Analysis: Tax Incidence Study points to a system in growing need of overhaul

How many of Minnesota’s wealthiest households does it take to equal the income of the state’s poorest 1 million households? It turns out the answer is a little fewer than 6,000. I know this thanks to the state’s new tax incidence survey, which was released yesterday. It’s no wonder this biennial study is a favorite among so many Capitol-watchers we know. It’s a rich and endlessly useful source of information about the public purse and who’s paying to fill it–a vital document for politicians, policymakers, and tax-code critics of all ideological persuasions.

This year’s edition is packed with ammunition for critics who charge that Minnesota’s tax system has catered to the top brackets and shifted the burden downward in the past decade.

I. Overview

The top-line numbers in the 2009 Minnesota Tax Incidence Study (PDF) underline a fairly dramatic turn toward regressivity in the state’s tax collections between 2004 and 2006. While the overall tax burden was declining slightly (from 11.6 percent to 11.2), a key index called Suits suggests that the burden shifted downward by a striking margin in 2006 and, absent any changes to the tax code, will remain at roughly the same levels in 2011. The overall regressivity of the system is now greater than in 1998, on the eve of Gov. Jesse Ventura’s first round of tax cuts.

Here’s the Suits chart from the report. (Note that all the Suits calculations fall within a range of +1 to -1. Positive numbers are an expression of net progressivity, and negative numbers of net regressivity.)

Why the big change? It appears the growing income gap is a prominent reason. The report’s authors write, "There are no obvious policy changes between 2004 and 2006 that could explain a reduction in the Suits index that is as large as reported here. Nor does the change in the mix of taxes over those years–away from progressive taxes toward regressive taxes–explain such a decline. If anything, the mix of taxes moved the other way. If the mix of taxes were the only thing that changed, the system would have become slightly less regressive. Increased regressivity is due not to a shift in the tax mix, but to an increase in the regressivity of almost every separate tax type. Such a widespread pattern–for property, consumption, and income taxes alike–strengthens the case that the primary cause of increased regressivity was greater inequality in the distribution of income, rather than policy changes." [Emphasis added.]

The figures show that in 2006, the top 10 percent of Minnesota earners paid the lowest overall effective tax rate for the first time since 1998. And by a historically large margin: Back in ‘98, the next-lowest-taxed decile paid just 0.2 percent more than the most well-off Minnesotans; in ‘06, the next-lowest-taxed decile paid 1.5 percent more than the wealthiest bracket.

Here’s a chart that traces the historical breakdown from 1988 forward of the effective rates paid by each of the 10 brackets, including 2011 estimates. (A word of warning first: The first decile tax numbers are junk. Or, in the study’s words, "not reliable." That’s due in large part to income anomalies involving retired people; you can find a fuller explanation of the first decile on page 31 of the PDF document linked above.)

You can see that the 2006 burden weighed heaviest upon the bottom (second decile) and in the middle (fifth, sixth and seventh deciles). These groups all paid taxes at rates more than 2 percent greater than the most affluent group’s rate.

The chart indicates that lower-income Minnesotans will fare a little better by 2011 than they did in 2006. But the imbalance in rates between the middle brackets and the top bracket will only grow larger. According to the study, "There are quite significant changes in the distribution of the tax burden between 2006 and 2011. The effective tax rate falls in the second and third deciles, rises substantially in the deciles 5 through 9, and remains unchanged for the top 5 percent of households. The tax system becomes relatively more progressive in the lower range but more regressive at the top. These two patterns offset one another, so the Suits index changes little."

II. The mix of taxes

The aggregate tax burden of 11.2 percent is a synthesis of income, business, sales, and property taxes. As the table here indicates, Minnesota’s income taxes remain progressive, but not by a sufficient margin to offset the regressivity of the other three tax classes. Note that the second-poorest 10 percent of Minnesotans face effective business and sales tax rates more than three times those of the most affluent 10 percent. Their property tax rates (albeit before rebates are counted) are roughly twice as high.

Here’s a better visual representation of how heavily or lightly these taxes fall on the various deciles. (And the property tax numbers here are net after rebates.)

The mix of state vs. local taxes has implications for the long-range progressivity of the system. Local taxes are by their nature more regressive. They revolve around property levies, and they always omit the most progressive element of state taxation–the income tax. And local taxes are growing as a share of Minnesota’s total tax burden. According to the study, they rose "from 25.8 percent in 2004 to 26.7 percent in 2006 and [are] projected to rise signficantly to 31.7 percent in 2011. The state tax share fell from 74.2 percent in 2004 to 73.3 percent in 2006 and is projected to fall to 68.3 percent in 2011."

In the short term, the study claims, the regressive force of these and other changes will be largely offset by declining revenues from other regressive taxes. (See page 37 of the PDF for an explanation.) But the trend line is still worrisome for long-term tax fairness.

Here’s a breakdown of state and local tax rates that each decile paid in 2006 and is projected to pay in 2011.

III. The mix of incomes

The study offers a vivid picture of the polarization of Minnesota incomes, which has paralleled the growing national gap.

The lesson–surprise!–is that the bigger they are, the harder their tax rates fall.

The Minnesota incomes picture can be parsed two ways. Here it is by population decile, which carves Minnesotans into 10 groups with the same number of people. As you can see, the top 1 percent of Minnesotans had more income than the bottom 50 percent. (And yes, those first decile numbers are faulty–but you take the point.)

(Household income column dollars in this table are in thousands.)

Here’s the Minnesota incomes pie as sliced by income decile, which carves Minnesotans into 10 groups with the same amount of income. And the lesson is, it’s much better from a tax standpoint to be very rich than merely kind of rich.

A total of 1,002 households, representing the top 5 percent by this measure, earned more than $3.3 million in 2006 and paid an effective tax rate of 8.5 percent as a group; of these, the creme de la creme–24 households earning $32 million-plus apiece–paid only 7.4 percent overall.

(The household income column dollars are in thousands.)