The vast majority of the attention given to the Bush tax cuts has been focused on changes in top marginal rates, the treatment of capital gains income, and the estate tax.  But another, less visible component of those cuts has been gradually making itemized deductions more unfair and expensive over the last five years.  Since the vast majority of states offering itemized deductions base their rules on what is done at the federal level, this change has also resulted in state governments offering an ever-growing, regressive tax cut that they clearly cannot afford. 

In an attempt to encourage states to reverse the effects of this costly and inequitable development, the Institute on Taxation and Economic Policy (ITEP) this week released a new report, "Writing Off" Tax Giveaways, that examines five options for reforming state itemized deductions in order to reduce their cost and regressivity, with an eye toward helping states balance their budgets.

Thirty-one states and the District of Columbia currently allow itemized deductions.  The remaining states either lack an income tax entirely, or have simply chosen not to make itemized deductions a part of their income tax — as Rhode Island decided to do just this year.  In 2010, for the first time in two decades, twenty-six states plus DC will not limit these deductions for their wealthiest residents in any way, due to the federal government's repeal of the "Pease" phase-out (so named for its original Congressional sponsor).  This is an unfortunate development as itemized deductions, even with the Pease phase-out, were already most generous to the nation's wealthiest families.

"Writing Off" Tax Giveaways examines five specific reform options for each of the thirty-one states offering itemized deductions (state-specific results are available in the appendix of the report or in these convenient, state-specific fact sheets).

The most comprehensive option considered in the report is the complete repeal of itemized deductions, accompanied by a substantial increase in the standard deduction.  By pairing these two tax changes, only a very small minority of taxpayers in each state would face a tax increase under this option, while a much larger share would actually see their taxes reduced overall.  This option would raise substantial revenue with which to help states balance their budgets.

Another reform option examined by the report would place a cap on the total value of itemized deductions.  Vermont and New York already do this with some of their deductions, while Hawaii legislators attempted to enact a comprehensive cap earlier this year, only to be thwarted by Governor Linda Lingle's veto.  This proposal would increase taxes on only those few wealthy taxpayers currently claiming itemized deductions in excess of $40,000 per year (or $20,000 for single taxpayers).

Converting itemized deductions into a credit, as has been done in Wisconsin and Utah, is also analyzed by the report.  This option would reduce the "upside down" nature of itemized deductions by preventing wealthier taxpayers in states levying a graduated rate income tax from receiving more benefit per dollar of deduction than lower- and middle-income taxpayers.  Like outright repeal, this proposal would raise significant revenue, and would result in far more taxpayers seeing tax cuts than would see tax increases.

Finally, two options for phasing-out deductions for high-income earners are examined.  One option simply reinstates the federal Pease phase-out, while another analyzes the effects of a modified phase-out design.  These options would raise the least revenue of the five options examined, but should be most familiar to lawmakers because of their experience with the federal Pease provision.

Read the full report.

The vast majority of the attention given to the Bush tax cuts has been focused on changes in top marginal rates, the treatment of capital gains income, and the estate tax.  But another, less visible component of those cuts has been gradually making itemized deductions more unfair and expensive over the last five years.  Since the vast majority of states offering itemized deductions base their rules on what is done at the federal level, this change has also resulted in state governments offering an ever-growing, regressive tax cut that they clearly cannot afford. 

In an attempt to encourage states to reverse the effects of this costly and inequitable development, the Institute on Taxation and Economic Policy (ITEP) this week released a new report, "Writing Off" Tax Giveaways, that examines five options for reforming state itemized deductions in order to reduce their cost and regressivity, with an eye toward helping states balance their budgets.

Thirty-one states and the District of Columbia currently allow itemized deductions.  The remaining states either lack an income tax entirely, or have simply chosen not to make itemized deductions a part of their income tax — as Rhode Island decided to do just this year.  In 2010, for the first time in two decades, twenty-six states plus DC will not limit these deductions for their wealthiest residents in any way, due to the federal government's repeal of the "Pease" phase-out (so named for its original Congressional sponsor).  This is an unfortunate development as itemized deductions, even with the Pease phase-out, were already most generous to the nation's wealthiest families.

