Could tax loopholes and exemptions provide a route out of Minnesota’s budget standoff?
Is Minnesota’s tax code rigged to promote cross-country skiing?
Minnesota residents who strap on their downhill skis at Buck Hill in Burnsville are required to pony up the state’s 6.85 percent sales tax when purchasing lift tickets. By contrast, individuals who choose to explore the state’s cross-country ski trails are spared the sales tax when purchasing a pass from the Minnesota Department of Natural Resources.
The cross-country ski pass exemption represents a minuscule pot of money. It costs the state less than $50,000 in revenue annually. But it’s one of nearly 300 “tax expenditures” that cumulatively result in billions of dollars in lost revenue each year.
Exact figures are difficult to calculate. That’s in part because opinions differ among economic experts about exactly what should be counted as a tax expenditure. But according to a 2009 report by the Public Strategies Group, such tax exemptions, credits and deductions totaled $11.4 billion in lost revenue that year.
The single largest segment of that pot is the exemption on taxation of services such as auto repairs, accounting work and legal representation. In the next biennium, the state is expected to forego $5.4 billion in revenue by excluding such services from taxation, according to the Minnesota Department of Revenue. That’s more than enough, in other words, to eliminate the state’s entire budget deficit – and put a hefty down payment on a stadium for the Minnesota Vikings.
Other tax expenditure figures are nearly as gaudy. Sales tax exemptions for clothing, food and drugs (prescription and over-the-counter alike) are projected to cost the state $2.7 billion in the next two-year budget cycle. Deductions for mortgage interest payments and charitable contributions are expected to provide another $1.4 billion hit to the state’s coffers.
Given these extravagant sums – and the state’s unprecedented budget deficit – tax exemptions, credits and deductions would seem likely candidates for a lot of attention at the Capitol. But the topic is seldom broached in sparring over the budget between the Republican-led Legislature and DFL Gov. Mark Dayton. That’s in part because of the peculiar nature of tax expenditures.
“Tax expenditures are really like the Robert Frost part of the budget. They’re the revenue not taken,” said Jenny Wahl, an economics professor at Carleton College. “There’s no one place where you could go look it up because it’s really an absence of something.”
Wahl was among six academics who worked with officials at the state Revenue Department last year on a thorough review of the state’s tax expenditures. The report, released in February, did not highlight specific tax loopholes that should be closed but rather recommended fundamental changes to how the state handles such expenditures. For instance, the report recommends that every tax exemption, credit and deduction be reviewed on a recurring eight-year cycle. It also calls for creation of a Tax Expenditure Commission to suggest changes based on those evaluations.
In addition, the report proposes bringing tax expenditures fully into the state budgeting process. The governor and the Legislature, for instance, could be required to make specific recommendations in their two-year budget proposals about whether to retain or drop each existing tax provision.
“It’s not saying tax expenditures all have to end,” noted John Spry, an economics professor at the University of St. Thomas, who also worked on the report. “But it’s saying let’s give them the same review.”
There have been some signs at the Capitol of interest in scrutinizing tax expenditures. Early in the session, some key Senate Republicans – most notably Senate Taxes Chairwoman Julianne Ortman – indicated support for reviewing tax exemptions and credits. “What we’re doing is forgoing revenue,” Ortman told the Associated Press in February. “We should be viewing each of these expenditures as a spending program, and we came here to review every single aspect of state spending.”
But such talk was quickly dismissed by GOP legislative leaders, and Ortman was soon reciting Republican talking points about government living with its means and additional revenue being off the table. More recently, chatter at the Capitol has suggested that tax expenditures are once again being examined by some key Republican legislators.
House Taxes Chairman Greg Davids didn’t completely shoot down that suggestion when asked about it this week. “I’m not aware of much movement on that,” he told the PIM Confidential newsletter. “The breaks are there. It would have to be a positive movement toward that… I don’t know that we’ll see that.”
With less than a month left in the legislative session, there are no indications of a break in the budget impasse between the Republican-led Legislature and Dayton. GOP leaders continue to insist that any revenue increases are verboten, while Dayton proposes solving roughly half of the $5 billion budget hole through tax increases on the state’s wealthiest 10 percent of residents.
That standoff could bring tax expenditures back into the mix. The key question will likely be whether GOP leaders can sell closing exemptions and credits to their members – as well as to their fiscally conservative core supporters – as tax reform rather than a revenue hike.
Economists who have studied the issue believe it presents the potential for compromise. “It’s not really new spending, and it’s not really new taxes,” Wahl said. “It seems like the two could come together if they’d look at it in those terms.”
Jay Kiedrowski, who served as finance commissioner under DFL Gov. Rudy Perpich, sees similar opportunities for compromise in reforming the state’s tax code. “They might suggest that it’s not a rate increase, but it’s simply cleaning up some of the tax code,” said Kiedrowski, who also worked on the Revenue Department report on tax expenditures. “That could be a very important distinction that might resolve the budget conflict between the governor and the Legislature. The fact that it’s not in their original packet of recommendations doesn’t mean that it won’t ultimately be considered.”
Spry points to President Ronald Reagan’s 1986 tax overhaul, which dramatically lowered income tax rates but also closed numerous tax shelters and loopholes. “Was Ronald Reagan a good Republican?” he asked rhetorically. Spry further points out that lowering tax rates and broadening the base is a widely accepted principle of sound economic policy.
“I am just not capable of predicting what lawmakers will do,” Spry said. “I can be hopeful they’ll be guided by good economic principles. But I realize it’s a political process; it’s not an academic process.”