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Comments on the 2011 Minnesota Tax Incidence Study

Comments on the 2011 Minnesota Tax Incidence Study. John A. Spry, Ph.D. Associate Professor Opus College of Business University of St. Thomas jaspry@stthomas.edu

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Comments on the 2011 Minnesota Tax Incidence Study

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  1. Comments on the 2011 Minnesota Tax Incidence Study John A. Spry, Ph.D. Associate Professor Opus College of Business University of St. Thomas jaspry@stthomas.edu The views expressed herein are solely those of the author and do not represent the views of the State of Minnesota or the University of St. Thomas. All errors are my own.

  2. Question Asked and Omitted • The Minnesota Tax Incidence Study asks: • Who pays the slice of state and local taxes paid by Minnesota residents that Minnesota and its localities collect from the point of view of Minnesota based on a one-year snapshot in time? • It does not ask: • Who pays the taxes that Minnesotans pay? • Who pays the total state and local tax burden on Minnesotans? • Who pays the taxes that finance Minnesota state and local government spending? • Distributes the tax burden of dollars collected in taxes, but omits the excess tax burden or deadweight loss of taxes.

  3. Misuse of the Tax Incidence Study • “The ’Tax Incidence Study’ is compiled every two years with the objective of providing policymakers with basic information about who pays what in state and local taxes. The report calculates two primary components: 1) Total state and local tax burden on households by income range; and 2) The burden of different taxes distributed across households.” • Phil Krinkie, President of Minnesota Taxpayers League, March 25, 2011 • “I think that if people recognize that if everyone is paying their fair share of taxes, that’s the way the system suppose to work. So when our own Department of Revenue says the very top income people are paying a smaller percentage of their income in state and local taxes than everyone else, the middle income families, the people making $30,000, $50,000, $70,000 a year, that’s not simply not fair.” • Governor Mark Dayton, April 20, 2011 • “They’re [conservatives] committed to preserving and expanding Minnesota’s public cost burden sharing, meaning that Minnesota’s highest income earners pay a lower percentage of their income in taxes than 90 percent of Minnesotans pay. As a policy objective, conservatives not only support this, they seek to further minimize the richest Minnesota’s tax obligations.” • John Van Hecke, Executive Director of Minnesota 2020, April 14, 2011

  4. Average Federal Tax Rates, 2007 CBO • Source: Congressional Budget Office. “Average Federal Taxes By Income Group.” June 2010. • http://www.cbo.gov/publications/collections/collections.cfm?collect=13

  5. Average Federal Tax Rates, 2009 TPC Source: Urban-Brookings Tax Policy Center http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2432

  6. Prof. Casey Mulligan’s Combined Federal, State, and Local Tax Incidence, 2005 Source: Professor Casey Mulligan, “Who Pays the Other Taxes?” New York Times. November 24, 2010. http://economix.blogs.nytimes.com/2010/11/24/the-other-taxes-who-pays-them/

  7. Tax Foundation’s Combined Federal, State, and Local Tax Incidence, 2004 Andrew Chamberlain and Gerald Prante, “Who Pays Taxes and Who Receive Government Spending? An Analysis of Federal, State, and Local Tax and Spending Distributions, 1991-2004”. Working Paper 1. March, 2007. http://www.taxfoundation.org/files/wp1.pdf

  8. Federal and State and Local Tax Systems are Interconnected • Federal and state governments share personal and corporate income tax bases • Minnesota’s personal and corporate income tax bases and tax revenues would be greater in the absence federal taxes on the same bases. • About 19% to 21% of Minnesota state and local expenditures are financed by federal revenue. • 26.3% for 2009 and 2010 because of ARRA stimulus. • Federal income taxes and excise taxes on alcohol would not be possible without the approval of state legislatures. Improvement: Include federal and other state and local taxes in future tax incidence studies as in the omnibus tax bills.

  9. Minnesota is a Small Open Economy • Minnesota has 0.08% of world population. • Minnesota GDP is about 0.33% of world GDP. • 1 of every 300 dollars of value produced in the world is produced in Minnesota.

  10. Mobility Limits the Effectiveness of State and Local Redistribution Source: Dr. Joseph Stiglitz, Columbia University and NBER, Public Sector Economics, 3rd edition. p. 758. Economists generally assign distributional policy to the federal government because state and local government have, at best, a limited ability to effectively redistribute income.