"Writing Off" Tax Giveaways examines five specific reform options for each of the thirty-one states offering itemized deductions (state-specific results are available in the appendix of the report or in these convenient, state-specific fact sheets).

The most comprehensive option considered in the report is the complete repeal of itemized deductions, accompanied by a substantial increase in the standard deduction.  By pairing these two tax changes, only a very small minority of taxpayers in each state would face a tax increase under this option, while a much larger share would actually see their taxes reduced overall.  This option would raise substantial revenue with which to help states balance their budgets.

Another reform option examined by the report would place a cap on the total value of itemized deductions.  Vermont and New York already do this with some of their deductions, while Hawaii legislators attempted to enact a comprehensive cap earlier this year, only to be thwarted by Governor Linda Lingle's veto.  This proposal would increase taxes on only those few wealthy taxpayers currently claiming itemized deductions in excess of $40,000 per year (or $20,000 for single taxpayers).

Converting itemized deductions into a credit, as has been done in Wisconsin and Utah, is also analyzed by the report.  This option would reduce the "upside down" nature of itemized deductions by preventing wealthier taxpayers in states levying a graduated rate income tax from receiving more benefit per dollar of deduction than lower- and middle-income taxpayers.  Like outright repeal, this proposal would raise significant revenue, and would result in far more taxpayers seeing tax cuts than would see tax increases.

Finally, two options for phasing-out deductions for high-income earners are examined.  One option simply reinstates the federal Pease phase-out, while another analyzes the effects of a modified phase-out design.  These options would raise the least revenue of the five options examined, but should be most familiar to lawmakers because of their experience with the federal Pease provision.

Read the full report.

A dramatic showdown over taxes has been building in the gubernatorial election in Minnesota. The candidates running in the Democratic-Farmer-Labor Party (DFL) primary said they would support tax increases, especially bold stances in a state where the current governor is Tim Pawlenty. After all, presidential hopeful Pawlenty has repeatedly refused to raise taxes.

The victor in the DFL primary is former United States Senator Mark Dayton with 41 percent of the vote. Dayton doesn't mince words when it comes to his views on how to raise necessary funds for the state: "Read my lips, tax the rich. Minnesota’s wealthiest citizens pay only two-thirds of their fair share of state and local taxes. That’s wrong. As Governor, I will raise taxes on the rich of Minnesota, NOT on the rest of Minnesota." In a recent Star Tribune op-ed, Richard Miller, a retired Wells Fargo executive, commented, "Three governors have let what was a very fair tax system become grossly distorted in favor of those among us who are most able to fund the common good. Dayton is the only candidate telling us that the emperor has no clothes. We ought to listen to him before it gets even more embarrassing."

Dayton will face Republican candidate Tom Emmer, a former Representative in the Minnesota House, who strongly supports regressive tax policies. Emmer says "We need to reform our tax structure so it is based on what people consume and not on the wealth they generate." In November Minnesota voters will be offered a rare chance to vote for who they think should contribute more — the wealthy or the poor.

The three candidates vying to be the Democratic candidate for Minnesota Governor are former Senator Mark Dayton, former Congressman Matt Entenza, and current House Speaker Margaret Anderson Kelliher. The candidates aren't likely to go negative during the primary, but the myriad of fiscal issues facing the state are anything but positive.

As the Minnesota Budget Project (MBP) reports in an analysis released just last week, the 2010 legislative session ended with "many opportunities lost." Elected officials didn't use a balanced approach to solving the state's budget shortfall, instead relying on spending cuts and various stop-gap measures that did not include revenue-raisers. They certainly did no favors for future lawmakers. MBP writes, "Because of heavy reliance on one-time spending cuts and timing shifts, these budget decisions did not make progress on reducing the future budget shortfall, leaving a profoundly difficult problem for the next legislature and governor to tackle next year. "

Voters will go to the polls on August 10 and it appears that all three of the Democratic candidates believe that new revenue will be necessary in order to deal with the state's budget. This is, of course, welcome news for Minnesotans compared to the "no new taxes" rhetoric of current Governor Tim Pawlenty.

