Minnesota is left behind as nine other states cut taxes

In our report ‘Closing Minnesota’s Budget Deficit: Why we should make spending cuts and not raise taxes,’ we noted that Minnesota already has some of the highest tax rates in the
United States:

As Figure 1 shows, Minnesota has the fifth highest top rate of state personal income tax in the United States—9.85 percent on income over $164,400 a year. Only Oregon, New Jersey, Hawaii, and California have higher top rates. But Minnesota doesn’t just tax “the rich” heavily. Our state’s lowest personal income tax rate—5.35 percent on the first dollar of taxable income—is higher than the highest rate in 25 states.

It is a similar story with state corporate income tax rates, as Figure 2 shows. At 9.80 percent on the first dollar of taxable revenue, our state has the fourth highest state corporate income tax rate in the United States. Only Pennsylvania, New Jersey, and Iowa have higher rates.

This is bad news for Minnesota because the balance of empirical research shows that high tax rates restrain economic growth:

In a review of the literature measuring the impact of taxes on economic growth, economist William McBride concluded:

“…that there are not a lot of dissenting opinions coming from peer-reviewed academic journals. More and more, the consensus among experts is that taxes on corporate and personal income are particularly harmful to economic growth, with consumption and property taxes less so. This is because economic growth ultimately comes from production, innovation, and risk-taking”

Of the 26 papers reviewed by McBride, 23—88 percent—find a negative impact of higher tax rates on economic growth. The other three papers find no impact. Not one paper finds a positive impact. Of the six studies looking at state tax rates specifically, every one found a negative impact of high taxes on economic growth.

More recent research corroborates this conclusion. Of 12 papers looking at the impact of taxes on economic growth published since 2012, seven find negative effects, the other five find “mixed” or “unclear” effects, and none finds a positive effect. Furthermore, research suggests that the negative effects on economic growth from increased taxes are more pronounced when, as in Minnesota’s case, taxes are already high.

For this reason, among others, we have long argued that Minnesota needs to cut its taxes. In the session just ended, attempts to raise them even further were, thankfully, defeated. Indeed, the tax burden ended up being a little lower than it might have been, but only a little. We still need to cut taxes.

The need is even more pressing when we look at what other states are doing. As Brad Polumbo writes for the Foundation for Economic Education:

In nine states and counting, residents will owe less on their next state income tax bill as local officials seek to stimulate the economic recovery by lowering taxes. 

Arizona is the latest state to slash income taxes, Fox Business reports, with Governor Doug Ducey signing into law last week a “flat tax” reform that will lower the average Arizonan’s tax bill by $340. According to the Tax Foundation, the other states to lower income taxes include Ohio, Idaho, Oklahoma, Iowa, Louisiana, Missouri, Montana, and New Hampshire. Others such as North Carolina and Wisconsin are currently considering doing the same.

“Many states that are in a strong fiscal position despite the pandemic view tax reform as an opportunity to make a down payment on continued long-term economic growth and to make a name for themselves as a taxpayer-friendly state, especially given the increased remote work flexibility many employers are offering,” Tax Foundation senior policy analyst Katherine Loughead said.

Whether we like it or not, Minnesota is in competition with other states for investment, workers, and entrepreneurs. As I wrote in the Star Tribune yesterday, we cannot afford to be complacent.

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