It’s been a whirlwind week on the Minnesota tax policy front. On Tuesday, the House and Senate Conference Committee approved a tax bill. The bill went quickly to the House floor, where it passed the same day. On Wednesday, the Senate approved the same bill. And on Thursday, Governor Dayton vetoed it, citing among other reasons, that the bill benefits corporations at the expense of working families.
Governor Dayton and legislative leaders have found common ground on several important issues. The major challenge for policymakers this year is on how to respond to the overhaul of the federal tax code via the Tax Cuts and Jobs Act (TCJA) enacted by Congress late last year. All parties in Minnesota agree to:
- Move from Federal Taxable Income to Federal Adjusted Gross Income as the starting point for calculating Minnesota individual taxable income.
- Maintain pre-TCJA standard deductions and personal and dependent exemptions.
- Fully conform to two other major new federal laws.*
- Decline conforming to the TCJA’s convoluted pass-through income provisions.
A principal area of difference between the Governor and the Legislature is regarding income tax rates. The bill that passed the House and Senate reduces the first tier individual income tax rate from 5.35% to 5.3% in tax years 2018 and 2019 and to 5.25% in tax years 2020 and beyond, while the second tier rate is reduced from 7.05% to 6.95% in tax years 2018 and 2019 and 6.85% in 2020 and beyond.†
These rate reductions provide no relief to many lower-income working households whose taxable income is reduced to zero after deductions and exemptions. For example, a family of four with an annual income of $30,000 would receive no tax relief from the rate reductions in the bill approved by the legislature this week and vetoed by the Governor on Thursday.
As an alternative to rate reductions, the Governor earlier this session proposed a Personal and Dependent Credit of $60 per person for individuals earning less than $90,000 and married joint filers earning less than $180,000. Thus, a family of four with a $65,000 income (the state median) would get a $240 tax reduction. The same family would see a $92 reduction from the legislative income tax rate reductions, according to the Minnesota Department of Revenue.
Missing from the bill was an increase to Minnesota’s Working Family Credit—the state’s version of the federal Earned Income Tax Credit. The Governor’s proposes to expand the Working Family Credit to filers who are 21 years old, allow families with more than two children to obtain a larger credit, and expand income eligibility levels. These enhancements to the credit would provide 329,000 Minnesotans with an average $160 state tax reduction.
The legislature’s bill provided a substantial reduction in the corporate income tax rate, from 9.8% to 9.65% in tax years 2018 and 2019 and to 9.1% in tax years 2020 and beyond. These corporate rate reductions are substantially larger than the first and second tier income tax rate reductions in the bill.
The now-vetoed bill also eliminated the corporate alternative minimum tax (AMT). In the absence of the corporate AMT, some profitable Minnesota corporations would avoid paying any state corporate income taxes.
The corporate income tax rate reductions and the corporate AMT elimination sought by the Legislature would reduce state corporate income taxes by a $46 million in the current biennium (FY 2018-19) and by $152 million in the next biennium (FY 2020-21), based on legislative estimates. This tax relief would be offset by $81 million in corporate tax increases in FY 2018-19 and $198 million in FY 2020-21 based on TCJA conformity provisions in the vetoed tax bill.
The TCJA conformity provisions in the Governor’s proposal would increase corporate taxes by $272 million in FY 2018-19 and $507 million in FY 2020-21, based on DOR estimates.‡ However, the increase in state corporate taxes due to TCJA conformity pale in comparison to the estimated $1.5 billion federal tax reduction that Minnesota corporations are projected to receive through the TCJA in 2019 alone. Because of the massive TCJA tax cut, total state and federal corporate taxes in Minnesota will drop by over $1 billion annually, regardless of whether the Governor’s or the Legislature’s corporate tax provisions become law.
The individual and corporate income tax rate reductions sought by the Legislature run the risk of damaging Minnesota’s long-term fiscal stability. After properly accounting for inflation per recommendations of the non-partisan Minnesota Council of Economic Advisors, Minnesota is already projected to have over a $900 million structural deficit in the FY 2020-21 biennium—even if with no tax cuts. A reasonable extrapolation of general fund revenues and expenditures beyond the FY 2020-21 beinnium indicates a recurring string of deficits, even if we assume no recession.
The legislature and the Governor also differ on conformity to TCJA changes to section 529 educational savings plans. As we discussed in a recent article, federal changes now allow use of 529 savings for private and religious K-12 school expenses. The legislature’s approach would not subject private K-12 school disbursements from a 529 plan to the state’s recapture tax, effectively allowing private educational choices to be funded with public dollars through a state tax subsidy. In contrast, the Governor has stated that 529 savings plans should be used for their designed purpose—to pay for higher education—and if used for other purposes should be subject to a recapture tax.
With just over three days remaining in the 2019 session, there is an ever shrinking window of time to reach a deal on these and other outstanding issues.
*The two new federal laws that the House and Senate tax bill conforms to are the Disaster Tax Relief Act of 2017 and the Bipartisan Budget Act of 2018.
†In tax year 2019, the first tier rate applies to income below $37,851 for married joint filers, below $18,931 for married separate filers, below $31,881 for heads of households, and below $25,891 for single filers; the second tier rate applies to income from $37,851 to $150,380 for married joint filers, from $18,931 to $75,190 for married separate filers, from $31,881 to $128,090 for heads of households, and from $25,891 to $85,060 for single filers.
‡The difference between the Governor’s proposal and the legislative proposal in terms of the tax increase due to conformity is the result of different approaches to the deemed repatriation of foreign income, global intangible low tax income, and foreign derived intangible income.