Tax Triggers: An Unnecessary Fiscal Autopilot

At least officially, Minnesota’s general fund is projected to have a budget surplus in the current and upcoming bienniums. Conservatives have proposed a “tax trigger” that would automatically reduce state individual and corporate income taxes whenever such a surplus occurs. Such proposals are unnecessary, regressive, fiscally irresponsible, and would skew fiscal policy outcomes away from  a fair and balanced budget process.

The call for tax cut triggers is in response to a persistent and misguided belief among some conservatives that such automatic revenue reductions are necessary to rein in rapidly escalating state revenue. While state revenue is greater today than during the depths of the Great Recession, this is an extremely low bar by which to gauge revenue adequacy. Real (i.e., inflation-adjusted) per capita general fund revenue is less today than at the beginning of century,* despite the fact that additional public expenses—including all-day kindergarten and an increased share of general education costs—have been shifted into the general fund since fiscal year (FY) 2000. In addition, the aging of the state population contributes to higher health and human service costs in the general fund today relative to 2000.

Beyond the lack of a need for automatically triggered tax cuts, the proposed trigger mechanism itself is flawed. Under current state law, the official state forecast counts the impact of inflation on state revenue, but ignores most of the impact of inflation on state spending. The non-partisan Minnesota Council of Economic Advisors (CEA) has repeatedly confirmed that this practice is “fundamentally misleading” and “potentially encourages legislators and the public to regard the state’s financial position more optimistically than the facts warrant.”† Based on February 2018 forecast projections, the projected structural budget surplus for FY 2020-21 becomes a deficit after adjusting for inflation per the recommendations of the CEA.

Basing permanent cuts in state tax rates upon overly optimistic projections is an invitation for future deficits and long-term fiscal instability that will undermine the state’s ability to adequately fund public services.

If the proposed tax cut trigger had been in place in previous years,  it could have contributed to deficits on multiple occasions, even if we ignore the failure to adequately account for inflation. Since the turn of the century, a four-year structural surplus was projected in seven November forecasts.‡ In four of these instances, the size of this surplus shrunk by anywhere from $54 million to $1.2 billion by the time the subsequent February forecast was released a scant three months later. In these instances, tax cuts triggered by a November forecast surplus could have contributed to a structural deficit in short order.

Once triggered, the subsequent tax cuts would increase the regressivity of Minnesota’s tax system, since the largest cuts would be to Minnesota’s individual income tax. When a progressive tax—such as the individual income tax—is cut, a disproportionate share of the benefit flows to high income households, with low- and moderate-income households getting a much smaller tax break. As a result, these lower- and moderate-income taxes would end up bearing an even larger share of total Minnesota taxes.

The smaller reductions in corporate taxes would not be sufficient to offset the regressivity of the individual income tax cuts. Furthermore, much of the corporate income tax cut would be exported to the federal government (through an increased federal tax liability) and out-of-state taxpayers.

The most fundamental flaw with tax reduction triggers is that they prioritize tax cuts over all other legitimate uses of surplus dollars. Why should tax cuts automatically take precedent over any number of public investments, such as restoring school aid, which has undergone a real per pupil decline of 9% since the general education levy buy-down of FY 2003, a partial restoration of the 49% cut in real per capita city Local Government Aid over the same period, or funding for early childhood education? These are issues that policymakers should debate and decide during each budget cycle; this legislative discretion should not be sacrificed for the sake of a policy that reflexively prefers tax cuts over public investment.

The tax trigger proposal currently under consideration by the Minnesota legislature is unnecessary, regressive, and fiscally irresponsible. It would be less objectionable if automatic tax cuts triggered by a surplus corresponded with automatic tax increases in the event of a deficit. However, no such symmetry exists. Presumably the framers of the tax trigger want tax cuts in the case of a surplus and expenditure reductions in the case of a deficit. Proponents of a balanced and responsible budget process should not tolerate such a lopsided and ideologically skewed fiscal autopilot.

 

*This conclusion and the information in the state general fund revenue graph are based on information presented in a February 9 North Star article, updated based on information from the February budget forecast (released February 28) and extended to include projections and planning estimates for FY 2018 through FY 2021. Inflation adjustments in this graph and elsewhere in this article are based on the Implicit Price Deflator for State & Local Government Purchases, which is the appropriate index to use to adjust general fund finances for the effects of inflation.

The CEA has repeated its recommendation to more fully account for the impact of inflation in state expenditure forecasts in every forecast document since 2003. This CEA recommendation was most recently restated in the February 2018 state forecast document.

The tax trigger proposal currently before the legislature bases the automatic income tax rate reductions upon the presence of a positive structural balance over a two biennium (four year) period as indicated in the November state budget forecast. For a November forecast released in an odd-numbered year, the period includes the biennium in which the forecast was released and the subsequent biennium. For a November forecast released in an even-numbered year, the period includes the two bienniums following the biennium in which the forecast was released.