The 2019 tax bill agreed to by Governor Tim Walz and the Minnesota Legislature in the recently completed special legislative session includes both important hits and worrisome misses.
The tax bill determines how much the state raises to fund education, health care, and other essential public services, and how we share the responsibility for funding those services. Both of these issues were high priorities this year.
The state needed to update the tax code in response to 2017 federal tax changes - a process called "tax conformity." We argued that Minnesota policymakers should not replicate the mistakes of the federal bill, but instead should prioritize everyday Minnesotans in the state's tax policy. And fortunately, the 2019 tax bill includes provisions that put everyday Minnesotans first, including by expanding the Working Family Credit and protecting exemptions and deductions that Minnesotans count on.
Given the state is projected to have only a short-term budget surplus, more revenues are needed to keep the state's current commitments and fund new investments in our schools, our people, and our communities, especially in the longer term. The tax bill takes the essential step of retaining the health care provider tax, which would have otherwise expired and resulted in the loss of about $700 million a year in funding for affordable health care and community health initiatives.
Elsewhere in the budget, policymakers agreed to important increases in funding for schools and other investments so that more Minnesotans can fully take part in the state's prosperity. But the tax bill doesn't help sustainably fund those investments, because it doesn't raise general fund revenues overall.
Instead, nearly $500 million will be taken out of the state's budget reserve on July 1, 2021. That's a temporary solution that uses one-time resources to fund ongoing services, and it weakens Minnesota's readiness to respond to the next economic downturn.
Here's a closer look at some of the details in the final tax bill.
Tax changes for individuals and families
About 275,000 households will benefit from the bill's $30 million per year expansion of the Working Family Tax Credit. That means that Minnesota workers and their families across the state will be better able to afford what they need to get to work and succeed on the job, and get their children off to a stronger start in life.
For both workers without dependent children and families with three or more children, the bill increases the amount of tax credit and makes more Minnesotans eligible. Minnesota joins a growing number of states improving their tax credits for workers without dependent children: the maximum amount of credit they can receive is now $279, double the previous amount. Single workers without children will be able to qualify for the credit until their incomes reach $22,673, significantly higher than previously, and married couples without children can qualify with incomes up to $28,513. The bill also includes modest expansions for families with one or two children.
Unfortunately, the tax bill does not include the House's proposed increases in state property tax refunds for homeowners and renters. In fact, because the bill adopts chained CPI, a slower-growing measure, to make annual inflation adjustments across the tax code, property tax refunds will be worth $1.1 million less in FY 2020-21 and $5.3 million less in FY 2022-23 than if the state kept the existing measure of inflation.
The bill's tax conformity provisions for individuals and families largely protect the tax exemptions and deductions that Minnesotans counted on before the passage of the federal tax bill (called the TCJA). A majority of Minnesotans take the standard deduction (rather than itemize), and many modest- and middle-income Minnesotans will benefit because the tax bill adopts a higher standard deduction while maintaining the value of dependent exemptions. The bill also maintains many itemized deductions, including some that were eliminated at the federal level by the TCJA.
The bill lowers the income tax rate in the second tax bracket from its current 7.05 percent to 6.8 percent, starting this year. At a cost of $361 million in FY 2020-21, this is by far the largest tax-cutting item in the bill. However, nearly half of all Minnesotans, especially low- and middle-income households, will see no benefit from it, according to the Institute on Taxation and Economic Policy. For example, only about half of Minnesota households with incomes $50,000 to $79,000 will get a tax cut averaging $44 from the rate reduction. In contrast, the vast majority of high-income households will receive a tax cut up to $288.
Tax conformity for businesses
The federal tax bill cut the corporate tax rate by 40 percent and created a new 20 percent tax deduction for many "pass-through" businesses that pay taxes on their profits through the individual income tax, rather than corporate tax. At the same time, the TCJA "broadened the base" by expanding the share of business profits that are taxable. Coming into final tax negotiations, Walz, the House, and the Senate all had tax plans that raised revenues by conforming to some of the TCJA's base broadeners.
The final tax bill recognizes that it makes sense for Minnesota to recapture a portion of the federal tax cuts businesses received as the state updates the tax code, and raises $649 million in FY 2020-21 from corporations and pass-through businesses from tax conformity. Walz and the House also proposed raising state revenues through provisions that tax corporations' foreign income, following the TCJA's lead, but none of these provisions made it into the final tax bill.
Walz and the House had also sought to shore up state revenues by reversing cuts to the estate tax, statewide property tax paid by businesses, and tobacco taxes that were enacted in the 2017 tax bill and that contribute to the revenue shortfall in future years. None of these reversals were included in the final tax bill. In fact, the bill goes in the opposite direction by further cutting the statewide property tax for businesses and cabins by an additional $50 million per year.
Investing in communities and families
The 2019 tax bill boosts funding for local public services, primarily through increases in Local Government Aid to cities, County Program Aid, and equalization aid to some school districts. The bill also seeks to improve the ability of rural school districts to pass school referenda by increasing a related property tax credit for farmers.
Another important provision in the tax bill ends the practice of funding a portion of the state's Working Family Tax Credit with federal TANF (Temporary Assistance for Needy Families) dollars. Instead, from now on, the Working Family Credit will be paid for out of the general fund, like other tax provisions, and the TANF dollars are put to better use helping pay for a long-overdue increase in the monthly cash grant under MFIP, the state's welfare-to-work program.
Despite a lot of attention to the issue this session, the final budget does not increase the state's gas tax or make other major changes to transportation funding sources.
The 2019 tax bill has many positives, including expanding the Working Family Credit, maintaining the provider tax, prioritizing everyday Minnesotans in tax conformity, and boosting funding for local services. In other parts of the budget, progress is made in investing in our schools, public colleges and universities, and family economic security. However, in drawing from the budget reserve, policymakers are making a big gamble that no serious recession will hit in the next three years - a risky move considering the nation's economic recovery is already quite long by historic standards. And there's more for policymakers to do to ensure that Minnesota is raising the revenues needed to sustainably fund essential public services out into the future.