If Dayton, Kelliher, or Entenza are elected in November they will be forced to address many issues. But the one that perhaps looms largest is the state's fiscal future. All three candidates have their own proposals.

Dayton has said, "I would raise $4 billion by making the richest Minnesotans, the [top] 10 percent, pay their fair share of taxes." Kelliher also wants to raise taxes on the wealthy, but is looking to only raise about $600 million from taxing the best off. Entenza critiques Dayton's tax increase by saying that the proposal is too strong, "I think some of the business consequences of that are something we don't want to look at." However, he does hint at supporting some type of temporary tax surcharge and taxing internet sales.

Minnesota Governor Tim Pawlenty is at it again.  Like most states, Minnesota continues to face a sizeable budget gap as a result of the economic recession.  In response, for the second year in a row, the state’s legislature passed a progressive tax increase aimed at mitigating the need to cut the state’s vital services.  Also for the second year in a row, however, Governor Pawlenty has decided to veto that package.

The plan put forth by the Minnesota legislature would have created a new top income tax rate on incomes over $200,000 for married couples, and over $113,100 for single filers.  The bracket, had it been enacted, would have expired in 2013 if the state’s budgetary situation had improved to the extent specified in the legislation.  Overall, a mere 15% of the state’s budget gap would have been filled via the income tax hike, with most of the remainder being handled through spending cuts pushed by the Governor. 

Despite the targeted, temporary, and modest nature of the hike, Governor Pawlenty repeated the same tired line regarding the “job-killing” aspects of the tax. 

Unfortunately, Pawlenty demonstrated no such hesitation to tax hikes when he very recently agreed to raise taxes on low-income families via a reduction in the renter’s credit and the elimination of the state’s gas tax credit.

Despite the conservative mantra that all tax hikes harm the economy, current economic theory suggests that reductions in state spending are actually likely to do more harm to a state’s economy than targeted tax hikes. 

Wayne Cox, director of the Minnesota Citizens for Tax Justice, recently explained this point in the context of the Governor’s veto: “Last year state economist Tom Stinson described Pawlenty’s cuts-only solution as the one that would reduce jobs the most. Pawlenty appears to be the one with the hearing problem. … Governor Pawlenty has taken his nine-iron to Minnesota’s jobs again.”

The Minnesota Budget Project (MBP) recently updated their policy brief, Revenue-Raising Options to Help Solve Minnesota's Budget Deficit. According to MBP, "Minnesota faces a weak economy, daunting state deficits and some very tough choices." The state's February economic forecasts show an expected budget deficit for the fiscal year 2012-13 biennium of $7 billion.  

However, this grim news doesn't mean that policymakers are without options. In fact, the policy brief explains that their options include enacting a 10 percent income tax surcharge, creating new income tax brackets, modernizing the sales tax, and eliminating various business tax preferences. Minnesota lawmakers should follow in the footsteps of other states facing tough economic times and use a balanced approach of spending cuts and tax increases to fill the state's shortfall, rather than relying entirely on cuts in public services.

 

Minnesota Governor Tim Pawlenty released the details of his budget proposal this week.  If enacted, it would cut both health care and education funding by hundreds of millions of dollars, while actually reducing taxes for corporations and other businesses.

Among the tax cuts being pursued by Gov. Pawlenty are a 20% cut in corporate income taxes, a 20% tax exclusion for small businesses, a new investment tax credit, an expansion of the research tax credit, capital gains tax breaks for small business investments, and a slew of other tax incentives.  As the Minnesota Budget Project (MBP) has pointed out, the precise costs of these tax breaks are still unclear, and are likely to grow significantly over time.  The Governor has framed his proposal as a type of job-growth plan, though the massive cuts in state services needed to finance his unbalanced approach will inevitably result in additional layoffs.  

For more detailed analyses of the Governor’s proposal, be sure to follow the good work being done at the MBP’s blog: Minnesota Budget Bites.

