Budget Trends Commission

February 27, 2008

Minnesota Taxes:Growth, Stability, and Demographic Changes

Presented by:

Paul WilsonMN Department of Revenue

Outline

Overview of Minnesota Tax System

Three-Legged Stool State vs. Local Taxes

Demographics and the Impact of Aging

Income Tax Sales Tax Property Tax

Growth and Stability

Introduction: Growth, Standard Deviation, and Cyclical Swing Index Income Tax Sales Tax Corporate Tax Property Tax

Source: Price of Government and DOR History file

Chart 1History of Minnesota State and Local Tax Shares

FY 1962 to FY 2011

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Fiscal Year

Per

cen

t o

f T

ota

l T

axes

Other Taxes

Income Tax

Sales Tax Rebate

Sales Tax (with MVET)

Prop Tax (before PTR)

Forecast

What’s different about Minnesota?

More equal mix of income, sales, and property taxes than is typical. In 2006: 39% income tax, 32% property tax, 29% sales tax.

State share of tax revenue is higher than in most states.

Local sales taxes relatively low, and there are no local income taxes. Local governments are unusually dependent on state aids.

Chart 2-A Minnesota Income, Sales, and Property Tax Shares

FY 1962 to FY 2011

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Fiscal Year

Sh

are

of

To

tal T

axes

Income Tax

Sales Tax

Property Tax

Forecast

Source: US Census

Few states have greater “balance” in tax shares.

In 2005, according to US Census data, only 7 states had greater balance (and only 4 had greater balance than Minnesota did in 2002-04).

18 states depend on one of the big three taxes for over half of total state and local revenue (including 12 states who lack one of the three).

The median state’s “Big Three” ratios in 2005 were 46%, 33%, and 21%.

9 states had a longer income tax “leg” than Minnesota (including 3 states with no sales tax).

28 states had a longer sales tax “leg” (including the 7 states with no income tax).

37 states and DC had a longer property tax “leg”.

Source: US Census

Chart 2-B All States Income, Sales and Property Tax Shares

FY 1962 to FY 2005

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Fiscal Year

Sh

are

of

To

tal T

axes

Income Tax

Sales Tax

Property Tax

Implications of relying more heavily on income tax relative to sales and property taxes:

Less stable revenue, but higher average revenue growth.

Progressive income tax helps balance regressivity of other taxes in overall tax system.

Source: US Census

Chart 3State Share of State & Local Taxes

(US Census Data for 2005)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Verm

ont

Arkan

sas

Hawaii

Delawar

e

Wes

t Virg

inia

Minn

esot

a

Kentu

cky

New M

exico

Miss

issipp

i

Idah

o

Mon

tana

North

Car

olina

Oklaho

ma

Califo

rnia

Alabam

a

Mich

igan

North

Dak

ota

Wyo

ming

Was

hingt

onUta

h

Alaska

Nevad

a

Mas

sach

uset

ts

Tenne

ssee

South

Car

olina

Wisc

onsin

Conne

cticu

t

Louis

iana

India

na

Arizon

a

Kansa

sIo

wa

Penns

ylvan

ia

US Tot

al

Main

e

Orego

n

Rhode

Islan

d

Nebra

ska

Virgini

aOhio

Georg

ia

Florida

Mar

yland

Miss

ouri

New Je

rsey

Illino

is

South

Dak

ota

Colora

do

Texas

New H

amps

hire

New Y

ork

MN

US

Source: US Census

Chart 4 State Aid as Percentage of State Aid Plus Local Taxes

(US Census Data, 2005)

