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MN2020 - Senate Proposes Repealing Flawed Sales Tax Policy
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Senate Proposes Repealing Flawed Sales Tax Policy

May 09, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

During the 1992 legislative session, state policymakers were struggling to find a way to balance the state budget. One of the solutions was requiring non-school local governments to pay the state sales tax on all purchases. This solution was politically shrewd, but failed the smell test of good public policy. Fortunately, the Senate omnibus tax bill—Senate File (SF) 552—makes progress toward cleaning up the state’s tax system by repealing this flawed bit of tax policy.

The sales tax on local governments enabled the state to generate tax revenue without directly increasing the tax on Minnesota citizens. Instead, it imposed a new cost on local governments, thereby requiring them to increase taxes on their residents; the cost of the state sales tax on local government purchases most likely translated into higher property taxes. State government gets additional revenue, while local governments get blamed for raising property taxes.

However, the very feature of the state sales tax on local government purchases that made it appealing to state elected officials is the same feature that makes it bad tax policy. Transparency and accountability are undermined when one level of government is able to shift it costs to another level of government.

Some may argue that payments of state aid to local governments are also bad tax policy for the same reason: one level of government is collecting the revenue while another level is doing the spending. However, state aid to counties and cities—such as County Program Aid and city Local Government Aid—are different from the sales tax on local government purchases in at least three important regards:

  • State aid payments to local governments satisfy an important public need by helping all counties and cities provide necessary public services at affordable tax rates. The aid payments are based on each city’s need for revenue and their ability to generate revenue locally from their own tax base. In this way, aid payments are targeted to where they are most needed.*
  • State aid payments help to make Minnesota’s tax system less regressive by reducing dependence on regressive property taxes and increasing dependence on state general fund revenue which are—in aggregate—much more progressive than local property taxes. Minnesota’s tax system would be more regressive than it already is without the state aid system.
  • State aid payments are overt. The policy behind state aid payments is openly debated in the Legislature and the criteria on which payments are based are clearly defined in statute. Furthermore, the amount of aid that is paid to each local government is clearly listed.

Contrast this with the state sales tax on local government purchases. The only policy goal served is to generate revenue to pay for state services—and this could be done far more transparently by simply increasing a state tax. Furthermore, the state sales tax on local governments probably increases the overall regressivity of Minnesota’s state and local tax system through higher property taxes. Finally, the state sales tax on local governments is anything but overt; the policy is rarely debated openly and no one knows for sure exactly how much revenue is transferred each year from each Minnesota city and county to state government via the sales tax payment.

The League of Minnesota Cities and the Association of Minnesota Counties have long called for the repeal of the state sales tax on local government purchases. Numerous bills to repeal this tax have been introduced over the last twenty years; however, due to a scarcity of state revenue and the reluctance to increase state taxes, state policymakers were content to leave the sales tax on Minnesota counties and cities in place.†

Kudos to the Minnesota Senate for repealing this hidden tax in its omnibus tax bill,‡ which will reduce county and city costs by over $100 million annually. As the failed “no new tax” agenda loses its grip on the Minnesota legislature, bad tax policies like the state sales tax on local government purchases may finally be repealed during the 2013 legislative session.

 

*The new city Local Government Aid formula contained in both the House and Senate omnibus tax bills reforms the LGA program and does a better job of targeting state aid dollars.

†When it was imposed in 1992, the sales tax on non-school local governments was imposed on counties, cities, and townships. The state sales tax on township purchases was previously repealed. The tax on counties and cities remains in place.

‡In some instances, local governments provide goods and services that are also provided by private businesses, such as golf courses, campgrounds, and liquor stores. The sales tax exemption for local government purchases in the Senate tax bill does not extend to purchases that are inputs to goods and services that are generally provided by a private business. This was done so that local governments do not have an unfair pricing advantage relative to private businesses that are providing similar services. County and city organizations have no objection to this provision.

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