Time for a New Conversation on Taxes

Now that both the November elections and the November budget forecast is behind us, the political dynamics associated with the 2013 legislative session is much clearer.  The evaporation of GOP influence across all levels of state governance was admittedly a bit surprising.  However, what was not surprising was the rhetoric from both parties regarding their reaction to the November economic forecast projecting an upcoming biennial budget deficit of $1.1 billion.  While representatives of both parties were quick to agree that such a deficit was much more manageable than the $5+ billion deficit faced 2 years ago, their respective solutions were predictably routine.  Almost immediately after the forecast was released Republican voices were emphasizing that the current biennial balance of approximately $1 billion was a “surplus” and that there was no need for any tax increases.  Equally predictable was DFL Governor Dayton’s call for higher income tax rates on Minnesota’s top earners; a call he has made since his 2010 election. 

To say that we need a new conversation about taxes in this state is obvious.  How else can you explain such rhetoric?  First, suggesting that Minnesota has a budget surplus is like your brother-in-law telling you that he received a $500 raise and therefore has more money to spend, all the while ignoring the fact that he still owes $20,000 on his credit card.  Similarly, calling for higher income taxes on the rich (or anybody) simply exacerbates Minnesota’s already disproportionate dependence on the income tax.  So before both parties stake their ground on these all too-familiar positions, can’t we try to change the conversation?

One idea that has been around for quite a while, but seldom seriously addressed is the notion of broadening the sales tax base.  The arguments for changing the conversation in this direction are two-fold; and from my perspective compelling.  The first is that since the establishment of the sales tax in 1967, our Minnesota economy has fundamentally shifted from one that produces “goods” to one that delivers “services.”  However, the current sales tax is primarily imposed on the purchase of goods and not the delivery of services.  This means that each year as our economy continues to transform, the sales tax becomes less relevant and effective. 

Such deliberate policy decisions to exclude certain goods or services from the collection of sales tax is often called a “tax expenditure,” and Minnesota has plenty of them.  But the decision to exclude many consumer and business services is a big one.  According to a study by the Public Strategies Group in 2009, the inclusion of many consumer and business services currently exempt from the sales tax could yield up to $2 billion in additional revenue per year.  In light of the fact that the projected biennial budget deficit is $1.1 billion, isn’t such a change in conversation worthwhile?

The second reason for looking more closely at these tax expenditures is that while the appropriated general fund budget must be debated and approved line-by-line by legislators and signed by the Governor every biennium, once a tax expenditure is approved by the legislature it remains in place until the legislature intentionally modifies or repeals it.  In simple terms, this means that after being passed a tax expenditure go on “auto-pilot” and remains in place for decades without any legislative discussion or review.  Is this really the best way to legislate tax policy?

Of course the high profile “poster child” for such sales tax exemptions is the one on clothing; an exemption that many suggest is woven into the cultural fabric of Minnesotans. But the truth is that there are many sales tax exemptions that no one would ever want to change; such as the sales tax exemption on prescription drugs, groceries, and yes … clothing.  But just because we can agree on a variety of such exemptions is not a rationale for ignoring a thorough review of the more than 200 such tax expenditures currently in statute (yes … over 200!).  For example, do we really still need a sales tax exemption on newspapers and magazines ($65 million); an exemption on telecommunications equipment ($26 million); or an exemption on farm machinery ($36 million)?  

My point here is not to specifically pick on these exemptions, but rather to point out that collectively these special tax breaks add up to more than $11 billion in revenues not collected (Public Strategies Group, 2009).  And as noted above, once enacted these tax exemptions tend to go on auto-pilot.  Could a thorough review of all these tax expenditures by the Legislative Auditor lead to the elimination of at least one out of every ten of these exemptions?  Now that would totally change the conversation!