Put Minnesota tax code revisions on ‘to do’ list

In response to new federal changes, action is needed on estate tax exemption and deduction for state and local taxes, or folks will leave.

This op-ed appeared February 19, 2017 in the Star Tribune.

Just before Christmas, Congress passed the biggest overhaul of the federal tax code in decades. As the Minnesota Legislature convenes this week, the 2017 Tax Cuts and Jobs Act will shape what legislators do.

Two of the federal tax act’s measures, in particular, ought to prompt state action.

First is the limitation of the state and local tax (SALT) deduction to a maximum of $10,000 for income, sales and property taxes (except as they are related to business activity).

The SALT deduction allows tax filers to deduct taxes they pay to state and local governments from their income for federal income tax purposes. It is popular with high-income households in high-tax jurisdictions like Minnesota. Our state has the third-highest top rate of income tax in the country and is in the top third of states for percentage of filers claiming a SALT deduction.

In Hennepin County, which has the second-highest per capita income in the state, half of all households claim SALT, netting an average deduction of $17,600. By contrast, in neighboring South Dakota, which has no state income tax, just 17 percent of filers claim SALT deductions, receiving an average deduction of $5,800.

Curiously, Democrats have reacted angrily to this measure, which would impose higher taxes on the rich. Across the U.S., Democrats in high-tax states, who have spent years arguing that high taxes are good and don’t encourage people to leave, are now raging that high taxes will, in fact, do exactly that.

“People with higher incomes pay a lot more money, and some of them may be tempted to leave,” California’s Gov. Jerry Brown observed in unveiling his 2018-19 budget proposal recently.

If this is a problem for California, it is a problem for Minnesota, too. Democrats who are worried that taxpayers will relocate to lower-tax jurisdictions as a result of this measure should support moves in the coming session to lower our state’s high income taxes.

And not just at the top rate. Minnesota’s lowest income tax rate of 5.35 percent is higher than the highest tax bracket in 23 states, hitting the middle class hard. Significantly, according to IRS data, between 2011 and 2015, Minnesota saw a net outflow of people earning more than a modest $25,000 annually.

The second measure requiring a response is the raising of the federal estate tax exemption from $5.6 million to $11.2 million.

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 of Columbia have a higher exemption. Minnesota’s starting rate of estate taxation — 12 percent — is higher than any of the other jurisdictions that levy one and equal to the top rate in both Connecticut and Maine. Its top rate is 16 percent; only the state of Washington has a higher top rate.

As with the elimination of the SALT deduction, the federal change will encourage people to move from high-tax to low-tax jurisdictions unless the state government acts. In our new report, “The Cost of Minnesota’s Estate Tax,” we use data from a Twin Cities Business survey and the IRS to estimate that, in 2015-2016, 515 Minnesotans age 55 or older left the state owing to the estate tax, taking with them $232.5 million in future state income and sales tax payments.

Overall, set against the $183.2 million the estate tax brought in, the tax cost the state government $49.3 million in lost revenues in 2016.

Again, applying the logic Democrats have rightly applied in the case of the SALT deduction, those who are worried that taxpayers will relocate to lower-tax jurisdictions as a result of this measure should support moves in the coming session to raise Minnesota’s estate tax exemption to the federal level or, better yet, to abolish the state estate tax.

“Incentives do make a difference” Gov. Mark Dayton told Twin Cities Business recently. He’s right, and he uses high taxes on things like cigarettes explicitly to stop people from consuming them. Apply that logic consistently. Taxes affect behavior. In a competitive environment, Minnesota cannot afford to remain an outlier.

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