Overview of Business Taxes in Minnesota
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Overview of Business Taxes in Minnesota Presentation to 21 st Century Tax Reform Commission By Paul Wilson Eric Willette Tax Research Division Property Tax Division [email protected] [email protected] Minnesota Department of Revenue June 6, 2008 (Updated June 18, 2008) 2

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Overview of Business Taxes in Minnesota

Presentation to

21st Century Tax Reform Commission

By

Paul Wilson Eric Willette

Tax Research Division Property Tax Division

[email protected]@state.mnus

Minnesota Department of Revenue

June 6, 2008

(Updated June 18, 2008)


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Outline

  • Context: Comments About Minnesota’s Tax System

  • Definition of Business Taxes

  • Property Tax

  • Sales Tax

  • Corporate Franchise Tax

  • Income Tax

  • Alternative Business Taxes?

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Minnesota’s Rankings: Total Revenue and Total Taxes

See DOR Website at: www.taxes.state.mn.us/taxes/legal_policy/research_reports/tax_rankings.shtml

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States from Lowest to Highest Per Capita Income

Predicted tax per capita = -1,194 + 0.150 (income per capita)

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Continued at: http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf


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State vs. Local Taxes http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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State Aid to Local Government http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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Local Revenue Option: Sales Taxes http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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Local Revenue Option: Income Taxes http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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History of Tax Shares http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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Three-Legged Stool: Minnesota http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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Three-Legged Stool: Average Shares http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

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Business Taxes http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

Definition of “Business Taxes” in COST study (by Phillips, Cline, and Neubig) is similar to that used in the Minnesota Tax Incidence Study.

Note that neither equates business taxes with taxes on capital.

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Definition of Business Taxes http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf: “Taxes levied on Minnesota businesses that are not expected to be fully shifted forward to consumers in higher prices.”

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This Business Tax Definition … http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

Does not include:Excise taxes on cigarettes or alcohol.

 Sales tax on purchases by consumers.

May not include:* Insurance premiums tax on insurance purchased

by individuals.

 MinnesotaCare 2% tax on health care services.

 Income tax on income from sole proprietors and pass-through entities.

Does not include: Individual income tax on capital gains or dividends. (Taxed mostly based on residency, not location of

business assets.)

___________

*Defined as business tax in the COST study but not in the Tax Incidence Study.

Note: Information on payroll taxes (unemployment and workers’ compensation) and

business licenses is also omitted from the Tax Incidence Study.

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What is Minnesota business income? http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdf

Business

100% MN

$

Non-MN Investors

Interest

Dividend

Capital Gains

$

$

Business

100% Non-MN

$

MN Investors

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Property http://www.taxes.state.mn.us/taxes/legal_policy/research_reports/content/104_faq.pdfTax

Minnesota’s property tax rank is relatively low (either per capita or as a percent of income).

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Due to Minnesota’s class-rate system, though, tax rankings for some business property types are high relative to homestead property tax rankings.

Source: Minnesota Taxpayers Association, (50-State Property Tax Comparison Studies), Urban

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In 1997, Minnesota’s system of property classification shifted taxes from homes and agricultural property to commercial/industrial and apartment properties.

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Class compression since 1997 has reduced the size of those shifts, particularly for local property taxes.

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Net commercial/industrial taxes have declined as a share of the total tax, but increased in absolute terms.

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Simply reducing class rates for business property (“class rate compression”) will shift local property taxes on to homes and other property.

  • These shifts vary greatly among taxing jurisdictions, because the mix of property (homes versus C/I) varies greatly.

  • When done in the past, reductions in class rate differentials for business property have been combined with higher state aids to local governments (including schools) to “buy down” homeowner taxes that would otherwise have risen due to this shift.

  • A reduction in the state property tax levy (on C/I) would not have this effect.

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Property Taxes: Some Bright Spots rate compression”) will shift local property taxes on to homes and other property.

  • Minnesota has not taxed personal property (machinery, fixtures) since 1973 (except for utility property).

    • According to MTA’s most recent 50-state property tax comparison study, 37 states and DC tax personal property as well as real property.

    • For companies with a high proportion of personal property, Minnesota’s tax rank is lower than shown in Chart 11 above.

  • Class rate compression has significantly reduced the ratio of the C/I class rates to homestead class rates. (Also true for apartment property.)

  • The 2001 reform enacted a state C/I property tax to offset shifting. As a result, business property’s share of an incremental increase in local property taxes fell.

  • Minnesota has mostly avoided arbitrary caps and limits on taxable value or effective tax rates. In states where these caps and limits apply only or primarily to homeowner property, they shift increasing shares of the property burden on to business property.

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Sales Tax rate compression”) will shift local property taxes on to homes and other property.

Minnesota’s sales tax rank has been relatively low relative to other states, whether measured per capita or as a percent of income.

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Despite claims to the contrary, Minnesota’s sales tax base is not particularly narrow (or particularly broad).

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The business share of Minnesota’s sales and use tax – revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

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The future of the sales tax is cloudy revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”.

