The public in general and businesses in particular understandably pay close attention to the taxes they pay. However, the other side of the coin—the benefit derived from the expenditure of tax dollars—is frequently overlooked. This makes about as much sense as focusing on the price of the new car you’re buying, but ignoring the quality of the car itself. Relative to businesses in other states, Minnesota businesses are doing quite well in terms of getting what they pay for from their state and local taxes.
Each year, Ernst & Young (EY), in conjunction with the Council on State Taxation (COST) and the State Tax Research Institute (STRI), publishes Total State and Local Business Taxes. The report includes a cost-benefit analysis of business taxes in all fifty states and the District of Columbia.*
Using a methodology developed by economists at the Federal Reserve Bank of Chicago, the report allocates state and local spending between households and businesses to reflect the extent to which each category benefits from these expenditures. The business tax-benefit ratio is “calculated by dividing business taxes in each state by estimated government expenditures benefiting business.” A low tax-benefit ratio means that business taxes are low relative to the benefit they receive from state and local government spending.
The business tax-benefit ratio varies based upon the extent to which we assume businesses benefit from education expenditures.† To cover all the bases, the EY report calculates the ratio under three different assumptions: (1) businesses derive no benefit from education spending; (2) 25% of education spending benefits in-state businesses; and (3) 50% of education spending benefits in-state businesses. The business tax-benefit ratio declines as the assumed percentage of education spending that benefits businesses increases.
In comparison to other states, business taxes in Minnesota are low relative to the benefit they derive from state and local government spending. Minnesota’s business tax-benefit ratio ranges from significantly below the U.S. average under the 0% assumption to slightly below under the 50% assumption.
Minnesota has the 41st lowest business tax-benefit ratio among the fifty states, based on the 0% education benefit assumption; in other words, only ten states have lower taxes per dollar of benefit received from tax-funded state and local government expenditures. Based on the 25% assumption, Minnesota is tied with seven other states with the 36th lowest business tax-benefit ratio (i.e., 34 states and the District of Columbia have a higher ratio and eight states have a lower ratio). Based on the 50% assumption, Minnesota is tied with eleven other states with the 25th lowest ratio (i.e., 23 states and the District of Columbia have a higher ratio and fifteen have a lower ratio).
It should be noted that not all states are equal in terms of their ability to derive tax revenue from businesses. Energy-producing states in particular can impose very high taxes on energy, since demand is somewhat inelastic and thus these taxes can be shifted to consumers, many of whom live out-of-state. As a result, these states are able to impose higher taxes—and tolerate a higher business tax-benefit ratio—than other states.
Using data from the EY report, it is possible to approximate the U.S. business tax-benefit ratio, excluding energy producing states.‡ Even after excluding these states, Minnesota’s business-tax benefit ratio is still modestly to slightly below average and Minnesota continues to rank in the middle (under the 50% education assumption) or toward the bottom (under the 0% assumption) of the remaining states.
Because the data in the EY report is for FY 2016, it does not take into account the impact of the state business property tax freeze enacted during the 2017 legislative session. Most business taxes tend to increase from year to year due to inflation and increased economic activity. Over time, the freeze of Minnesota’s state business property tax should have the effect of reducing Minnesota business taxes and business tax-benefit ratio relative to other states, all other things being equal.
While complaints about business taxes in Minnesota will no doubt continue, it is important to note that those taxes are not high compared to other states, after we take into account the benefit that businesses derive from the expenditure of tax dollars. In short, Minnesota businesses are getting a relatively high bang for the buck from their state and local tax dollar.
* The most current edition of the EY report examines business taxes paid in fiscal year (FY) 2016. The business taxes examined in the report include property taxes on business property, general sales taxes on business inputs, corporate income taxes, unemployment insurance taxes, excise taxes on business inputs, individual income taxes on business income, business and corporate license taxes, public utility taxes, insurance premium taxes, severance taxes, and “other business taxes.”
†The EY report notes that “While economic theory suggests that individuals are the primary beneficiaries of education due to higher wages, business owners can benefit if an educated workforce generates higher returns to capital… A review of the literature finds that a 1% increase in the share of workers with a college education in a city increases output by 0.5 to 0.6 percentage points. If businesses are able to capture some or all of the additional productivity from increased education, they are deriving benefits from this type of government spending.”
‡Energy producing states as used here include Alaska, Kentucky, Louisiana, North Dakota, Oklahoma, Texas, West Virginia, and Wyoming.