Budget Trends Commission February 27, 2008 Minnesota Taxes: Growth, Stability, and Demographic Changes Presented by: Paul Wilson MN Department of Revenue

Outline Overview of Minnesota Tax System  Three-Legged Stool  State vs. Local Taxes Demographics and the Impact of Aging  Income Tax  Sales Tax  Property Tax Growth and Stability  Introduction: Growth, Standard Deviation, and Cyclical Swing Index  Income Tax  Sales Tax  Corporate Tax  Property Tax

Source: Price of Government and DOR History file

What’s different about Minnesota?  More equal mix of income, sales, and property taxes than is typical.  In 2006: 39% income tax, 32% property tax, 29% sales tax.  State share of tax revenue is higher than in most states.  Local sales taxes relatively low, and there are no local income taxes.  Local governments are unusually dependent on state aids.

Source: US Census

Few states have greater “balance” in tax shares.  In 2005, according to US Census data, only 7 states had greater balance (and only 4 had greater balance than Minnesota did in ).  18 states depend on one of the big three taxes for over half of total state and local revenue (including 12 states who lack one of the three).  The median state’s “Big Three” ratios in 2005 were 46%, 33%, and 21%.  9 states had a longer income tax “leg” than Minnesota (including 3 states with no sales tax).  28 states had a longer sales tax “leg” (including the 7 states with no income tax).  37 states and DC had a longer property tax “leg”.

Source: US Census

Implications of relying more heavily on income tax relative to sales and property taxes:  Less stable revenue, but higher average revenue growth.  Progressive income tax helps balance regressivity of other taxes in overall tax system.

Source: US Census

 Large percentage of the income seniors report on their tax returns is tax exempt.  Two-Thirds of Social Security (for income tax filers – higher overall)  One-quarter of pension and IRA income.  For all senior filers, 28% of income reported on tax returns is exempt.  Note that the share of exempt income for seniors is lower in Minnesota than in many states. In a few states, all Social Security and pension income is exempt. (Minnesota follows federal law on taxation of Social Security and pensions.)

 Tax Incidence Study Database  Includes non-filers  More comprehensive measure of income

Impact of Aging on Minnesota Income Tax Revenues Nina Manzi, Joel Michael, and Paul Wilson, “State Income Tax Revenues in 2002 and 2030: The Impact of the Retirement of the Baby Boom,” National Tax Association Proceedings, November Reprinted in State Tax Notes (January 23, 2006), pp House Income Tax Simulation (HITS) Model Used to estimate tax revenue in 2002 assuming:  2030 age distribution, and  2030 estimated shares of income (wages, retirement income, capital income). Simulation results: Revenues would fall by only 1.8 percent. Why so small an impact?  Fewer young people – who also pay a relatively small amount of tax.  Under Current law, the share of retirement income subject to tax will rise.  Social Security threshold is not indexes for inflation, so between 2002 and 2030 the share of SS subject to tax will rise from 32% to 63%.  Effective tax rates for seniors would rise from 2.90% of income to 3.43% of income.

The Big Question: Will current law related to senior preferences continue?

Minnesota Estimates – Impact of Aging AND Added Senior Preferences (Income held constant) Revenue impact as percent of: Total change 2002 to 2030 with preference in both years Total change 2002 to 2030 if add new senior tax benefit 2002 base revenues 2030 base revenues Current Minnesota law (“2010 Law”)NA -1.8%NA Full exemption for Social Security-2.3%-5.0%-4.5%-6.8% Index Social Security BenefitsNA-1.9%-3.7% $10,000 pension exclusion, not indexed -2.7% -1.8%-4.5% Full exemption for Social Security and $10,000 pension exclusion, not indexed -4.9%-7.4%-4.4%-9.2% Full exemption for Social Security and $10,000 pension exclusion, indexed -4.9%-9.2%-6.3%-11.1% Full exemption for Social Security and pension exclusion -8.1%-15.8%-10.0%-17.6%

Revenue impact of aging:  Based on a 2004 study of consumption differences by age, Paul Menchik (Michigan State University) suggested that aging alone would reduce sales tax revenue by 5% in the typical state between 2000 and  In contrast, more recent analysis by Peter Fisher (University of Iowa) suggests that aging by itself will increase sales tax revenues by 0.3% between 2005 and 2030.

Source: Peter Fisher, University of Iowa (2007)

 Seniors are more likely to be homeowners.  Senior homeowners have lower income than non-senior homeowners – but only about 19% less.  Seniors own homes only slightly lower in value than non-seniors.  Homeowner tax before property tax refund is 9% lower, but because incomes are lower the tax equals a higher percentage of income.  The PTR reduces senior property tax by more than it reduces non-senior tax, and tax after PTR as a percent of income is roughly the same for seniors and non-senior homeowners. Homeowner Property Tax Statistics by Age

Tax Growth & Instability Measure 1: Tax base growth. How does historical growth in the tax base compare to growth in per capita income? Growth rates stated in per capita terms, and in real (inflation-adjusted) dollars. Compared to growth in real per capita personal income. Measure 2: Standard deviation of tax base annual growth rates. How much does the growth rate (real per capita tax base) vary from year to year? Captures amount of variation around the long-run trend. Larger standard deviation means more instability. Measure 3: Cyclical swing index. How much does the tax base “swing” between expansion and recession years? CSI =Average annual growth in expansion years Minus Average annual growth in recession years

The Challenge of Remote Sales  The tax gap from uncollected remote retail sales is substantial and growing rapidly.  From $150 million in 2008 to over $200 million in  Reduces growth in general sales tax revenues by about 0.25% per year.  Possible solution: Streamlined sales tax to simplify tax collection plus either:  Congressional action or  Court decision.