0%

10%

20%

30%

40%

50%

60%

70%

80%

Verm

ont

Arkan

sas

New M

exico

Minn

esot

a

Miss

issipp

i

Califo

rnia

Delawar

e

Mich

igan

Wes

t Virg

inia

North

Car

olinaId

aho

Nevad

a

Alabam

a

Wyo

ming

Kentu

cky

Wisc

onsin

Oklaho

ma

Mon

tana

Arizon

a

Orego

n

Was

hingt

onOhio

North

Dak

ota

India

na

South

Car

olina

US Tot

alUta

h

Penns

ylvan

iaIo

wa

Kansa

s

Alaska

Tenne

ssee

Louis

iana

Mas

sach

uset

ts

Georg

ia

Virgini

a

Florida

New Y

ork

Miss

ouri

Illino

is

Nebra

ska

Colora

do

New Je

rsey

South

Dak

ota

New H

amps

hire

Rhode

Islan

d

Texas

Main

e

Mar

yland

Conne

cticu

t

Hawaii

MN

US

Source: US Census

Chart 5Local Share of Sales Tax Revenues by State

(US Census, 2005)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Conne

cticu

t

Hawaii

Idah

o

India

na

Main

e

Mar

yland

Mas

sach

uset

ts

Mich

igan

New Je

rsey

Rhode

Islan

d

Wes

t Virg

inia

Miss

issipp

i

Kentu

cky

Verm

ont

Minn

esot

a

Penns

ylvan

ia

South

Car

olina

Nevad

a

Florida

Wisc

onsin

Illino

is

Was

hingt

on

Nebra

ska

North

Dak

otaOhio

US Tot

al

Tenne

ssee

Texas

Califo

rniaIo

wa

Kansa

sUta

h

Arkan

sas

Wyo

ming

Virgini

a

South

Dak

ota

Arizon

a

North

Car

olina

New M

exico

Georg

ia

Miss

ouri

Alabam

a

Oklaho

ma

New Y

ork

Louis

iana

Colora

do

Alaska

State Share Local Share

MN US

Source: US Census

Chart 6Local Shares of State & Local Income Tax Revenue

(US Census, 2005)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Arizon

a

Arkan

sas

Califo

rnia

Colora

do

Conne

cticu

t

Georg

ia

Hawaii

Idah

o

Illino

is

Kansa

s

Louis

iana

Main

e

Mas

sach

uset

ts

Minn

esot

a

Miss

issipp

i

Mon

tana

Nebra

ska

New H

amps

hire

New Je

rsey

New M

exico

North

Car

olina

North

Dak

ota

Oklaho

ma

Rhode

Islan

d

South

Car

olina

Tenne

ssee

Utah

Verm

ont

Virgini

a

Wes

t Virg

inia

Wisc

onsinIo

wa

Orego

n

Alabam

a

Delawar

e

Mich

igan

Miss

ouri

US Tot

al

India

na

New Y

ork

Kentu

cky

Penns

ylvan

iaOhio

Mar

yland

State Share Local Share

MN US

Chart 7-APercent Reduction in Income and Minnesota Tax Per Return

Compared to Age 55-59 Minnesota Resident Income Tax Filers, 2002

-18%

-24%

-34% -34%

-43%-40%

-52%

-63%

-71%

-4%

-17%

-67%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%60 to 64 65 to 69 70 to 74 75 to 79 80 to 84 85 and over

Total Income Minnesota Tax

Chart 7-BPercent Reduction in Income and Minnesota Tax Per Person

Compared to Age 55-59 Minnesota Resident Income Tax Filers, 2002

-4%

-20%-22%

-28%-25%

-42%

-51%

-59%-63% -62%

-26%

-17%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%60 to 64 65 to 69 70 to 74 75 to 79 80 to 84 85 and over

Total Income Minnesota Tax

Chart 8-AAverage FAGI and Exempt Income Reported on Tax Return

Minnesota Resident Income Tax Filers, 2002

6

16

34

49

6067

72 74 75

65

5145

37 3431

16

17

17 20

15

0

0

0

1

1

2

23 6

13

0

10

20

30

40

50

60

70

80

90

lessthan 20

20 to24

25 to29

30 to34

35 to39

40 to44

45 to49

50 to54

55 to59

60 to64

65 to69

70 to74

75 to79

80 to84

85 andover

Age of Taxpayer

$ T

ho

usa

nd

s

Exempt SS, pension, IRA, andinterest reported on return

FAGI

Large percentage of the income seniors report on their tax returns is tax exempt.

Two-Thirds of Social Security (for income tax filers – higher overall) One-quarter of pension and IRA income. For all senior filers, 28% of income reported on tax returns is

exempt.

Note that the share of exempt income for seniors is lower in Minnesota than in many states. In a few states, all Social Security and pension income is exempt. (Minnesota follows federal law on taxation of Social Security and pensions.)