By all accounts, Minnesota Governor Tim Pawlenty is more focused on his next career move than anything happening in Saint Paul. As his political ambitions rise, so does the state's budget deficit, which is now tallied at $1.2 billion for the current two-year budget period and $5.4 billion for the next biennium. The Governor has called the state's budget situation "significant but solvable" and once again vowed to fill the state's shortfall without raising taxes. At a time when Minnesotans are as dependent on government services as ever, it seems negligent to once again reduce the number of options that are available to lawmakers working to dig the state out of its budget hole.

And it gets worse.

Apparently, renewing one's "no new taxes pledge" doesn't win you enough brownie points with anti-taxers, so Pawlenty has also recently proposed a deeply flawed constitutional amendment which would limit state spending.

As the Minnesota Budget Project so aptly states, "his Spending Limit Amendment is an extreme and inflexible tool that takes decision-making power out of the hands of the people and their representatives." Where they've been enacted, these sorts of spending limits have had disastrous impacts on a state's ability to educate children and even repair roads.

In most states where proposals like this have been put before voters or legislative bodies, they have failed to actually pass. Let's hope that happens in Minnesota.

It’s a problem that’s common across many states. Too many exceptions are carved into state sales taxes, which consequently apply to far too narrow a range of purchases.  In large part, this is the predictable result of lawmakers’ desire to enact policies that allow them to claim they’ve cut taxes, while also being able to redirect resources toward their favorite activities or groups.

In Kansas, Secretary of Revenue Joan Wagnon has been leading the charge in encouraging more systematic thinking about the multitude of exemptions from the state’s sales tax.  Specifically, Wagnon has suggested a three-year moratorium on creating new sales tax exemptions, and an examination of the effects of current sales tax exemptions.  The idea has received notable support.  State Rep. Jim Ward, for example, has concurred with the proposal to more closely scrutinize these programs: "Without some criteria to balance the public good, it is very difficult [to ensure tax exemptions are warranted], and we haven't done a great job of it.”  One way to inject such criteria into the policy process in Kansas, and other states, would be to enact a “performance review” system of the type proposed in a recent CTJ report.

Sales tax exemptions can also come about as a result of historical accident.  Minnesota, like most states, exempts a huge number of personal services from taxation, largely because the state’s sales tax was created before the economy shifted to its current, more service-oriented nature.  Fortunately, recent press coverage from Minnesota shows a lot of interest among lawmakers, including gubernatorial candidates, in correcting this flaw in the state’s tax code.  For more on the folly of exempting services from the sales tax base, be sure to read this ITEP Policy Brief.

This week, the Institute on Taxation and Economic Policy (ITEP), in partnership with state groups in forty-one states, released the 3rd edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.”  The report found that, by an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy.  The response has been overwhelming.

In Michigan, The Detroit Free Press hit the nail on the head: “There’s nothing even remotely fair about the state’s heaviest tax burden falling on its least wealthy earners.  It’s also horrible public policy, given the hard hit that middle and lower incomes are taking in the state’s brutal economic shift.  And it helps explain why the state is having trouble keeping up with funding needs for its most vital services.  The study provides important context for the debate about how to fix Michigan’s finances and shows how far the state really has to go before any cries of ‘unfairness’ to wealthy earners can be taken seriously.”

In addition, the Governor’s office in Michigan responded by reiterating Gov. Granholm’s support for a graduated income tax.  Currently, Michigan is among a minority of states levying a flat rate income tax.

Media in Virginia also explained the study’s importance.  The Augusta Free Press noted: “If you believe the partisan rhetoric, it’s the wealthy who bear the tax burden, and who are deserving of tax breaks to get the economy moving.  A new report by the Institute on Taxation and Economic Policy and the Virginia Organizing Project puts the rhetoric in a new light.”

In reference to Tennessee’s rank among the “Terrible Ten” most regressive state tax systems in the nation, The Commercial Appeal ran the headline: “A Terrible Decision.”  The “terrible decision” to which the Appeal is referring is the choice by Tennessee policymakers to forgo enacting a broad-based income tax by instead “[paying] the state’s bills by imposing the country’s largest combination of state and local sales taxes and maintaining the sales tax on food.”

