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Tax Fairness is Simply Fair

May 18, 2009 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Proposals to make Minnesota's state and local tax system fairer and less regressive are often met with cries of "class warfare" from some on the right.  The absurdity of this claim becomes apparent when we examine the real impact of the shift from a regressive state and local tax system to a more proportional system in which taxes are based on the ability to pay.

In a regressive tax system, low and moderate income families pay a larger percentage of their income in taxes than do wealthy families.  The regressivity of Minnesota's state and local tax system is examined in the Revenue Department's 2009 Minnesota Tax Incidence Study (MTIS).  In Minnesota, high income families pay a smaller percentage of their income in state and local taxes than do other families.  Furthermore, Minnesota's state and local tax system is more regressive today than at any time in recent history.

By piggybacking federal effective tax rate (i.e., taxes as a percent of income) information from the Institute on Taxation and Economic Policy (ITEP) on top of state and local effective tax rates from the 2009 MTIS, it is possible to approximate the income of Minnesota households after subtracting federal, state, and local taxes.  This approach is crude due to differences between ITEP and the MTIS in the data and methodology used to calculate effective tax rates.  However, this approach does provide an approximate indication of differences in after-tax income between high and moderate income households.

Based on this methodology, the approximate average income of the middle quintile of Minnesota households (i.e., the 20 percent of Minnesota households that fall in the middle of the statewide income distribution, which includes households with a 2006 pre-tax income from $30,900 to $51,500 based on the 2009 MTIS) after subtracting state, local, and federal taxes is $29,000.  By contrast, the wealthiest five percent of Minnesota households (which includes households with a 2006 pre-tax income of $175,700 and above) would have an average after-tax income of approximately $295,000.*

In other words, the average income of the wealthiest five percent of Minnesota households after subtracting state, local, and federal taxes is approximately 10.2 times greater than that of the middle quintile.  So what would happen if the wealthiest five percent were to pay the same percentage of their income in state and local taxes as other Minnesota households?  Would this constitute the class warfare regressive taxation apologists so fear?

Hardly.  If the state and local effective tax rate of the wealthiest five percent of Minnesota households were to increase from 9.7 percent-what they actually pay based on the 2009 MTIS-to the statewide average of 11.2 percent, their after-tax income would fall from about $295,000 to $289,000.  (This estimate probably overstates the after-tax income decline by ignoring the federal deductibility of the state and local tax increase.)  The average after-tax income of the wealthiest five percent would still be approximately 10.0 times greater than that of the middle quintile.

The bottom line is this: if the wealthiest five percent of Minnesotans were to have a state and local effective tax rate equal to the statewide average, the average income of the wealthiest five percent after subtracting state, local, and federal taxes will be about 10.0 times greater than that of a typical Minnesota household instead of 10.2 times greater.

It should be noted that there is no proposal on the table during the current legislative session (which must end by midnight tonight) that would increase the state and local effective tax rate of the top five percent to the statewide average.  However, even if there were such a proposal, would this constitute the "class warfare" that we hear so much about?  Will high income households stop working if their after-tax income drops to a paltry 10.0 times more than the typical household instead of 10.2 times more?  Is this "soaking the rich"?  Will they flee the state on the heels of this economic oppression?  Is this the dreaded descent into socialism?

It is a shameless act of political spin to equate simple tax fairness with class warfare. There is no good reason households with total income of $176,000 (the low end of the top five percent) or more cannot pay the same percentage of their income in state and local taxes as households with an income of $20,000, $40,000, or $60,000.  If the wealthiest Minnesotans pay taxes at the same rate as their fellow citizens, their after-tax income will still exceed the state average by several fold and they will still be amply rewarded for their hard work, creativity, and initiative.

There should always be a vibrant debate regarding the appropriate use of public dollars and the appropriate level of state and local taxes.  However, once the level of state and local taxes is set, there is no good reason to shift a disproportionate share of those taxes on to those families with the least ability to pay.

*It should be noted that for both income ranges the majority of tax dollars go to the federal government, not to state and local governments.

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