There are good and bad ways to cut taxes
The good news is that Minnesotans are likely going to get tax cuts one way or another.
The bad news, however, is that the type of tax cuts currently being championed at the state legislature will likely not go to all taxpayers, and will also bring in some unintended negative consequences.
What’s being proposed?
The 2023 legislative session is well past its midpoint. So it has become much easier now to predict what will go through the legislature and what won’t.
And according to Minnesota Public Radio (MPR), it does seem likely that tax cuts of some version are coming to Minnesotans. This shouldn’t be too surprising considering our historic budget surplus. What is not clear, however, is who will get those tax cuts and how much they will get.
Why is this the case?
About three proposals seem to have gained traction in the legislature. The first proposal gives
extra dependent credits for low-to-middle income families, particularly those with young children. The argument is it would help offset child care expenses. Credits might be higher for children younger than five but there would be some allowance for those up to age 17.
The second one gives Minnesotans rebate checks. As for tax credits, there are also numerous proposals under rebate checks. Walz, for example, wants to give single tax filers earning under $75,000 a $1,000 check and married joint filers earning under $150,000 a $2,000 check. He proposes an additional $600 for dependents. Republicans have introduced more generous proposals, some of which will even give checks to all taxpayers.
The third proposal concerns tax cuts on social security income. On this, lawmakers have proposed to either raise the income limit under which social security recipients are not subject to income or eliminate the tax entirely.
Suffice it to say, there is very little overlap in any of these proposals, which is why who benefits will depend almost entirely on which proposals make it to the finish line.
Why the proposals are problematic
Minnesotans — even low-income ones — face some of the country’s highest income tax rates. So tax cuts will be most welcome. However, looking at all of the above proposals, it’s clear to see that apart from universal tax rebate checks — which are unlikely to happen — all of these proposals accrue to specific types of taxpayers, not all taxpayers.
The dependent care credit, for example, by name only goes to taxpayers’ children. This means that taxpayers with no dependents will get no relief regardless of how much they pay. in taxes. And even among families with dependents, the tax credits are phased down as incomes go up, meaning that those who pay the highest taxes will see little relief. It is essentially a form of redistribution.
Only individuals with social security income will benefit from any type of social security exemption. And these people only make up a tiny segment of the taxpaying population. And for rebate checks, it’s likely that any proposal that will be passed will also target low-income taxpayers.
But apart from the fact that these proposals do not universally cut taxes, they each possess some features that make them especially unattractive as a tool for tax cuts.
Child and Dependent Tax Credit
There are a lot of issues associated with credits. For one, tax credits distort economic activity. To some extent, this is a feature, not a bug, as tax credits are mostly intended for a specific social or economic goal. In this case, tax credits are meant to reduce the cost of raising a family in Minnesota.
But tax credits do not necessarily lower the cost of raising a family, they merely subsidize it. So while families may pay a lower price, which would make raising a family more attractive, taxpayers will pick up the slack to make up for the low price that families are paying. This is distortionary, and thereby inefficient. Certainly, high birth rates, which could result from such low costs, have their own advantages to Minnesota, but that does not take away from the fact that tax credits are an inefficient way to cut costs.
Tax credits also complicate the tax system, making it inefficient. Not to mention that currently, about 25 percent of Minnesota adults do not pay income taxes. Expanding the child and dependent care credit will wipe out the tax liability of many other taxpayers, effectively narrowing the income tax base even further.
Minnesota is heavily reliant on the individual income tax, whose revenues are in turn heavily reliant on high-income people. Narrowing the income tax base will make Minnesota even more reliant on the rich, which could be unsustainable, especially since we keep losing high-income, highly productive workers to other states.
Checks and social security exemptions
Rebate checks do nothing to relieve Minnesotans from permanent high taxes. And instead of lowering costs, these checks will likely worsen inflation.
Currently, more than half of social security recipients are already exempt from the social security tax, which makes it questionable that cutting the social security tax is a top priority. But to the extent that the legislature partially or fully exempts social security, that will mean that retiree incomes from other sources — like 401k — will be taxed while social security isn’t. This would mess with something called “horizontal equity” — the idea that taxpayers with similar incomes should pay the same tax.
This means that
For example, a married filing jointly (MFJ) senior household receiving the average state social security benefit of $32,600 supplemented with $27,000 of non-Social security income ($59,600 total) pays no state income tax under current law. Simply flipping those income shares around ($27,000 in social security benefits supplemented by $32,600 in other income) and the household now has a $1,600 state income tax bill.
Not to mention that fully exempting social security will cost the state a lot of money. These costs will also only rise as the state’s population ages. Additionally, the benefits from fully exempting the tax will almost exclusively accrue to high-income retirees, while at the same time forcing other taxpayers not receiving social security to potentially shoulder a higher tax burden.
All tax cuts are not created equal. There are good and bad ways to cut taxes. And unfortunately, for Minnesotans, only the bad proposals seem to be gaining traction in the state legislature.