In Texas, The Dallas Morning News ran with the story as well, explaining that “Texas’ low-income residents bear heavier tax burdens than their counterparts in all but four other states.”  The Morning News article goes on to explain the study’s finding that “the media and elected officials often refer to states such as Texas as “low-tax” states without considering who benefits the most within those states.”  Quoting the ITEP study, the Morning News then points out that “No-income-tax states like Washington, Texas and Florida do, in fact, have average to low taxes overall.  Can they also be considered low-tax states for poor families?  Far from it.”

Talk of the study has quickly spread everywhere from Florida to Nevada, and from Maryland to Montana.  Over the coming months, policymakers will need to keep the findings of Who Pays? in mind if they are to fill their states’ budget gaps with responsible and fair revenue solutions.

In unusually difficult times like these, one of the most responsible decisions a policymaker can make is to keep all revenue options on the table. Unfortunately for residents of Minnesota and Hawaii, their governors have approached the current crisis with exactly the opposite mentality. Governor Tim Pawlenty of Minnesota and Governor Linda Lingle of Hawaii have clung to the "no new taxes" mantra in recent months, despite the passage of responsible revenue-raising packages by the legislature of each state. Prominent in each of those packages were progressive income tax hikes.

In Hawaii, despite the Governor's veto, as well as her repeated assertions that any tax increase would be economically damaging for the state, the legislature managed to pass the revenue package over the Governor's stubborn opposition. The bill raises income taxes on single Hawaii residents earning over $150,000 per year, and married couples earning over $300,000.

Minnesota thus far has not been so lucky. Less than a week ago, Governor Pawlenty vetoed a tax package (based on the House and Senate bills we described last week) containing progressive income tax increases. So far that veto has held up, as proponents of the bill appear to be just a few votes shy of an override. Deeper cuts in public services or increased borrowing (the preferred solution of the Governor) may be turned to next in order to win wider support for the package.

Staring down a $6.4 billion deficit, Minnesota legislators last week decided that tax increases would have to be included in any plan to balance the budget.

In the Senate, SF 2074 increases income tax rates across the board, but also adds a new top rate on income over $250,000 per year for married couples. On top of that, the Senate bill also prevents those owning multiple homes from taking the mortgage interest deduction for interest paid on their second home.

The House plan, HF 2323 is a bit more ambitious in its pursuit of true tax reform. Like the Senate plan, the House adds a new top rate as well -- in this case on income over $300,000 for married couples. In addition, the House converts costly and poorly targeted deductions for mortgage interest and charitable giving into tax credits that should be accessible to a wider range of Minnesota families. The bill also repeals the credit for child/dependent care costs, but does add a refundable per-child tax credit. Furthermore, the House bill ends the exclusion for interest received from state/local bonds, eliminates the deduction for real and personal property taxes, and ends a variety of education tax preferences. From a tax simplification standpoint, the bill earns high marks. As the Minnesota Budget Project put it, "the House bill wipes the tax expenditure slate mostly clean."

Unlike the Senate plan, the House does include a variety of significant tax increases on cigarettes and alcohol in its bill. While such increases are usually among the easiest to enact politically, it's important to remember that they are also among the most regressive. Progressive offsets, such as an enhanced EITC, could help temper this regressivity.

For the Minnesota Budget Project's roundup of the House bill, click here. For the Senate bill, click here.

P>Minnesota's Department of Revenue released a study last week showing that the regressivity of the state's tax system has grown significantly in recent years. On the heels of this study comes a proposal from the Chairwoman of the House Tax Committee seeking to clean up the tax code by eliminating a slew of tax expenditures in order to fund more progressive changes to the state's tax system.

You can find more details on the Minnesota Budget Project's blog, but the general idea is to replace a variety of tax breaks that are either regressive or too narrowly targeted with three simplifying tax credits, including credits for mortgage interest, charitable contributions, and lower-income families with children. Tax rates on the lower two income tax brackets would also be reduced.

