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MN2020 - Recessions Mask Tax Regressivity Trends
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Recessions Mask Tax Regressivity Trends

February 12, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Every two years, the Minnesota Department of Revenue publishes the Minnesota Tax Incidence Study (MTIS). In 2000, Minnesota’s state and local tax system was regressive, meaning that low and middle income households were paying a large percentage of their income in state and local taxes than were high income households. By 2002, the system had become somewhat less regressive and more fair. Data from more recent versions of the MTIS is likely to show a similar decline in regressivity from 2006 to 2010.

Sadly, the decline in tax regressivity from 2000 to 2002 turned out to be temporary. The same is likely to be true for the decline in regressivity from 2006 to 2010.

Economists measure the degree of tax regressivity using a statistical tool known as the Suits index. A Suits index below zero denotes a regressive tax system; the further below zero, the greater the degree of tax regressivity. According to the MTIS, Minnesota’s Suits index* in 2000 was -0.031, denoting a modest degree of tax regressivity. By 2002, it had increased to -0.018—a modest but significant improvement in the direction of tax fairness.

So what accounts for the improvement in Minnesota tax fairness from 2000 to 2002? Large scale property tax reductions enacted in 2001 and implemented in 2002 probably played a role. However, economists would likely point to a different factor as the primary cause of the reduction in Minnesota tax regressivity: the 2001 recession.

While recessions hurt low and middle income families in the form of job losses and wage decline, the greatest loss of income typically occurs among high income households as a result of a decline in capital gains and investment income. The 2001 recession was no exception; from 2000 to 2002, the total share of income in the hands of the top one percent fell from 16.8% to 13.9%. Because the highest income households typically have the lowest effective tax rates, a decline in the extent to which income is concentrated at the top leads to a reduction in tax regressivity. Thus, by reducing the concentration of income in the hands of the most well-to-do households, the 2001 recession contributed to a reduction in tax regressivity in Minnesota.

However, reductions in tax regressivity due to recessions are often fleeting. After the 2001 recession, the march of income inequality resumed and—along with it—growth in tax regressivity. By 2006, the share of income in the hands of the top one percent had grown to 17.2% and Minnesota’s Suits index had fallen to -0.059, the lowest level seen since the MTIS began tracking the Suits index in 1990.

The pattern of the 2001 recession was repeated during the Great Recession. As a result of the Great Recession, the concentration of income in the hands of the top one percent of Minnesota households fell to 16.2% in 2008, contributing to growth in the Suits index to -0.054. Just as happened during the 2001 recession, the concentration of income at the top declined during the Great Recession and—along with it—the degree of tax regressivity.

The recession of 2001 lasted only six months and was puny in comparison to the Great Recession, which straddled 18 months from December 2007 to June 2009. The effects of the Great Recession are likely to still be observed again in the upcoming 2013 MTIS, which will examine tax data from 2010. Anticipate another decline in the concentration of income at the top from 2008 to 2010 and another reduction in tax regressivity as measured by Minnesota’s Suits index.

The moral of this story is that we should not be deceived by the decline in tax regressivity that occurs during a recession. During the 2001 recession, the decline in regressivity was more than wiped during the subsequent recovery. The recoveries that occurred after the 1990-91 and the 2001 recessions have been far kinder to high income households than to low and middle income households, as evidenced by the increased concentration of wealth at the top of the income spectrum; stagnant wages and continued job scarcity for lower and middle income workers—hallmarks of recent recoveries—have no doubt contributed to this trend. The resulting income concentration at the top has contributed to an increase in tax regressivity.

To get a true indication of the overall trend in tax regressivity over time, it is important to look at comparable points in the business cycle; if we do this, it is clear that Minnesota’s tax system has become more regressive over time. For example, from just prior to the 2001 recession to just prior to the Great Recession, tax regressivity in Minnesota as measured by the Suits index increased significantly.

Data from the upcoming MTIS will likely show that Minnesota’s tax system in 2010 was less regressive than it was in 2008. There will be those who use this fact to argue that state policymakers no longer need to concern themselves with the lack of fairness in Minnesota’s tax system. Don’t be fooled. This reduction in tax regressivity is a temporary byproduct of the Great Recession, not a long term trend; in the absence of deliberate state policy changes, Minnesota’s state and local tax system will almost certainly begin again to grow more regressive after 2010 as the economic recovery continues.

 

*All Suits index values cited in this article are from the most recent version of the MTIS published in 2011.

†Concentration of total income in the hands of the top one percent of households was calculated using data from the 2003, 2005, 2007, 2009, and 2011 Minnesota Tax Incidence Studies, corresponding to tax years 2000, 2002, 2004, 2006, and 2008 respectively.

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