Tax Fairness: How Minnesota Compares to Other States
Low- and middle-income households pay a disproportionate share of Minnesota state and local taxes relative to high income households. However, these taxpayers can take some consolation from the fact that Minnesota’s income-based tax disparities are less pronounced here than in most other states, as demonstrated in a recent Minnesota 2020 report, Minnesota Moves Ahead: Tax Fairness in the 50 States. That report further demonstrates that Minnesota made strides toward increased tax fairness as a result of the 2013 tax act.
The level of taxes are commonly measured in terms of the “effective tax rate” (or ETR), which—as used in this article—refers to combined state and local taxes as a percentage of income. In a regressive tax system, low- and middle-income households tend to have higher ETRs than high-income households. In a progressive system, high-income households tend to have higher ETRs. In a proportional tax system, the average ETRs of high- and low-income households are the same.
We can measure the degree of regressivity or progressivity in a tax system using the "Suits index." The Suits index has a range from -1.0 to +1.0. The closer to +1.0, the more progressive a tax system is and, conversely, the lower the value (i.e., the closer to -1.0) the more regressive it is. A perfectly proportional tax system has a Suits index of zero.
Based on the Suits index, Minnesota had the 16th least regressive state and local tax system in the nation in 2010, the last year for which tax incidence information for all 50 states is available.* In that year, Minnesota's Suits index was -0.0331. By comparison, California has the nation's most progressive tax system (ranked #1), with a +0.0497 Suits index.† Florida has the most regressive system (ranked #50), with a -0.2152 Suits index.
If we adjust Minnesota’s Suits index to reflect the progressive impact of the 2013 tax act, Minnesota improves from the 16th to the 10th least regressive state, holding all other states constant. Minnesota's Suits index increases from -0.0331 prior to the 2013 tax act to an estimated -0.0178 after the 2013 act.
The Suits index is admittedly an abstract measurement of tax regressivity. For that reason, it is difficult to translate into layman’s terms the significance of the increase in Minnesota's Suits index. Furthermore, it is difficult to interpret the significance of the difference between Minnesota’s Suits index and that of other more regressive and less regressive states.
The task of expressing the degree of regressivity or progressivity associated with a Suits index of a particular value in concrete terms is made difficult by the fact that ETRs generally do not increase or decrease at a uniform rate from the lowest income decile (i.e., the ten percent of households with the lowest income) to the highest decile (i.e., the ten percent of households with the highest income). However, it is possible to make useful generalizations about the degree of regressivity associated with a particular Suits index if we assume that ETRs increase (or decrease) at a uniform rate from the lowest to highest income households.
The following analysis uses a technique developed by Dr. Paul Wilson of the Minnesota Department of Revenue (DOR) to illustrate the distribution of Minnesota taxes by population decile from lowest to highest income under various Suits index values assuming (1) an average ETR for all Minnesota taxpayers of 11.6 percent (the actual ETR for Minnesota after passage of the 2013 tax act), (2) an income distribution by decile as projected by DOR for 2015, and (3) a uniform rate of change in ETRs from low- to high- income deciles.
Based on these assumptions, the graph below shows Minnesota ETRs by income decile under four scenarios. The ETRs for the highest income decile and the middle-income quintile (a combination of the fifth and sixth deciles) are displayed.
Before the 2013 tax act, based on the assumptions above, high-income households (those in the highest income decile) would have an 11.0 percent average effective tax rate. Meanwhile, middle-income households (those in the middle quintile) would have a 12.5 percent average ETR. Expressed another way, state and local taxes per dollar of income are 13.2 percent higher for middle-income households than for high-income households. If we assume instead a Suits index of -0.0178—Minnesota’s estimated Suits after the 2013 tax act—the disparity in taxes per dollar of income between the middle-income and high-income households would shrink from 13.2 percent to 6.9 percent.
While the information presented above does not represent actual ETRs paid by Minnesota taxpayers (although the reduction in the ETR disparity between the middle-income and high-income households turns out to be similar to the actual reduction), this approach illustrates how significant Minnesota’s Suits increase from -0.0331 to -0.0178 is in terms of who pays state and local taxes.
Where this approach is most useful is in illustrating how the distribution of state and local taxes by income could change if Minnesota’s Suits index were to dramatically increase (i.e., become less regressive) or decrease (i.e., become more regressive). For example, if Minnesota’s Suits index looked like California's (the most progressive state at +0.0497), the average ETR for middle-income households would fall to 10.4 percent, while that of high-income households would increase to 12.6 percent under the assumptions described above. In other words, Minnesota's middle-income taxpayers would go from paying almost 6.9 percent more in state and local taxes per dollar of income than high-income households (assuming a -0.0178 Suits index) to paying 17.4 percent less.
Meanwhile, if Minnesota’s Suits index looked like Florida's (the most regressive state at -0.2152), the average ETR for middle-income households would increase to 17.1 percent, while that of the top decile would fall to 7.7 percent. Under this scenario, middle-income Minnesotans would go from paying 6.9 percent more in state and local taxes per dollar of income than the top decile to paying 124 percent more!
State officials should avoid policies that would allow Minnesota to drift in the direction of the extreme regressivity observed in Florida. For reasons explained in Minnesota Moves Ahead, excessive regressivity not only undermines tax fairness, but also jeopardizes revenue adequacy and economic growth.
Minnesota’s tax system remains regressive, even after the improvements made in the 2013 tax act. Whether Minnesota wants to move in the direction of significant progressivity such as that seen in California is another question and beyond the scope of this article. However, even if policymakers seek to make Minnesota’s state and local tax system truly progressive instead of just less regressive, they should not do it in the way that California has done.‡
A closer examination of Suits index disparities using the approach developed by Dr. Wilson shows that the 2013 tax act has succeeded in making significant progress toward tax fairness by reducing the tax disparity between middle- and upper-income households by nearly 50 percent. The same approach also helps to illustrate the range of disparities among states in terms of who pays state and local taxes and the magnitude of change necessary in Minnesota in order to make our tax system comparable to other more regressive and less regressive states.
*The Minnesota Suits indices in the 2013 Minnesota Tax Incidence Study and a subsequent Minnesota Revenue Department tax incidence analysis of the 2013 tax act are more accurate and reveal a greater degree of Minnesota tax regressivity than the Suits indices calculated by Minnesota 2020 using data from the Institute on Taxation & Economic Policy (the basis of the interstate comparisons in Minnesota Moves Ahead). However, this article uses Suits indices calculated using ITEP data because this is the only set of Suits indices that are comparable across all fifty states. That information is based on 2010 data but incorporates tax changes enacted through January 2013.
†Only two other states in the nation have positive Suits indices based on 2010 ITEP data; in other words, only two other states have progressive state and local tax systems. They are Oregon (+0.0230) and Delaware (+0.0115).
‡Ironically, California’s drift toward greater progressivity is largely a product of a conservative tax policy that requires a supermajority for any legislatively approved tax increase; as a result, California frequently foregoes the legislative process in favor of a direct appeal to voters via an initiative statute. In order to improve the likelihood of public approval, state tax increases in California frequently target only extremely high income households. An example of this is California’s “millionaires tax” approved via the initiative process in 2012. Income tax increases targeted to extremely high income households has made California’s tax system more progressive—an unintended consequence of a conservative policy designed to restrict California tax revenue.