The series of tax changes enacted in 2001—which included the creation of a general state business property tax—have worked out well for businesses. The previous article in this series showed that if the changes that most directly pertain to businesses had never been enacted, statewide business property taxes would be 11.5 percent higher today, holding everything else constant. Business taxes in each of Minnesota’s 28 regions would have increased.
Now businesses want to repeal or reduce the state business property tax. This tax was the one component of the 2001 tax act that partially offset the windfall of tax relief that businesses received through the near elimination of general education property taxes and the massive reduction in the business share of the local tax base. It was part of the deal that the business lobby happily endorsed at the time. Now, driven by the allure of a 25 percent statewide business property tax reduction,* business groups now want to eliminate the tax. But can the state afford it?
Before going further, it is important to note that plans to reduce the state business property tax come in three distinct flavors:
- Exempt the first portion of business property value from the state business levy and reduce the state general levy amount so that the tax does not shift to higher valued properties.
- Freeze the state business levy amount permanently by removing the annual inflation adjustment.
- Reduce the state business levy over time until it is completely eliminated.
Business groups argue that reductions to the state business property tax—including full repeal—are justified because the general fund currently has a surplus and thus the state can afford these tax cuts. The amount of revenue that the state would lose under the first of these options depends on the portion of business value exempted. Exempting the first $150,000 of taxable business value from the state property tax would reduce the revenue generated by the tax by about $197 million in the FY 2020-21 biennium.† This amount would likely grow modestly in subsequent years.
The cost of the second option would be somewhat less in the short term. Assuming that the state business levy is frozen at the tax payable year 2017 level, it would be reduced by about $130 million relative to the level projected for FY 2020-21 under current law. However, the cost of this tax cut would likely increase rapidly in subsequent years. Based on an extrapolation of current projections, the cost to the state general fund of freezing the state business levy would likely surpass the cost of exempting the first $150,000 of value in the FY 2022-23 biennia and would continue to escalate rapidly after that.
The state business property tax is expected to generate $1.732 billion in FY 2020-21 biennium. The complete elimination of this tax would reduce general fund revenues by this amount. (A gradual elimination of the tax would reduce the FY 2020-21 cost, but ultimately the full amount generated by the tax would be removed from the general fund.) The loss to the general fund would grow modestly in subsequent biennia.
Large tax cuts—even ones that are within the official projected structural surplus—are a risky proposition, for three reasons. First, dramatic changes in federal policy pertaining to trade, immigration, and health care could adversely impact state general fund revenues in ways that cannot currently be foreseen. Second, as the current recovery ages, the likelihood of a recession increases. A recession would reduce projected general fund revenues, making tax cuts that appear affordable today suddenly unaffordable.
Third, as noted in a recent North Star article, the projected surpluses for FY 2018-19 and FY 2020-21 ignore the impact of inflation in most categories of state general fund spending, as required by state law. Based on informal MMB projections, inflationary costs not factored into the official state forecast would be sufficient to wipe out the entire projected surplus—even before any of the tax cuts discussed above.
MMB’s projections of inflation for the FY 2020-21 biennium are not as rigorous as they would be if the full recognition of inflation were required in the official forecast. Even if these estimates are only remotely in the ballpark, the large budget surplus that tax cutting conservatives are banking on is largely illusory, the risky byproduct of willfully ignoring the full impact of inflation on state general fund spending, contrary to the sage advice of the non-partisan State Council of Economic Advisors.
It is important to note that the last time the state enacted large reductions to a major state tax—the 1999 and 2000 across-the-board income tax rate reductions—the impact of inflation was factored into the state budget forecast, so policymakers had greater assurance that these tax cuts would not plunge the state into deficit. The current dubious practice of ignoring the impact of inflation on most state general spending means that no such assurance exists today.
Even if it is unaffordable given the current state of general fund finances, the business lobby appears hell bent on reducing or eliminating the state business property tax. The next installment in this series will begin to examine the policy arguments put forward by proponents of state business property tax repeal and reduction.
*Based on estimates for tax payable year 2016.
†FY 2020-21 information cited in this and the next two paragraphs is based on Minnesota Department of Revenue (MDOR) revenue analyses and Minnesota Management & Budget (MMB) projections. This analysis focuses on FY 2020-21 because it is the earliest biennium that all three variations of state business property tax repeal or reduction could be implemented. The amounts listed in these three paragraphs do not take into account interactions with the state income tax, which would reduce the net loss of revenue to the state general fund by approximately three percent or less. In addition, the estimated impact of the full elimination of the tax and the inflation-adjusted structural balance are based on the February 2017 forecast, while estimates of the cost of exempting the first $150,000 of taxable value and removing the inflation adjustment are based on the November 2016 forecast. However, given the stability of state property tax revenues, the cost of exempting the first $150,000 of value and removing the inflation adjustment should not change significantly from the November 2016 to February 2017 forecast.