The T Word: Crunch time is here; what will tax committees do?

April is the cruelest month, said T.S. Eliot, and you’d be hard-pressed to find any Democrats at the Capitol who would disagree. After months of playing it close on the session’s most politically delicate subject–tax hikes during a deep recession–they will soon have to open their playbooks and go public with plans for doing just that.

When the Legislature reconvenes next Tuesday, House and Senate tax committees will have just eight working days left to pass omnibus bills spelling out how they propose to meet the revenue targets set last month by DFL legislative leaders. In the House, taxes chair Ann Lenczewski’s (DFL-Bloomington) crew is on the hook for raising $1.5 billion. Her Senate counterpart, Tom Bakk (DFL-Cook) (pictured), faces an even taller order; the $2 billion in new revenues his committee was initially charged with raising has been hiked another 10 percent, to $2.2 billion.

Particulars are still hard to come by, and it appears that many of the details remain not just undisclosed but undecided. But it’s now possible to see some likely outlines of their eventual tax plan.

For starters, the revenue increases hammered out in conference committee will probably be much closer to the House’s $1.5 billion figure than the Senate’s $2.2 billion. The reason? Cost shifts. At present, both Gov. Tim Pawlenty and the House DFL are pitching shifts in the education budget ($1.3 billion and $1.7 billion, respectively) that would alleviate some of the fiscal pressure.

The Senate DFL didn’t include shifts in its plan, but can probably be moved in that direction. Taxes chair Bakk has been sympathetic to shifts in the past, and more to the point, he is said to believe that $2.2 billion in new taxes is an impractically high target. A source close to the tax committee told PIM there’s a "decent chance" that the chamber will in the end opt for an approach that includes shifts and a lesser sum in tax increases.

Here’s a quick rundown of the most frequently mentioned tax hike proposals and their estimated yields in new revenue, starting with the smaller stuff. (I’ve left sales tax extenders off this list because there are endless permutations in the possible revenue involved; I’ll get into them below.)

• Sin taxes: $100-$200 million. As reported here last week, House DFLers are bullish on the potential to bring together the party’s liberals and normally tax-averse Democratic moderates and conservatives with tax hikes on cigarettes and alcohol. One additional selling point: They see it as a possible point of agreement with Pawlenty, who in 2005 raised cigarette taxes by dubbing the new charges a "health impact fee."
• Marquart’s sales and property tax reform: $100 million. Rep. Paul Marquart’s (DFL-Dilworth) bill to allow counties to levy up to one-half of 1 percent in local sales taxes isn’t a state tax increase per se, but the associated savings for the state could leave up to an additional $100 million in the general fund.
• Ending the McMansion exemption and closing loopholes: $300 million. This measure, targeting a couple dozen current exemptions that mainly benefit the most affluent Minnesotans, is a key feature of the tax overhaul plan introduced by Lenczewski earlier this session. But one of the most critical exemptions at stake–ending the state’s mortgage interest deduction and substituting a credit for less affluent homeowners in its place–is also extremely sensitive. Though Lenczewski is correct that current law unmistakably favors the owners of expensive homes, the central political fact is that saying bad things about the mortgage interest deduction is roughly as popular as saying bad things about mom, apple pie, and baby Jesus.
• A new fourth tier of income taxes: $300-$600 million. Both tax chairs have indicated their support in principle for this approach, and the state’s 2009 Tax Incidence Study [previous PIM item] buttressed their case by demonstrating that a) the top 10 percent of Minnesota earners pay just 10 percent in taxes, the lowest effective rate of any income decile, and b) the rates are lower still for the top 5 percent (9.7) and the top 1 percent (8.9).

Lenczewski recently told PIM that she’s "not going to abandon [a new high-end income tax bracket] just because the governor’s not for it," and Bakk initially indicated that upper-bracket hikes would constitute the "lion’s share" of the $2 billion he was then seeking. He later backpedaled a bit, and Senate staffers now say upper-income changes will be closer to 30 percent of the total package–which would come to approximately $600 million.

For the record, it’s currently estimated that a 9 percent top bracket kicking in at $400,000 per household–akin to the House’s 2007 approach–would produce $309 million in revenue for the upcoming biennium. A new 9.7 percent bracket for household incomes exceeding $250,000–a la the 2007 Senate DFL plan–would generate about $643 million. But the House is likely to set its income threshold lower this time around; yesterday at a press conference, Speaker Margaret Anderson Kelliher (DFL-Minneapolis) mentioned the $250,000-$300,000 range as a possible starting point for upper-bracket increases. If they were to go 9 percent on incomes over $250,000, the added revenue would come to a little less than $600 million.

If you assume that all the tax proposals described above pass the Legislature in some form, the expected revenues would fall in a range between $800 million and $1.2 billion–which is another way of saying DFLers will need an additional $300 million to $700 million to reach a $1.5 billion target.

Barring some new or substantially revised proposal in one of the areas listed, that leaves two obvious candidates for making up the difference: sales tax extenders and income tax surcharges. Both are capable of raising a lot of money, and income surcharges in particular are relatively easy to scale to the size of the hole that needs filling.

The great white whale in the debate over sales tax extenders (STEs) is the current exemption on clothing purchases, which Sen. Ann Rest (DFL-New Hope) has proposed to end in her tax bill. Revoking it outright would add an estimated $670 million to state coffers during the 2010-11 biennium. But there seems to be a distinct lack of political will among DFLers for going there, particularly on the part of Senate tax chair Bakk, who is also running for governor next year.

More generally, talk around the Capitol has also raised the possibility of extending the sales tax to certain services. According to legislative fiscal estimates, extending the sales tax to legal services would generate $577 million for the biennium; doing the same with accounting services would mean $317 million. But of course either approach would engender fierce resistance from the Capitol lobbyist corps and the governor’s office.

Which brings us to income tax surcharges. On the Senate taxes side, Bakk is said to have expressed interest in taking this tack, which was last used during the state’s 1981-82 fiscal crisis. House taxes chair Lenczewski is no fan of surtaxes, but a number of her colleagues in the House DFL caucus like the idea–in part because they believe a "temporary surcharge" might stand a chance of eluding Pawlenty’s veto pen.

Each point of an income tax surcharge would be worth an estimated $150 million; a 10 percent surcharge like the one imposed during the Quie era in the early ’80s would raise the whole $1.5 billion revenue target. The latter is unlikely this time around, but the scaleability and–arguably, at least–saleability of surcharges would seem to make them a prime candidate for a Legislature scrambling to find 11th-hour fixes.