The DFL majority in the Minnesota Legislature is considering adding a fifth tax bracket to our income tax, one that would levy an additional 1 percentage point on incomes above $600,000. The new top rate of 10.85% would be paid by some 24,000 filers at an estimated average cost near $10,000 each. Is this a good idea?
As is often the case on public issues, a pithy quote from Colbert may provide insights — referring to the 17th century French finance minister Jean-Baptiste, not late-night talk show host Stephen. King Louis XIV’s most competent official supposedly said that “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
That is a political judgment of feasibility, not of economic efficiency or fairness. But as another great European minister, Prussia’s Otto von Bismarck, said, “politics is the art of the possible.” Legislators today need to be aware of these pragmatic European insights.
On such questions of taxation, no economist can say what the “right” decision would be. The issues at hand are inherently subjective. Yet there are general insights to keep in mind.
First, the question of the total amount of revenue to be raised is different from that of what schedule of rates be applied to what “base.” The base, in the DFL’s case, is income, not property or sales. The proponents’ apparent assumption seems that the increase in the rate for this fifth income tier should increase total state revenues but not rebalance the current overall burden. But it would be entirely possible also to increase the rate on high-income households and reduce it on others.
Second, one must consider how tax revenues versus government spending balance out over the span of one or more business cycles. Politically, many citizens will not see any need for additional taxes at a time when the state has an unprecedented large budget surplus, one that would not immediately vanish in a recession. Yet a singularly long era of artificially suppressed interest rates, coupled with large federal outlays for the worst public health crisis in a century, were important one-time contributors to the surplus. Both revenue sources are going away. It isn’t clear what the “next-normal” equilibrium will be.
Minnesota does a very good job compared to many other states in tabulating “the price of government,” combining state and local finances. But we don’t have published estimates of what would be needed to achieve a “structurally balanced budget” when all of the “cyclical” variations from well-established fluctuations in output, employment and prices are taken into account. Proponents of the new tax rate argue that additional revenue will be needed in the longer-run. There certainly are factors, such as the increasing average age of the working tax paying population as the baby boom retires. But advocates of the new rate need to articulate exactly what new needs we face.
Third, exacting new tax revenues inherently involves judgments on where spending the additional long-term revenue will create the greatest impact for the people. Will the increase in well-being from new spending be greater than the increase in well-being if that dollar had been left in private hands and spent or saved?
Some things are elementary: For spending on physical infrastructure like a bridge, road or flood control structure, benefit-cost studies provide insights. Ditto for a block nursing program that succeeds in keeping seniors in their own homes and out of more expensive facilities.
It is harder to set a per dollar-impact value on a new library, technical college classrooms and labs, hiking trail at a state park or community mental health programs. Yet at least implicit weighing of the benefits to society of these programs is embodied in yea-nay votes on their funding.
Fourth, there are strong fairness arguments for having a graduated set of marginal tax rates with higher-income households paying a higher percentage of the last dollar they earn than do lower-income ones. The underlying idea is to raise needed revenue without cutting into resources to meet essential family needs rather than wants. But greater numbers of brackets increase the complexity of household financial planning and of completing tax returns.
A few decades ago, both Minnesota and the federal government had many brackets. These were telescoped down to three for our state. But then in 2013, a DFL-majority Legislature added a fourth, bringing the top rate to 9.85%. Now they want a reprise with a fifth rate and one more percentage point.
Does the fairness aspect of making the 0.8% of highest income payers bear a greater burden offset the added complexity of a multi-rate schedule to all filers? One should note that widespread use of TurboTax and other return preparation and filing software has reduced what economists would call the “transaction costs” of income taxes generally — the price we pay in time and labor to prepare our taxes.
Fifth, legislators, whether they like it or not, always must remember our country is a federal one with 50 autonomous states. These all compete with each other to some degree in terms of taxes versus services. The competition is both in terms of total tax burden and perceived fairness of it. Conservatives often err in overestimating the degree to which high-taxed households will move to other states and to which in-migration of productive people from other states will be deterred. Liberals often err in dismissing these factors too quickly and casually.
Minnesota is high in the ranking of states in terms of the top marginal tax bracket. We currently are sixth from the highest. Adding a new bracket would put us at fourth. When one looks at all taxes, on property, sales, motor vehicles and other bases imposed at local as well as state levels, we are not as near the top, but still high.
Sixth, one must look at the benefits of public spending as well as the cost of taxes. Minnesota is a high-service state as well as a high-tax one. Tax revenues fund good infrastructure, excellent parks and other amenities, good schools and superb institutions to foster high-tech research and development. Poor states in the deep south, plus Kansas and Oklahoma, for example, have touted their low taxes for decades, but don’t exactly have vibrant economies. Forty years ago, the middle-south states did lure auto assembly plants with huge tax subsidies. These “created” jobs at great taxpayer cost, but all remain poor states with limited success in bootstrapping their own business development.
These all are a reprise of arguments dating back to when the Legislature was a territorial one rather than a state. Once again, elected officials will have to judge the degree of goose hissing versus down gathered. What is politically possible will emerge and the proposed fifth bracket will be decided one way or another. Yet the arguments will be with us always.
St. Paul economist and writer Edward Lotterman can be reached at [email protected].