  11. Ability to Pay: Annual, Average, and Lifetime Income “A final important distinction that must be drawn in incidence analysis is between current and lifetime tax incidence. The CBO analysis just presented measures individual incomes on an annual basis. This approach can be misleading given the extensive mobility across income classes observed in the United States. Recent estimates show that between 25 and 40% of Americans change income quintiles within a one-year period, and 60% change within a decade.” • Professor Jonathan Gruber, MIT “Household income measured over long horizons is less variable than annual household income. This implies that low-income households in one year have some chance of being higher income households in other years. Thus, even if the share of income consumed by lowest income groups is higher than that for higher-income groups, excise taxes or taxes on consumption more generally may be less regressive than calculations based on annual income suggest… Failure to distinguish between lifetime and annual incidence overstates the degree of inequality in tax burdens between groups, suggesting that progressive taxes are more progressive and regressive taxes more regressive than a lifetime analysis would suggest. The illustrative calculations presented here suggest that for studying the incidence of excise taxes, these biases may be substantial.” • Professor James Poterba of MIT writing in the American Economic Review.

  12. Conclusion The 2011 Minnesota Tax Incidence Study Carefully Answers: • Who pays the slice of state and local taxes paid by Minnesota residents that Minnesota and its localities collect from the point of view of Minnesota based on a one-year snapshot in time? • Strong national reputation at economic conferences Directions for Improvements • Don’t misuse the Minnesota Tax Incidence Study • Include federal and other states’ taxes in the future • Report results using annual income, average income for some years, and lifetime income as ability to pay measures in the future • Report results using finer age categories in the future

  13. Supporting Material

  14. Mobility Limits the Effectiveness of State and Local Redistribution “The evidence presented in this paper supports the basic theoretical presumption that state and local governments cannot redistribute income. Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust until the resulting net wage is equal to that available elsewhere. The current empirical findings go beyond confirming this long-run tendency and show that gross wages adjust rapidly to the changing tax environment. Thus, states cannot redistribute income for a period of even a few years. The adjustment of gross wages to tax rates implies that a more progressive tax system raises the cost to firms of hiring more highly skilled employees and reduces the cost of lower skilled labor. A more progressive tax thus induces firms to hire fewer high skilled employees and to hire more low skilled employees. Since state taxes cannot alter net wages, there can be no trade-off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in the state, create deadweight efficiency losses without achieving any net redistribution.” Source: Feldstein and Wrobel, Journal of Public Economics, 1998.

  15. Mobility Limits the Effectiveness of State and Local Redistribution • Labor mobility of highly skilled individuals “This paper examines the responsiveness of the rich to state income taxes. We use Major League Baseball free agents who were named All-Stars at some point in their career and who signed with a U.S. team for the 1991 through 2002 seasons. This data set overcomes some of the previous difficulties encountered in similar studies but also has limitations representing the general rich population. We find evidence that the wages of this subset of players do adjust to offset the burden of state income taxes, specifically a 1% decrease in net-of-tax rate leads to a 3.3% increase in salary.” Source: Ross and Dunn, Contemporary Economic Policy, 2008.

  16. Increasing Prosperity and Income Inequality: The United States 1970-2006 • Source: Maxim Pinkovskiy & Xavier Sala-i-Martin, 2009. "Parametric Estimations of the World Distribution of Income," NBER Working Paper 15433

  17. Increasing inequality AND substantial middle class gains in Median Household income Source: Dr. Terry J. Fitzgerald, Federal Reserve Bank of Minneapolis

  18. Income Mobility and the Minnesota Tax Incidence Study “Income received in a single year can be a misleading measure of economic well-being. Individual households may have unusually high or low income in a particular year due to business losses, unemployment, or the sale of capital assets… Because of such transitory income, a snapshot of the income distribution in a single year shows more income inequality than a time exposure over several years. In addition, income varies over a household’s life cycle. For these reasons, annual income may not be an accurate measure of a household’s more permanent economic well-being. In spite of these shortcomings, there are two strong reasons why this study uses annual rather than permanent income. First, an adequate record of the income of individual households over a longer period is rarely available. Consequently, state incidence studies have always used an annual accounting period. Second, an annual perspective may be preferred because taxes are paid out of a household’s current income, not out of what might be earned in the future. If the purpose of an incidence study is to make policy decisions regarding current ability to pay taxes, then it is reasonable to argue that the appropriate measure should be based on annual rather than permanent income.”   Source: 1995 Minnesota Tax Incidence Study, pp. 16-18.

  19. US Income Mobility:1996-2005 Source: Gerald Auten and Geoffrey Gee. “Income Mobility in the United States: New Evidence from Income Tax Data.” National Tax Journal. June 2009. pp. 301-328.

  20. US Income Mobility:1996-2005 Source: Gerald Auten and Geoffrey Gee. “Income Mobility in the United States: New Evidence from Income Tax Data.” National Tax Journal. June 2009. pp. 301-328.

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