economic performance has been average or worse. For example, a 2015 report by the Brookings Institution’s Metropolitan Policy Program offered similar, and in some cases more pessimistic, data.
With respect to economic output, the Brookings report says: “The state’s economic output—a measure of the total value of products and services produced in Minnesota—grew by 1.5 percent per year on average from 2000 to 2013 (the latest year for which state output data are available), just below the national rate of 1.6 percent.”
Brookings also notes that “Minnesota’s rapid recent productivity growth has not translated to higher wages for most workers.” Most alarming, perhaps, Brookings found that, from 1999 to 2013, “fully 70 percent of Minnesota workers experienced declining wages on average.”
Last year the Minnesota Department of Employment and Economic Development (DEED) reviewed Minnesota’s recovery from the 2008 – 2009 recession and, compared to the United States, reported the same generally average economic performance on growth in jobs, wages and personal income over various time periods. Though the state’s low unemployment rate is an exception to the state’s otherwise average performance, DEED notes that “Minnesota’s tighter job market has likely contributed to the state’s slower job growth.”
The Metropolitan Council also reviewed the economic competitiveness of the Twin Cities region in 2015. Though the Twin Cities regained jobs faster than the nation since the lowest point of the recession, the study found “fairly average job growth” compared with the nation’s 25 largest metropolitan areas over the same time period.
Cracks in Minnesota’s economy are showing
Part one of the report surveyed the general performance of Minnesota’s economy over recent years and as it exists today. What does the future hold? A more in-depth look at key trends reveals weaknesses that will likely undermine future growth if left unremedied.
Job growth is centered on less productive jobs. Jobs may be growing in Minnesota at close to the same rate as the U.S. as a whole, but not all jobs are equal. As DEED reported last year, “the quality of job openings—in terms of hours and wage offers—is still below pre-recession levels.” Figure 5 shows the increase in GDP associated with the average job in various occupational categories as well as the increase or decrease in those jobs since 1997. It is clear that the jobs being created are not necessarily the most valuable. In some occupations with a high impact on GDP, such as mining, information and utilities, the number of jobs has stagnated or even fallen. In contrast, the fastest growing occupations, health care and educational services, have a relatively low impact on GDP. For as long as this continues to be the case, net job growth may not imply rising average incomes.
Minnesota suffers from a lack of new business creation. Economists generally recognize that most jobs are created by new businesses. Moreover, the small new businesses of today are, in some cases, the large, established businesses of tomorrow. Therefore, it is a dangerous warning signal if a state falls behind in new business formation. Unfortunately, that is what has happened in Minnesota. New firm foundation in Minnesota has steadily declined since 2000. Figure 6 shows the number of new and young firms per 1,000 residents and the percentage of employment provided by these firms. The decline in new firm employment began in approximately 2003. Despite the economic recovery, the trend has continued through 2013.
Not enough Minnesotans are employed in high-tech industries. While job creation per se is important to any state, the type of jobs being created also matters a great deal. Jobs that are in traded industries in which a region has a competitive advantage
are likely to be more secure and to pay higher wages than jobs that are not. Also, jobs that require a great deal of training almost always come with higher salaries to justify the extra investment in human capital. For these reasons, high technology jobs are especially important to Minnesota, as to any other region. Given the importance of high-tech jobs, it is troubling that the number of high tech jobs in Minnesota has fallen since the turn of the century.
Minnesota is attracting less venture capital. It goes without saying that capital is required today to build the businesses of tomorrow. Here, once again, Minnesota has been falling short in recent years. Venture capital is one of the important potential sources of funding for new businesses. At one time, Minnesota had the reputation of being home to an above-average network of venture capitalists. Unfortunately, that is no longer the case. In recent years, as Figure 7 shows, Minnesota has fallen well below the national average in venture capital as a share of earnings. A lack of venture capital, like a shortage of new business and declining high tech employment, is a sign of a stagnant economy.
Minnesota is experiencing a net out-migration of its most productive residents. Minnesota’s state demographer released a report in January 2015 underscoring the importance of migration to filling Minnesota’s future workforce demands. The natural rate of population change (births minus deaths) is projected to steadily decline year after year into the foreseeable future. Current migration trends, however, already show Minnesota has been, on net, losing people to domestic migration since 2002.
IRS data show that this net out-migration of residents also results in a substantial net loss of household income. In 2014, after Minnesota’s legislature enacted a significant income tax increase, the net loss in household income rose to $948 million. It will be difficult to turn around Minnesota’s underachieving economy if every year the state loses thousands of its most productive and high income residents, and fails to attract equally productive residents from other states.