Chart 8-BComponents of Average Income Reported on Tax Return

Minnesota Resident Income Tax Filers, 2002

0

10

20

30

40

50

60

70

80

90

lessthan 20

20 to24

25 to29

30 to34

35 to39

40 to44

45 to49

50 to54

55 to59

60 to64

65 to69

70 to74

75 to79

80 to84

85 andover

Age of Taxpayer

$ T

ho

usa

nd

s

Exempt income per returnTaxable Retirement IncomeTaxable Capital IncomeOther Taxable (incl Sch E)Taxable Earnings

Chart 9Average Minnesota Income Tax (Before Credits)

Minnesota Resident Income Tax Filers, 2002

507

1,248

1,964

2,554

3,007

3,580

3,761

3,123

2,249

1,2301,095

481

109

1,816

1,407

3,361

986

858926

841

1,118

1,323

109

1,354

1,633

2,2642,2672,150

1,915 1,886

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

lessthan20

20 to24

25 to29

30 to34

35 to39

40 to44

45 to49

50 to54

55 to59

60 to64

65 to69

70 to74

75 to79

80 to84

85 andover

Age of Taxpayer

Do

llar

s

Per Return

Per Taxpayer

Tax Incidence Study Database Includes non-filers More comprehensive measure of income

Lowest Highest Income Income

Population of Particular Type of Household

First Quartile Median Third Quartile

Chart 10-ATotal Household Income in 2004

$38,911

$35,042

$15,788

$23,384

$12,851

$24,589

$74,674

$35,574

$51,135

$97,087

$46,296

$69,003

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

First Quartile Median Income 3rd Quartile

Single Senior

Single Non-Senior

Married SeniorMarried Non-Senior (no dependents)

Chart 10-BMinnesota Income Tax in 2004

$93

$431

$121 $106

$3,019

$0

$1,715

$760

$2,641

$762

$4,830

$1,318

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

First Quartile Median Income 3rd Quartile

Single Senior

Single Non-Senior

Married SeniorMarried Non-Senior (no dependents)

Impact of Aging on Minnesota Income Tax Revenues

Nina Manzi, Joel Michael, and Paul Wilson, “State Income Tax Revenues in 2002 and 2030: The Impact of the Retirement of the Baby Boom,” National Tax Association Proceedings, November 2005. Reprinted in State Tax Notes (January 23, 2006), pp. 215-240.

House Income Tax Simulation (HITS) Model Used to estimate tax revenue in 2002 assuming:

2030 age distribution, and 2030 estimated shares of income (wages, retirement income, capital income).

Simulation results: Revenues would fall by only 1.8 percent.

Why so small an impact? Fewer young people – who also pay a relatively small amount of tax. Under Current law, the share of retirement income subject to tax will rise.

Social Security threshold is not indexes for inflation, so between 2002 and 2030 the share of SS subject to tax will rise from 32% to 63%.

Effective tax rates for seniors would rise from 2.90% of income to 3.43% of income.

Effective Tax Rate

5%

4%

0%

Age Group

20-2425-29

30-3435-39

40-4445-49

50-5455-59

60-6465-69

70-7475-79

80-8485 and over

Under 20

1%

3%

2%

TY 2030 projected

TY 2002 base

Figure 6: Effective tax rates by age group, 2002 base and 2030 projected

The Big Question: Will current law related to senior preferences continue?

Minnesota Estimates – Impact of Aging AND

Added Senior Preferences(Income held constant)

Revenue impact as percent of:

Total change 2002 to 2030

with preference in

both years

Total change 2002 to 2030 if add new senior tax

benefit

2002base

revenues

2030 base

revenues

Current Minnesota law (“2010 Law”) NA NA -1.8% NA

Full exemption for Social Security -2.3% -5.0% -4.5% -6.8%

Index Social Security Benefits NA -1.9% -3.7% -3.7%

$10,000 pension exclusion, not indexed

-2.7% -2.7% -1.8% -4.5%

Full exemption for Social Security and $10,000 pension exclusion, not indexed

-4.9% -7.4% -4.4% -9.2%

Full exemption for Social Security and $10,000 pension exclusion, indexed

-4.9% -9.2% -6.3% -11.1%

Full exemption for Social Security and pension exclusion

-8.1% -15.8% -10.0% -17.6%

Chart 11Sales Tax on Consumer Purchases

Seniors Compared to Non-Seniors2009 Estimates from Tax Incidence Study Database

$1,502

$690

$743

$1,706

$1,907

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

Single Couple Family of 4

Senior Non-Senior

Revenue impact of aging:

Based on a 2004 study of consumption differences by age, Paul Menchik (Michigan State University) suggested that aging alone would reduce sales tax revenue by 5% in the typical state between 2000 and 2030.