Shift to consumer services (1970 to 2006)

Consumer Services: 51% ==> 67% of PCE (10% taxable)

Consumer Goods: 49% ==> 33% of PCE (56% taxable)

Growth of remote sales.

Tax gap from remote sales in 2008 = $150 million.

Over $200 million by 2011.

Revenue neutral expansionof consumer base

Good for business, which shares 44% of rate reduction.

Examples:

 Add clothing, cut rate to 6.0%.

 HF 2163 would have cut rate to 4.5%

(included few business inputs – portion of motor fuels, vehicle repair).

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Sales Tax – Some Bright Spots revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

  • Tax rates on much of the capital equipment purchased by manufacturers, utilities, farms, and telecommunication companies were first reduced (1984-1994) and then effectively cut to zero (1989-1998).

    TY 2008 estimate: $340 million.

  • Inputs used in producing taxable services have generally been made exempt.

  • Until recently, at least, use of local sales taxes has been quite limited.

  • Minnesota is a member of Streamlined Sales Tax Agreement.

  • Attempts to expand the tax base to include many business services failed in 2001 (Governor Ventura’s “Big Plan”).

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Corporate Franchise Tax revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

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Corporate tax fails when measured against tax principles revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

  • High administrative and compliance costs.

  • Tax as share of corporate profits is falling. (Tax planning? Shift to S-corps?)

  • Very unstable revenue source.

  • Doesn’t fit well with benefit principle.

    • Narrow base and high rate (excludes S corps, partnerships, LLCs, sole proprietors).

    • Benefits from public services not proportional to profits.

    • 100% sales apportionment – but benefits from state services not tied only (or even mostly?) to location of sale.

  • Transparency?

    • No one knows who really bears the burden.

    • Public belief that tax is avoided by those who can afford a good legal team.

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Corporate Tax: Some Bright Spots? revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

  • Combined reporting (rather than separate reporting) – One of 17 combined reporting states.

  • Phase-in of 100% sales apportionment -- 14 states at 100% in 2008.

    “Destination based” rather than “source-based”.

    Reduces taxes by an estimated $170 million (17%) compared to equal weights on property, payroll, and sales.

  • Services sourced to where services are used or received (not cost of performance).

  • No throwback rule – 23 states have one.

    Lack of throwback reduces tax revenue by $30 million (3%).

  • Maintains preferential treatment for active foreign income of subsidiaries (foreign royalties subtraction and foreign operating company provision).

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Individual Income Tax revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”

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Minnesota’s top income tax rate is 9 revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”th highest*. (Effective capital gains tax rate is 6th highest.)

Most recent MTA study shows Minnesota’s ranking among 42 states with an income tax (married with 2 children, in 2003) as:

Income Rank

$ 20,000 42nd

$ 50,000 23rd

$ 100,000 18th

$ 250,000 10th

$1,000,000 9th

*11th highest if Maryland and New York’s average local income tax rates are included.

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For full spreadsheet, see 21 revenue from purchases of business inputs – is estimated at 44 percent. This causes “tax pyramiding.”st Century Tax Reform Commission website at:

www.taxes.state.mn.us/mntaxreform/studies/capgain_rates_by_state.XLS


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Reducing individual income taxes is an expensive way to reduce “taxes on Minnesota businesses”.

  • Most income is wages (only roughly 8% is income from sole proprietors or flow-through entities).

  • Most capital gains and dividends are from out-of-state investments.

  • However, some states have enacted targeted exclusions or rate reductions aimed at reducing rates on income from in-state businesses.

    • Example: Capital gains exclusions in Colorado, Iowa, Idaho, and Oklahoma.

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Alternative Business Taxes reduce “taxes on Minnesota businesses”.

“Business Activities Tax” (BAT)

Consumption-style value added tax.

(Allows expensing rather than depreciation)*

Twice included in House Tax Bill (late 1990s).

Levied at entity level.

100% sales apportionment for multi-state companies.*

Includes all forms of business (broad base) – with small business threshold.

Tax base is profits + employee compensation – (excess of expensing over depreciation).

___________________________

*Optional

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BAT (cont.) reduce “taxes on Minnesota businesses”.

  • Broad base, low rate.

    To replace corporate tax:

  • Grows with economy (tax base roughly equals gross state product).

  • Shifts tax burden among companies and industries.

  • Tax Burden: Much like broad-based consumer sales tax?

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2. Gross Receipts Taxes reduce “taxes on Minnesota businesses”.

  • Examples: Ohio’s “CAT” (Commercial Activities Tax); Texas’ “Margin Tax”; Washington’s “Business & Occupations Tax”; New Mexico’s GRT.

  • Each very different in its details.

  • Advantages: Broad-based (includes all business types) and low rate.

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Gross Receipts Taxes reduce “taxes on Minnesota businesses”.(cont.)

  • Problems:

    • Like an “old-fashioned” turnover tax.

      • Penalizes specialty companies / rewards vertical integration.

      • Tax Pyramiding: In Washington, average effective tax rate = 2.5 times the statutory rate (6.7 times for food manufacturing),

    • Not transparent.

  • “Not a favorite of tax economists,” because the tax fares poorly against tax principles.

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