There has been a lot of discussion in Minnesota recently concerning the regressivity of Minnesota taxes. This is especially pertinent to the governor’s race, with Dayton saying that the rich should pay their fair share of taxes.
These discussions usually stem from the every other year tax incidence reports created by the Minnesota Department of Revenue. The latest one is the 2009 Minnesota Tax Incidence Study, which can be found at
This study looks at all the taxes implemented at the state and local level and determines who really bears the burden of these taxes. It is not immediately obvious which households ultimately bear the burden of business taxes. At first glance one might think that the owners of businesses bear 100% of this burden, but if the businesses can pass on this cost to their customers in the form of higher prices, or to their employees in the form of lower wages, then the owners do not bear this full burden. And in fact economic analysis indicates that consumers and employees do indeed bear most of the burden of business taxes. The tax incidence report does this economic analysis to determine how much various categories of households are ultimately subject to state and local taxes.
The analysis that generates the most discussion is the study of the percentage of state and local taxation as a percentage of income for various income levels. The study gives this percentage of tax at ten different levels of income (deciles). Thus the 10% of households that make the lowest income are called decile 1, while the 10% of Minnesota households that make the highest income are decile 10.
This analysis indicates that Minnesota state and local taxes are somewhat regressive, that is, the level of state and local taxes as a percentage of income is higher for the lower deciles than the highest. This regressivity is most striking at the highest and lowest deciles, with the tax percentages being 23.8% for decile 1 and 10.0% for decile 10. However, the data is by far the weakest for decile 1, because much of the poorest Minnesotans’ income is excluded (see #4 below). The other eight deciles range from 11.5% to 12.5%.
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Regressive taxation is a bad outcome of a tax system, because of the law of diminishing returns. The richer a person is, the less valuable a single dollar is to them, so it makes sense that each dollar of taxation is less painful to the rich than to the poor. It is less clear that each percentage of income is less valuable to the rich than the poor. But I think that is true also, since the rich have more options for getting by than the poor, when a similar percentage of income is taken from each. Thus, it is a good thing to have a progressive tax structure.
However, regressivity in taxes is not the only important factor in tax policy. Other important factors include transparency and a correspondence between voting and paying taxes (see #6 below concerning the latter point). Furthermore, many use the Minnesota Incidence study as a call to action to increase the progressivity of taxes, without understanding the study itself very well. Below I list several issues concerning the study.
1) Business taxes. Few that decry regressive taxation in this state seem to favor the reduction of business taxes to the level required to just pay for the government services that directly benefit business. This is despite the fact that business taxes are one of the most regressive taxes in the Incidence Study, and removing business taxes altogether would result in Minnesota taxes being progressive as a whole. Business taxes are very regressive because the ultimate payers of these taxes are mostly the employees of the business (who receive lower wages due to these taxes), and the consumers of the business’s products (who pay higher prices due to these taxes). One can infer from this peculiar blind spot that most critics of Minnesota’s regressive taxation scheme don’t truly want to make the tax system more progressive. Their main agenda is to use the regressive taxation as a whipping boy to make political points. They don’t truly want a progressive system, because they would then lose this political advantage.
There are those that claim that the Incidence Study has it wrong. These critics say that business taxes are ultimately paid mostly by the owners of the business, and are thus truly progressive taxes. However, if this is these critics are correct, then Minnesota taxes are not regressive after all. If business taxes are refigured in the Incidence Report as progressive taxes, then the Minnesota tax system is actually progressive, and suddenly these critics of regressivity have nothing to complain about. So those who believe that business taxes are progressive should not also criticize Minnesota taxes as being regressive.
In fact, this dispute itself is another argument against business taxes. The best taxes are transparent taxes. When businesses pay the taxes, it can be very hard to see who is truly paying for these taxes. Minnesotans may vote for business taxes because they don’t seem to hurt actual people, not realizing that they themselves may be the ones being hurt. And even those with more subtle understanding about the ultimate payer of business taxes don’t all agree on who is bearing the cost.