In contrast, more recent analysis by Peter Fisher (University of Iowa) suggests that aging by itself will increase sales tax revenues by 0.3% between 2005 and 2030.

Source: Peter Fisher, University of Iowa (2007)

Chart 12Per Capita Income, Expenditures, and Taxable Expenditures by Age

States with Sales Tax, 2007

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

Under 25 24-34 35-44 45-54 55-64 65-74 75 and over

Age of Reference Person

Income

Expenditures

Taxable Expenditures

Seniors are more likely to be homeowners. Senior homeowners have lower income than non-senior homeowners –

but only about 19% less. Seniors own homes only slightly lower in value than non-seniors. Homeowner tax before property tax refund is 9% lower, but because

incomes are lower the tax equals a higher percentage of income. The PTR reduces senior property tax by more than it reduces non-senior

tax, and tax after PTR as a percent of income is roughly the same for seniors and non-senior homeowners.

Homeowner Property Tax Statistics by Age

Before PTR After PTR

Before PTR

After PTR

Under 65 60% $102,435 $155,045 $2,394 $2,258 2.3% 2.2% 6%65 and Over 72% $82,804 $146,316 $2,173 $1,913 2.6% 2.3% 12%

All Ages 62% $98,133 $153,132 $2,346 $2,182 2.4% 2.2% 7%

Difference as Percent of Non-

Senior Total21% -19% -6% -9% -15% 12% 5% 110%

Age of Homeowner

Percent Who Are

Homeowners (2004)

Average Home Value

(2004)

Homeowner TaxTax as Percent

Income Percent Less Due

to PTRHomeowner

Income

Tax Growth & Instability

Measure 1: Tax base growth.

How does historical growth in the tax base compare to growth in per capita income?

Growth rates stated in per capita terms, and in real (inflation-adjusted)dollars. Compared to growth in real per capita personal income.

Measure 2: Standard deviation of tax base annual growth rates.

How much does the growth rate (real per capita tax base) vary from year to year?

Captures amount of variation around the long-run trend. Larger standard deviation means more instability.

Measure 3: Cyclical swing index.

How much does the tax base “swing” between expansion and recession years?

CSI = Average annual growth in expansion yearsMinus

Average annual growth in recession years

Chart 13Growth in Real Per Capita Income

Minnesota 1989-2005

1.6%1.7%

1.9%

3.7%

4.8%

1.8%

0%

1%

2%

3%

4%

5%

Personal Income Federal Adjusted Gross Income Federal Taxable Income

Average Annual Growth Standard Deviation of Annual Growth

Chart 14Real Per Capita FAGI, FTI, and Personal Income

Minnesota, CY 1970 to CY 2005

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year

2005

Do

llar

s P

er C

apit

a

Real Personal Income per capita (+1.7%/yr)

Real FAGI per capita (+1.6%/yr)

Real Taxable Income per capita (+1.9%/yr)

Note: Growth rates are average rates per year for 16 years, with compounding.

Chart 15Growth in Components of Real Per Capita FAGI

Minnesota 1989-2005(Average share of FAGI shown in parentheses)

-5.8%

30.3%

11.5% 11.1%

1.6% 1.3%

5.1%

0.7%

6.4%

-0.1%

4.9%3.7%2.2%

5.2%

13.0%

3.9%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

FAGI (100%) Wages (75%) RetirementIncome (6%)

Capital Gains (5%)

Interest (3%) Dividends (2%) Sole Proprietor(3%)

Other (mostlySch. E) (6%)

Average Annual Growth Standard Deviation of Annual Growth

Chart 16Cyclical Swing Index

FTI, FAGI and Components of FAGI (1971-2005)

