Minnesota’s state and local tax system remains regressive, with lower- and middle-income households generally paying a larger percentage of their income in state and local taxes than higher-income households, although the degree of tax regressivity is modest and significantly reduced relative to what is was two years earlier. The decline in tax regressivity is primarily driven by the progressive changes in the 2013 tax act.
The 2017 Minnesota Tax Incidence Study (MTIS), prepared by the Minnesota Department of Revenue, examines 2014 state and local taxes by ten equally sized income groups, referred to as “deciles.” The first (or bottom) decile consists of the ten percent of households with the lowest incomes, while the tenth (or top) decile consists of the ten percent of households with the highest income. The tenth decile is further broken down into three groups: the next five percent (i.e., the bottom half of the tenth decile), the next 4 percent, and the top one percent. In addition, using “income decile” information from the 2017 MTIS,* it is possible to break down the top one percent into the next 0.7 percent (i.e., the bottom seven-tenths of the top 1 percent) and the top 0.3 percent. The 2014 income range for each of these groups is shown below.
The MTIS calculates the effective tax rate (ETR) for each income group by dividing total state and local taxes within each group by the group’s income. The statewide average 2014 ETR is 12.0 percent, which means that all state and local taxes examined by the MTIS (which includes 99.8 percent of all state and local taxes) equals twelve percent of total Minnesota income. The chart below shows the 2014 ETR within each income group relative to the 2014 statewide average (represented by the dashed red line), excluding the first decile; the first decile is omitted due to data anomalies within this decile.†
The state and local ETR for the second decile is 13.9 percent—1.9 percent above the statewide average. In other words, the average second decile taxpayer is paying 16 percent more of each dollar of income in state and local taxes than the statewide average. The ETR dips below the statewide average for the third and fourth deciles. The ETRs in the fifth through eighth deciles—including households with annual incomes from $35,361 to $102,785—are slightly to modestly above the statewide average, while ETRs in the ninth and tenth deciles—including households with incomes above $102,785—are slightly to modestly below the statewide average.
A comparison to 2012 ETRs from the 2015 MTIS demonstrates a significant reduction in tax regressivity in Minnesota from 2012 to 2014. Whereas ETRs in the fifth through eighth deciles—comprising the middle- to upper middle-income range—were 0.6 to 0.8 percent above the statewide average in 2012, they were just 0.1 to 0.4 percent above in 2014. Meanwhile, the tenth decile was a full one percent below the statewide average in 2012, compared to 0.5 percent below in 2014. On average, higher income households are still paying less state and local tax per dollar of income than middle-income households, but the gap between the two groups shrank significantly from 2012 to 2014.
There are some interesting patterns among the sub-groups that comprise the tenth decile. The ETR for the bottom half of the tenth decile (the “next 5%” in the chart above) is 12.0 percent—equal to the statewide average. This is not surprising, given that the ETR for the adjacent ninth decile is 11.9 percent. The ETR falls as we climb toward the top of the tenth decile, with the bottom seven-tenths of the top one percent (the “next 0.7%” in the chart above) having an ETR 10.8 percent—significantly below the statewide average; however, the top 0.3 percent—with annual incomes of nearly $1 million and above—have an ETR of 12.0 percent, again equal to the statewide average.
A possible explanation for the jump in the top 0.3 percent ETR relative to the rest of the tenth decile has to do with the increased income tax rate for high income households enacted in 2013. For most tenth decile households, taxable income is below the level where the new rate kicks in; thus, these households would be unaffected by the rate increase. Because the MTIS definition of income is very broad and includes all forms of cash income—including non-taxable income—a substantial portion of the income of many households in the bottom seven-tenths of the top one percent is likely not taxed at the new top rate. It is only once we get to households in the very top of the top one percent where a large share of income is consistently subject to the new top tier rate—and thus these households have ETRs that are on average higher than the rest of the top five percent or top one percent.
By examining the Suits indices published in the MTIS, we are able to further demonstrate this reduction in tax regressivity. A negative Suits index value denotes a regressive tax system: the further below zero, the more regressive the system. Minnesota’s Suits index went from -0.052 in 2012 to -0.029 in 2014, denoting a significant reduction in tax regressivity.
The significant change in tax regressivity from 2012 to 2014 was driven by many factors, including changes in the distribution of income beyond the control of state policymakers; however, the 2013 tax act undoubtedly played a major role in the decline in regressivity. While some features of the 2013 tax act—including the cigarette tax increase—were regressive, this was more than offset by progressive features, such as the higher income tax rate on high income households and increases in the homeowners’ and renters’ property tax refund and the Working Family Credit.
While Minnesota’s state and local tax system remains modestly regressive, the latest MTIS points to the powerful impact of the 2013 tax act in increasing tax fairness. This law not only provided significant new funding for property tax relief, affordable housing and health care, higher education, and K-12 education (including all-day kindergarten), but also contributed to the largest two-year reduction in tax regressivity ever observed in the 26 year history of the MTIS. It remains to be seen if current state leaders can maintain this accomplishment.
*The section of the MTIS dealing with “income deciles” provides information on the 7,888 Minnesota households with the highest 2014 income; these 7,888 households comprise the top 0.3 percent of households by income.
†According to the MTIS, the effective tax rate for the first decile (reported as 29.9 percent) is overstated for several reasons, including the fact that:
…the lowest decile includes households who have temporarily low incomes or have better overall economic well-being than was indicated by their money income in 2014. A portion of retirees, for example, may be living primarily on savings or other assets but report small amounts of annual money income received. Due to unemployment or business fluctuations, some households who normally have higher incomes are also included in the first decile. A small portion of all first-decile households were in this decile only because they reported business losses or large capital losses for income tax purposes in 2014.
…effective tax rates for the 1st decile are overstated because income is understated. The incidence sample was unable to identify all sources of income. Many first-decile households filed neither an income tax nor a property tax refund return… An underestimate of household income generally causes effective tax rates to be overestimated.