Flawed Conservative Tax Incidence Analysis
A conservative state legislator recently declared in a Rochester Post Bulletin commentary that “each and every Minnesotan is going to lose more of their hard-earned money thanks to more than $2 billion in tax and fee increases passed into law by the DFL-led legislature and Dayton this past session.” The statement, while startling, is false. But that hasn't stopped a chorus of conservatives from echoing it.
The above declaration is based on a misinterpretation of a tax incidence analysis of the 2013 omnibus tax act recently published by the Minnesota Department of Revenue (DOR). That analysis lists the estimated effective tax rate (i.e., total state and local taxes as a percentage of household income) change resulting from the 2013 tax act for each “population decile” in Minnesota.* The table below shows the income range for each population decile, with additional detail presented for the tenth (highest income) decile, based on projected 2015 data.
According to the DOR incidence analysis, the average effective tax rate (ETR) within each of the ten deciles will increase as a result of the 2013 tax act. However, for most deciles, the single largest tax hike is the tobacco tax increase.†
According to the 2010 Minnesota Adult Tobacco Survey published by ClearWay Minnesota and the Minnesota Department of Health, 16.1 percent of Minnesota adults are smokers. Thus, the vast majority of Minnesota households will be unaffected by the tobacco tax increases in the 2013 tax act. For these non-smoking households, the ETR change excluding the tobacco tax increase will provide a better representation of the impact of the 2013 tax act. This ETR impact is shown below.
Non-smoking households throughout entire middle section of Minnesota’s income range—consisting of the fourth through eighth deciles with household income from $26,398 to $101,616—will see a either a modest reduction or a negligible increase in average effective tax rates.‡ For these households, the increased property tax relief in the 2013 tax act—including the new homestead credit refund—will generally be sufficient to offset other tax increases in the act.
So taxes will go down for the typical non-smoking middle income taxpayer under the 2013 tax act. However, what about the lowest income households? According to the Post Bulletin commentary, “the bottom 20 percent of taxpayers [i.e., the first two deciles]—those making $19,316 or less—actually will pay more in new taxes as a percentage of their income than those making more than $146,401 per year [i.e., the tenth decile].”
The accuracy of this statement is suspect because it is based in large part on data for first decile households that have annual income less than $10,938. As noted in DOR’s 2013 Minnesota Tax Incidence Study, the ETR for the first decile is “overstated by an unknown but possibly significant amount” due to underreported and unidentified sources of income for first decile taxpayers. In addition, the first decile includes households that “have better overall economic well-being than was indicated by their money income…” This includes some ordinarily well-off households that report capital losses for income tax purposes as well as retirees who are living off savings or other assets as opposed to annual money income.
For these reasons, analyses of DOR tax incidence data typically ignore or discount findings for the first decile. We can have little confidence in the conservative claim contrasting tax increases among the bottom 20 percent versus the top ten percent, since it incorporates findings from the problematic first decile.
Furthermore, the above statement is certainly not true in regard to non-smoking households. The average ETR increase excluding tobacco taxes for the first and second deciles is 0.17 percent (which translates to $17 per household per year), even if we do not adjust for the fact that the ETR increase in the first decile is overstated; this is dwarfed by the 0.65 percent increase in the tenth decile.
In addition, the ETR increase in the bottom nine-tenths of the tenth decile (the 90th to 99th percentile of all households by income) is relatively modest. The tenth decile tax increase is overwhelmingly concentrated in the top one percent of households with incomes in excess of $510,005; excluding tobacco taxes, this top one percent experiences an average ETR increase of 1.40 percent—over eight times greater than the average ETR increase for the first and second deciles. This is not surprising, given that the bulk of the net tax increase in the 2013 tax act comes from an income tax increase concentrated among extremely high income households.
The bottom line is that among non-smoking Minnesota households, the impact of the 2013 tax act is overwhelmingly and powerfully progressive. Excluding tobacco taxes, there is virtually no net tax increase among the first nine deciles combined, which includes all Minnesota households with incomes under $146,401, as small tax increases among low income households are offset by small tax reductions among middle to upper-middle income households. Furthermore, nearly 83 percent of the increase in non-tobacco tax revenue will come from the top one percent of households and over 96 percent will come from the top five percent.
There is no need to shed crocodile tears for high income Minnesotans based on the above findings. As noted in a recent Minnesota 2020 Hindsight post, “The top one percent and the top five percent of all Minnesota households by income will continue to enjoy a state and local effective tax rate… that is less than that paid by any other income group in the state.” Such was the magnitude of regressivity in Minnesota’s state and local tax system going into the 2013 session that despite the progressive changes made in the new tax act, the overall system remains regressive.
But is it appropriate to exclude the tobacco tax increase from the other tax changes made in the 2013 tax act? Given that the tobacco tax changes will affect fewer than one in six Minnesotans, removing the tobacco tax changes gives a more representative picture of how the recently enacted tax changes will affect the vast majority of Minnesota households. In addition, the tobacco tax increase was a smart public policy move despite its regressivity. More on this when this series concludes next week.
*A “population decile,” as used in the DOR incidence analysis, consisted of ten equal-sized groups, ranging from the 10 percent of the state’s households with the lowest incomes (the first or bottom decile) to the ten percent with the highest incomes (the tenth or top decile). The DOR incidence analysis of the 2013 tax act further breaks down the tenth decile into three parts: the bottom half of the tenth decile (the 90th to 95th percentile), the next 4 percent (the 95th to 99th percentile), and the top one percent.
†As used here, the term “tobacco tax increase” will refer to the cigarette and tobacco tax increases in the 2013 tax act. The cigarette and tobacco tax results presented in the DOR incidence analysis of the tax act includes a tax reduction resulting from an increase in the small brewers’ credit, which DOR staff characterized as negligible.
‡The average ETR change excluding tobacco taxes ranges from an average 0.09 percent reduction for the sixth decile (an average tax reduction of $48 per household per year) to an average 0.02 percent increase for the fourth decile (an average tax increase of $7 per household per year).