Minnesota’s racial disparities will tend to suppress future economic growth. Minnesota has one of the widest gaps in economic achievement between white and minority citizens of any state. According to a report by Minnesota’s demographer, 83 percent of all white working-age adults (ages 16-64) participate in the labor force, of whom only six percent were unemployed at the time of the report. In contrast,
only 68 percent of black working-age adults and 77 percent of Mexican Americans participate in the labor force. The median full-time, year-round white worker earns $50,000 while his black and Mexican-American counterparts earn only $38,300 and $28,900 respectively.
Worse, there is every reason to expect these wide disparities to continue into the next generation. At present, Minnesota has one of the widest disparities between white and minority achievement in public schools of any state. At a time when many Minnesota companies are complaining about a lack of skilled workers, the state’s poor performance in educating and integrating minorities represents a significant lost resource and a drag on the state’s economy.
Official forecasts predict continued mediocre performance. Projections from Minnesota’s own state agencies forecast that Minnesota will fail to keep pace with the U.S. on a number of measures. Minnesota Management and Budget publishes an economic forecast twice a year to aid in budgeting and this forecast projects growth in Minnesota personal income and employment will lag the United States in every year through 2019.
The Minnesota Department of Employment and Economic Development (DEED) also periodically publishes detailed 10-year employment projections. Of 22 major occupations, DEED projects Minnesota will outperform the nation in job creation
on only three. Notably, Minnesota employment is projected to grow more slowly in a number of occupations that have historically provided a competitive advantage, including management, business and financial operations, and computer and mathematical occupations.
How Minnesota Can Do Better
For most of its history, Minnesota has enjoyed a strong and diverse economy. That history built up a high standard of living. Minnesota has long held key advantages that should contribute to a more productive and prosperous economy. Minnesota is among the nation’s leaders in educational attainment, family cohesion, workforce participation, health, cultural amenities and low crime. Minnesota also possesses abundant agricultural, mining, and timber resources. Moreover, while often considered flyover country, Minnesota’s central location gives its industry access to a number of important shipping avenues.
Despite all of these advantages and the state’s prosperous past, the analysis of Minnesota’s economy reviewed here shows that Minnesota’s recent economic performance is mediocre. Worse, data show a declining level of business creation, entrepreneurship, investment and job growth in key industries, all of which weaken future growth prospects. It seems clear that if the state continues on its present course, its economic performance will soon lag well behind that of most other states. Indeed, lagging growth is exactly what official economic projections predict will happen.
Why is Minnesota underperforming? Like other states and regions, Minnesota does suffer some drawbacks—most notably, its climate, which many consider inhospitable. But Minnesota hasn’t gotten any colder in recent years. One obvious factor that appears to be largely nullifying Minnesota’s historical, natural and cultural advantages is public policy. This is a good thing, because public policies can be changed.
Minnesota is justly regarded as a blue state. Minnesota’s taxes are among the highest and most progressive in the country. Minnesota’s regulatory environment also ranks among the most burdensome and fits the blue-state mold.
Are Minnesota’s blue-state policies responsible for its economic underperformance? There is no question Minnesota’s higher tax and regulatory burdens add to the cost of doing business. In recent years, Minnesota has increased these burdens while a number of other states, such as North Carolina, Indiana and Tennessee, have taken serious steps to reduce them. Without any other obvious weak points—beyond the inescapable realities of the state’s northern locale—Minnesota’s tax and regulatory burdens are among the only suspects at the scene of Minnesota’s mediocre economic performance.
Minnesota’s manufacturing sector may be the exception that proves the rule regarding Minnesota’s blue-state policies. Minnesota’s manufacturers are the main reason Minnesota GDP continues to grow at close to the same pace as the nation. The growth advantage in Minnesota’s manufacturing industry— the difference between Minnesota’s actual growth and what growth would have been if Minnesota’s manufacturing sector grew at the national average— added another $7.1 billion to Minnesota’s economy between 2000 and 2015.
A number of factors contribute to Minnesota’s manufacturing advantage. However, one particular factor, taxes, might come as a surprise. A recent analysis by the Tax Foundation reveals that Minnesota imposes one of the lowest tax burdens in the country on certain manufacturers. To make an apples-to-apples comparison of each state’s tax burden on business, the Tax Foundation developed a number of model businesses and asked the national accounting firm KPMG to estimate the actual taxes each business would pay in each state. Minnesota imposed the second lowest tax burden on the model capital intensive manufacturing business. This is largely due to the fact that Minnesota does not tax income derived from the sale of goods outside the state.
Though no one piece of evidence can prove Minnesota’s blue-state policies slow Minnesota’s economy, the weight of the evidence strongly suggests that this is the case. Fortunately for Minnesota, these policies are the result of human decisions and these decisions can be changed and improved upon. Coupling better tax and regulatory policies with the state’s current advantages in educational attainment, work ethic, public safety and family structure will give Minnesota its best opportunity to reach its full potential.