Before Hyperventilating About Tax Rankings…

Based on the most recent government finance data from the U.S. Census Bureau for 2013, combined state and local government taxes per capita in Minnesota are the tenth highest in the nation*—and this does not include tax increases enacted during the 2013 session. However, before going apoplectic about Minnesota’s “top ten” per capita tax status, consider the following.

Before delving into the fine points of state rankings, it is important to note that a high tax ranking is not necessarily a bad thing, provided that tax dollars are being used efficiently to provide public safety, a quality education system, robust infrastructure, an adequate social safety net, clean drinking water, and other public goods and services. While taxes will be higher, this will be offset by advantages derived from a more highly skilled workforce, safe and livable communities, and all of the other benefits from adequately funded public investments. To underscore the value that a state can derive from taxes, it should be noted that high per capita tax states tend to have higher median income and higher average annual pay and lower poverty than low tax states.†

State and local taxes per capita is a flawed measure of the relative size of government between states. For starters, taxes constitute only one of several ways through which state and local governments derive revenue from state residents and businesses. Other categories include charges, penalties, and special assessments, to name just a few. Total own-source revenue—as opposed to just taxes—provides a more complete picture of what state residents are paying to support the functions of state and local government.

States with high personal income per capita tend to have higher taxes and own-source revenue per capita.† According to the Minnesota Department of Revenue (MDOR):

Per capita income varies considerably among the states, from a low of $33,000 in Mississippi to a high of $60,000 in Connecticut. In FY [fiscal year] 2011, differences in per capita income explain 55 percent of the difference in tax revenue per capita (excluding energy-dependent states Alaska and Wyoming). On average, each $1,000 increase in per capita income is associated with a $156 increase in taxes per capita. It is no surprise, then, if a high-income state also ranks high in per capita state and local tax collections.

An update of this analysis based on FY 2013 data shows that the relationship between per capita taxes and per capita income is even greater than it was in FY 2011. The chart below shows the relationship between personal income per capita and combined state and local taxes per capita based on FY 2013 data, with each dot representing a state; the red dot denotes Minnesota. (To replicate the MDOR analysis of FY 2011 data, the energy-producing states of Alaska and Wyoming are excluded.)

py-tax

The chart indicates a strong correlation between per capita income and per capita taxes among the states. Minnesota’s FY 2013 state and local taxes per capita ($5,547) is approximately what we would expect given Minnesota’s 2013 personal income per capita ($47,410).

Further analysis of FY 2013 data reveals a similarly powerful relationship between per capita income and per capita own-source revenue, with differences in per capita income explaining 68 percent of the variation in own-source revenue per capita among states, excluding Alaska and Wyoming.† The chart below shows the relationship between personal income per capita and state and local own-source revenue per capita based on FY 2013 data, with the red dot again denoting Minnesota.

py-own

This chart indicates that the relationship between personal income per capita and own-source revenue per capita is approximately as strong as the relationship between income per capita and taxes per capita. As was the case with Minnesota taxes per capita, Minnesota’s FY 2013 own-source revenue per capita ($7,641) is about what we would expect based on Minnesota’s personal income per capita.

The strong correlation of per capita income with per capita taxes and own-source revenue is not surprising. High per capita income states tend to receive a smaller share of total revenue from the federal government than do low per capita income states.† As a result, high per capita income states must rely more heavily on taxes and other own-source revenues to pay for the functions of state and local government.

The powerful correlation between personal income per capita and taxes per capita is a clear indication that state tax per capita rankings are little more than an indirect way of measuring variation in per capita personal income among states. While own-source revenue per capita is a more inclusive measure of state and local government revenue than taxes alone, it too has an extremely strong correlation with per capita personal income, to the point where it too is little more than a circuitous measure of variation in per capita personal income.

The strong relationship between per capita personal income and per capita taxes and own-source revenue can be explained in terms that have nothing to do with the adequacy of public investments or the profligacy of state and local elected officials. Even if a high per capita income state is spending an amount identical to that of a low per capita income state, it will generally need to impose higher taxes and other own-source revenues to pay for this spending, since the federal government is picking up a smaller portion of the tab.

The above analysis reveals two important points. First, despite much handwringing from conservatives, Minnesota per capita taxes and own-source revenue are about what we would expect, given Minnesota’s level of per capita personal income. After controlling for our relatively high level of per capita personal income, Minnesota is not a particularly high tax or high own-source revenue state.

Second, total revenues or total expenditures per capita are a better basis for ranking states on the relative size of state and local government than taxes or own-source revenue per capita, since total revenue includes the significant funding that state and local governments receive from the federal government, while total expenditures includes the spending funded with federal dollars. However, total revenues and total expenditures per capita are still an imperfect measure of variation in the size of government among states, for reasons noted in the second article in this series.

 

*Unless otherwise noted, the rankings and other analysis in this article will be based on data for all fifty states and the District of Columbia.

These relationships are statistically significant at the 0.01 level.