4.7%3.2% 2.2%

6.0%

14.8%

0.6% 2.6%

-0.4%

-3.0% -3.1%

2.9%

-1.7%

-22.6%

-5.8%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

FTI(Index=7.6%)

FAGI(Index=6.3%)

Wages(Index=3.9%)

Retirement(Index=3.1%)

Capital Gains(Index=37.4%)

Interest & Div(Index=1.0%)

Sole Proprietor(Index=8.4%)

Expansion Years

Recession Years

Chart 17Real Per Capita FAGI and FAGI Minus Capital Gains

Minnesota, CY 1989 to CY 2005

0

5,000

10,000

15,000

20,000

25,000

30,000

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year

2005

Do

llar

s P

er C

apit

a

Real FAGI per capita (+1.6%/yr)

FAGI excluding capital gains (+1.4%/yr)

Note: Growth rates are average rates per year for 16 years, with compounding.

Chart 18 Durable Goods, Nondurable Goods, and Services Shares

of US Personal Consumption Expenditures

0%

20%

40%

60%

80%

100%

19701972

19741976

19781980

19821984

19861988

19901992

19941996

19982000

20022004

2006

Year

Sh

are

of

To

tal

PC

E

Durable Goods

Nondurable Goods

Services

Chart 19Average Annual Growth Rates 1970-2006

1.6%1.7%

1.2%

2.3%

1.3%

0.4%

0%

1%

1%

2%

2%

3%

Personal Income PCE TaxableConsumption

Services Durable Nondurable

Chart 20Taxable Shares of Personal Consumption Expenditures

(Assuming 2007 law applied in earlier years)

0%

10%

20%

30%

40%

50%

60%

19701972

19741976

19781980

19821984

19861988

19901992

19941996

19982000

20022004

2006

Year

Sh

are

of

PC

E

Goods

Services

All PCE

Chart 21-AGrowth Rates and Standard Deviation of Growth Rates

Real Per Capita Dollars, 1970-2006

2.4%

3.5%

2.5%

6.2%

2.5%

0.4%

1.7%

1.2%

1.6%

2.3%

1.3%

2.6%

0%

1%

2%

3%

4%

5%

6%

7%

Personal Income PCE TaxableConsumption

Services Durable Nondurable

Average Growth

Standard Deviation

Chart 21-BImpact of Base Expansions on Growth and Instability

1970-2006

1.2%1.1%

1.0%

2.1%

1.6%1.7%

3.5% 3.4%

3.0% 3.0%

3.5%

2.9%

2.6%

1.3%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Current Law Add Clothing Add Food Add Medical Add UntaxedServices

Add Fuels Add All Five

Annual Growth Standard Deviation

Chart 22Cyclical Swing Index for Current Law and Broader Tax Bases

(CSI Index in parentheses)

1.9%2.5%

2.3% 2.3%

3.0%

2.5%

2.7%

-0.8%-0.7%

-2.1%-2.0%-2.2%

-2.8%-2.5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

Current Law(5.0%)

Add Clothing(5.0%)

Add Food(4.1%)

Add Fuels(4.3%)

Add Pers.Serv. (4.8%)

Add Medical(3.7%)

Add All (3.3%)

Averagegrowth inexpansion

Averagegrowth inrecession

The Challenge of Remote Sales

The tax gap from uncollected remote retail sales is substantial and growing rapidly.

From $150 million in 2008 to over $200 million in 2011. Reduces growth in general sales tax revenues by about

0.25% per year. Possible solution: Streamlined sales tax to simplify tax

collection plus either: Congressional action or Court decision.

Chart 23Real Per Capita Corporate Tax Revenue

Growth and Standard Deviation of Growth 1990-2006

1.3%

16.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Growth Standard Deviation

Chart 24Cyclical Swing Index for Corporate Tax Revenue

1990-2006(CSI Index = 18.5%)

6.9%

-11.6%-12%

-8%

-4%

0%

4%

8%

Averagegrowth inexpansion

Averagegrowth inrecession

Chart 25Taxable Market Value Change by Class

0%

2%

4%

6%

8%

10%

12%

14%

16%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Residential Homestead

Commercial/Industrial