2) Federal taxes. The Federal government receives a lot more taxes from Minnesotans than the state and its localities. So why are Federal taxes ignored when having this discussion about regressive taxes? Almost half of the citizens of the United States pay no Federal income taxes or receive a refund. When Federal taxes are added to state and local taxes, our tax system in Minnesota is very progressive. We should include all taxes paid in Minnesota when judging its value. There is no reason to exclude Federal taxes from the mix.
3) Many “taxes” are really fees. Many of the so-called taxes in the Incidence Study are more like fees than taxes. We don’t expect to pay a sliding charge based on our income when we buy groceries, so why should we expect progressive charges for fees paid to the government? The clearest “tax ” of this type is the gas tax, which is used to pay for the roads and other transportation needs of the state. This ‘tax” should be removed from the Incidence Study, because there is no reason for it to be progressive. It just confuses the issue.
Other fees that are called taxes are the so-called “sin taxes.” We charge “tax” on cigarettes and alcohol, because we are using the tax system to try to decrease usage of these substances, and to mitigate some of the damage to society by taking funds from their users. These fees are more like fines than taxes, and so should not be included in the Incidence Study.
Gasoline taxes and “sin taxes” are very regressive when treated as taxes and so create much of the apparent regressive nature of Minnesota taxes. These fees should be judged on whether they achieve their purpose (pay for transportation or successfully reduce usage of tobacco or alcohol). They shouldn’t be cut just because the rich pay a lower percentage of their income than the poor for these fees. These fees should not be included in the Incidence Study.
4) Income excluded from study. Not all income of the poor is included in the Incidence Study, giving a skewed view of their true percentage of income paid as taxes. For example, income received but not included in the Study include the earned income credit, non-cash subsidies for food stamps, housing, medical, etc., as well as food shelves and other donations received. This exclusion of income, along with example #3 above, explains what appears to be a very high level of taxes as a percentage of income for the poorest in the Study.
5) Consumption as base instead of income. As a society, we try to encourage people to save more money, and not spend so much on current consumption. Saving by individuals is good for society, because it allows for investment and makes those individuals less dependent on government and charities in the case of financial setbacks. The opposite of savings, excessive holdings of debt, is a major cause of our current recession. Therefore, it makes sense that we should instead judge the progressivity of taxation as a percentage of consumption, not income.
That change in mindset would result in Minnesota state and local taxes no longer considered to be regressive. For example, sales tax would no longer be regressive, if we used consumption as the base. Sales tax is only considered regressive under our current system because the rich save a higher percentage of their income than the poor do. Sales tax shouldn’t be treated as bad tax as a result of the positive act of saving money.
6) Regressivity not only basis to judge tax. Regressivity should not be the only basis we use to judge the value of a tax. For example, we should judge a tax based on whether it results in citizens making good decisions in voting for representatives. Ideally, every citizen should treat government funds in the same way as they treat their own funds. Each voter should advocate spending tax money in the same way that they would spend their own money, if they had the government income available for their own use. But since the rich pay the majority of taxes to the government, for both Federal taxes and Minnesota taxes, there is a danger of voters not treating government money like their own. When voters receive much smaller tax increases than benefits when government expands, the likelihood of extravagance is greatly increased. It is thus dangerous to weight the taxes paid even more heavily on the rich, because that encourages the average voter to push unwise spending decisions onto their representatives. It is common enough already for government spending to be unaccountable to the public, due to the nature of representative democracy and large government bureaucracies. Further separation between taxes collected and government spending will increase the tendency towards unwise spending decisions.
Taxes in this state aren’t truly regressive as has been widely reported, due to the exclusion of Federal taxes in the calculations, exclusion of many welfare benefits in the income of the poor, and inclusion of many fees that have been labeled as taxes. Many of those who argue for more progressivity in taxes won’t agree to decrease business taxes, even though these are some of the most regressive taxes we have. Also many of the assumptions of regressivity should be re-visited, such as the use of income instead of consumption as the base, and the presumption that the concentrated payment of tax by the rich has no downsides.