Minnesota’s New Tax-and-Spend Policy Is a Precarious Experiment

States can be laboratories of democracy, and with Minnesota’s recently completed 2023 legislative session, the Bunsen burners were turned to their highest setting.

State Democrats used a historic surplus to enact a package of sweeping progressive policy changes that for Minnesota are unprecedented in scale and scope. State-funded family and medical leave, free college, universal school meals, housing initiatives, and expanded health insurance subsidies are just a few of the new investments that are now law.

The next phase is finding out if this transformation—and the tax policy supporting it—is fiscally responsible and economically sustainable. There are reasons for doubts beyond needing a constitutionally required balanced budget. Some revolve around the tax policy changes implemented this year.

The state enacted significant tax relief and income redistribution efforts paid for by other tax increases, reflecting the same progressive agenda driving the other side of the ledger. The tax reductions were targeted almost exclusively to low-income and senior households through both new and expanded refundable credit programs and a large increase in the state’s Social Security income exclusion.

Tax increases were directed at the usual suspects in progressive policy-making: corporations and high-income households. Corporations were targeted via global intangible low-taxed income taxation and reduced deductions for dividends received from domestic subsidiaries. High-income households will see a modified phase-out of standard and itemized deductions and a new net investment income tax.

The degree of fiscal exposure the state has now assumed with its tax changes will be influenced by the answers to these questions:

How reliable and dependable are the state’s new revenue raisers? Minnesota is replacing the least volatile sources of state income tax revenue—salaries, wages, and Social Security income—with the most volatile sources.

According to an analysis by the state’s finance agency, corporate profits are a little over three times more cyclically volatile than salaries and wages, while net capital gains are over 12 times more cyclically volatile. That is just from fluctuations in economic cycles and doesn’t include potential timing and realization effects: the ability of taxpayers to defer realizing gains until they die or move to another state.

Relying on these income streams to finance ongoing spending commitments as well as large new tax credits—which narrow the tax base and are more politically difficult, if not impossible, to reverse in difficult economic times—is a precarious strategy.

How will the state’s high-income earners react? Already facing some of the highest tax burdens in the nation, it remains to be seen if, and to what extent, the actions taken this session influences the out-migration rates of high-income households.

Because of the changes enacted this year, the fiscal impact of any high-income earners that do leave the state certainly will be magnified. If a $1 million married filing jointly household leaves the state, 22 new families of four at the $100,000 income level would be needed to make up for just the lost income tax revenue.

That replacement ratio will increase substantially going forward. This takes on additional significance with the state’s dependency on individual income taxation now at an all-time high.

How will business decision-makers look upon Minnesota? Some of the new spending and investments are likely to be looked on favorably. The state is making sizable investments in workforce housing, broadband expansion, transportation, and child care support, to name a few.

In a victory for big business, the state backed off from pursuing worldwide combined reporting, which would have taxed the income of foreign subsidiaries of multinationals. Lawmakers as well as the administration had concerns about enforcing and implementing the plan. Minnesota now conforms to federal taxation of GILTI with a 50% dividend received deduction.

The state also reduced its dividend received deduction to 50% and 40% from 80% and 70%, based on ownership thresholds. In addition, Minnesota’s net operating loss deduction dropped to 70% from 80% of taxable income in a given year effective tax year 2024.

But businesses likely will be influenced as much or more by the large number of new regulatory policies and labor laws also enacted this year as state tax changes. These include a new state paid family and medical leave program, mandated sick and safe time, banning of non-compete agreements, and a wide variety of new workplace health and safety initiatives, standards, and reporting requirements.

A recent study found Minnesota ranks 10th out of 12 Midwest regional states in new and expansion projects per capita. The study also found Minnesota-based companies are expanding in other states at a higher rate than out-of-state companies are expanding in Minnesota, resulting in a net investment deficit of $6.6 billion in capital expenditures.

Such findings suggest the value proposition offered by the state’s existing highly progressive tax structure, progressive spending, and general business climate in the eyes of business may not be as great as lawmakers may think.

Conclusion

The concept of states as laboratories makes considerable sense, but public finance theory suggests that many of the policy actions undertaken by Minnesota this year having strong redistributive and social welfare characteristics are best left to national governments that are less exposed to border effects.

Minnesota isn’t alone in seeking to take policy concerns into its own hands, but the sheer scope and scale of what the state has put in place makes it unique. But it may serve as an important litmus test as to what degree subnational governments can address the perceived failures and shortcomings of federal action without reaping unintended fiscal and economic consequences.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mark Haveman is the executive director for the Minnesota Center for Fiscal Excellence, a nonpartisan fiscal watchdog group.

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