On the business side, the proposal seeks to end a variety of ill-conceived business tax breaks, though unfortunately it does seek to replace them with other ill-advised measures, such as single sales factor and equipment expensing.

It's hard to believe, but there may actually be a trend in state tax policy more prominent than increasing cigarette taxes. Business tax credits aimed at spurring economic development have been among the most popular ideas in statehouses scrambling for ways to reduce unemployment. Just last week, we described a plan in Minnesota to boost investment tax credits and a budget in California containing a few credits of its own. This week, proposals to do the same in Iowa, Kentucky, and Missouri are under discussion.

In Iowa, Republican lawmakers have suggested paying (via tax credit) half the salary of each new job created by private businesses. Oddly, because this payment would be administered through the tax code rather than as a direct grant, the debate has become confused to the extent that this policy has been labeled as a way to return to a "market-based, capitalistic system".

An excellent op-ed out of Kentucky helps clear things up a bit, noting that Gov. Beshear's proposed expansion of business tax incentives would be a costly, nontransparent, and likely ineffective way of encouraging job growth. The op-ed goes on to argue that a "broader" approach, including better targeted and more closely scrutinized spending programs, could do far more good than creating more tax credits.

Finally, as an expansion in economic development tax credits works its way through Missouri's legislature, the admission of at least one legislator that he is a "recovering tax credit addict" helped to shine some light on the unfortunate politics behind these types of tax credits. These programs can cost a state enormously, and are rarely defensible on principled tax policy grounds. Instead, they constitute a type of spending done through the tax code -- commonly referred to as "tax expenditures" -- which add complexity, shrink the tax base, require higher marginal rates, and offer little if anything in terms of making the system more responsive to individuals' and businesses' ability to pay.

We've been lamenting for the past several years about the folly of Ohio's former Governor Bob Taft pushing through a phased-in 21 percent cut in income tax rates. Of course, the tax reductions made Ohio's overall tax structure less fair. Policy Matters Ohio recently released a report detailing the impact of the Taft tax cuts. Analysts there found that "key economic trends continued to go in the wrong direction after the tax overhaul." Despite this evidence, current Governor Ted Strickland has vowed to continue Taft's tax cutting legacy. But there is some hope brewing in the Buckeye state.

Representative Michael Skindell has called for freezing the phase-in of the Taft tax cuts for the wealthiest Ohioans. It's estimated that adopting Skindell's recommendation would bring in over $200 million and it's certainly a step toward making Ohio's income tax more progressive.

For tax justice advocates in Minnesota, it's a bleak time. Governor Tim Pawlenty is vehemently anti-tax, and his 21st Century Tax Reform Commission has largely followed his lead with recommendations to eliminate the state's corporate income tax and enact several investment tax credits, though in fairness the Commission does recommend two revenue raising options: expanding the sales tax base and increasing cigarette taxes. It's too bad that progressive revenue raising options weren't mentioned. It's hardly a surprise that some would like to see income tax cuts for the wealthiest Minnesotans preserved. But Wayne Cox at Minnesotans for Tax Justice argues against tax cuts in a recent commentary, correctly arguing that increasing the progressivity of Minnesota's tax structure would not harm the state's business climate. He warns that "the alternative is carrying out an even riskier plan that trims muscle, not fat."

There are more good proposals on improving the progressivity of state income taxes. Next we turn to Montana where Representative Dave McAlpin is trumpeting a "fix" to the state's 2003 major tax revision that reduced the top tax rate and bracket. State estimates were that the tax changes were supposed to cost $26 million a year, but in reality they actually cost the state $100 million. His legislation would introduce a new top income tax rate of 7.9 percent on Montanans with taxable incomes over $250,000, and help to right the wrongs of the 2003 revisions. If Rep. McAlpin's bill is adopted, the state could see $26 million in additional revenue and improve the progressivity of Montana's tax structure.

For more on the importance of progressive income taxes read ITEP's policy brief on this topic.