I would not hold my breath. But if you’re interested in reading about its latest reform effort, the NYT is out with a story today (1/30/2020). It’s worth spending a few minutes to read if you’re interested in taxes, property taxes, or the politics of property taxes or just the gaudy valuations of NYC residential real estate.
Anyone who has ever looked under the hood of the New York City property tax system knows that it is a true mess; a walking horizontal inequity if there ever was one. Homes of equal value pay starkly different property taxes with (no surprise) many very valuable brownstones, coops, condos, etc. paying multiples less than homes with often much lower values. For those who get depressed about the complexity of the Minnesota property tax with its 50+ classes, a good anxiety reliever is to spend a short time looking at New York. (My wife Amy is from NY and was living in NYC when we got married, so out of pure curiosity I have paid some more attention than usual to what goes on there tax-wise. And I have been preparing state and city income tax returns for my daughter who lives in Brooklyn – Minnesota is simpler and easier on that front as well, BTW.)
The article, for example, details a Manhattan condo with a value of $538 million (what??) and an annual property tax of $532,000 that would rise to a cool $3 million under the reform (hey, that’s only an effective rate of 0.6%, less than Prop 13’s 1% benchmark, if you ignore its value cap). You can certainly see why New Yorkers don’t like that $10,000 SALT cap, though!
TPC is out with a new research report, State Income Tax Expenditures, by Aravind Boddupalli, Frank Sammartino, and Eric Toder, that compares the tax expenditure budget (TEB) reports of three states, California, Massachsetts, and Minnesota, and the District of Columbia.
It’s a topic near and dear to my heart, on which I spent a fair amount of time during my career at House Research. See here and here. I promoted the idea (internally to legislators) and drafted the bill that required preparation of the Minnesota TEB back in the 1980s.
The TPC Report is well worth reading (only 12 pages long). It illustrates how variable the reporting of tax expenditures is from state to state, despite the fact that the authors picked four reports that are reputed to be among the higher quality of the state TEB reports. States (as well as analysts and Treasury and the Joint Committee staffs) don’t always agree on what a tax expenditure is. Disagreements at the state level are much common than at the federal level. Much of that is attributable disagreements about the baseline or reference tax structure. (I personally disagreed with a number of judgments that DOR has made in preparing its report. I many times have regretted my decision to parrot the very general terms of federal law in drafting the Minnesota statute and not providing DOR more statutory guidance as to what the reference or normal tax structure is. The House Research reports, as a result, deviated from some of the DOR decisions – in particular with regard to the treatment of the sales tax, which I think in principle is to be a broad tax on consumption, while DOR considers it to be a tax on final sales. That decision, for example, causes DOR to treat exemption of intermediate business inputs as tax expenditures, which the consumption tax norm would not.)
The TPC report also illustrates to me how ill-considered it was for Congress to repeal the ACIR. A federal government entity should be regularly doing work of this sort as part of its central mission and could, perhaps, promote some uniformity and consistency with greater authority and credibility. Instead, we’re left to rely on the good graces of the nonprofit sector (as good as TPC is and it is) for making these national comparisons of state practices and to make recommendations for improvements.
A few observations and nits to pick about the TPC Report and its coverage of Minnesota, since I’m pretty familiar with Minnesota’s practices.
Comparative percentages across states. I was modestly surprised that Minnesota had the highest percentage of its income and corporate income tax in tax expenditures – 61% versus a low of 51% for California. Unfortunately, the report dose not say exactly how those percentages were calculated, so I can’t get an impression (much less a clear answer) of the extent to which the differences are real or just a matter of how the reports define and estimate tax expenditures. Specifically, the Report does not indicate whether the adjustment made in its tables to eliminate a few of the very obvious reporting differences were used in calculating the percentages. Minnesota is the only state, for example, that treats the nontaxability of Medicare as a tax expenditure. Was that amount included in calculating the percentages? It is more than $500 million per year. The same goes for single sales apportionment ($379 million), which is excluded from TPC’s tables but is in the Minnesota report as a tax expenditure. Those are only a couple of the larger differences in reporting identified by the report.
As an aside, tax expenditure numbers cannot be summed to get an accurate total (even accepting the individual estimates as accurate), because they do not reflect the interactions if they were simultaneously eliminated. For example, some taxpayers would quickly revert to the standard deduction, while others would be pushed into higher tax brackets, and so forth. Moreover, behavioral responses to repeal are not taken into account at all (at least in Minnesota’s estimates). As a result, the percentage estimates are questionable as absolute numbers, but still could be useful as a comparative matter.
Treatment of Minnesota’s marriage credit. The Report lists Minnesota’s marriage credit as a tax expenditure. No surprise, given that the Minnesota TEB lists it as a tax expenditure. But the Report filters out filing status as a tax expenditure, because of differences among the states in how they treating filing status provisions. Is treating married couples or heads of households as a separate category of taxpayers with lower rates a tax expenditure? States come to different conclusions about that – Minnesota does not consider it a tax expenditure but other states do, so TPC did not included it in its tables. Minnesota’s quirky marriage credit is really an adjunct or alternative approach to rate reductions based on filing status. When Minnesota (in the 1990s) decided to reduce marriage penalties, it could have done so by simply increasing the married joint bracket widths to be twice the single brackets. That is the traditional way to eliminate a “marriage penalty” in the rate structure, but it also confers “marriage bonuses” on couples when one spouse earns all or most of the income. Minnesota chose instead to offer a credit to married couples when the lower earning spouse’s wages, self-employment income, or pension pushed the couple into a higher tax bracket than filing as two singles would. For some unknown reason, DOR treats that as a tax expenditure, but does not treat filing status differences as one. TPC followed that practice in the Minnesota table, but I would not count the marriage credit as a tax expenditure.
Minnesota’s waters edge unitary. The TPC Report (page 6) has a minor mistake in saying that Minnesota allows water’s edge as an election. Minnesota mandates water’s edge combined reporting, a practice that was upheld by the Minnesota Supreme Court (the US Supreme Court declined to review the case). Minnesota could still treat water’s edge apportionment (with worldwide unitary as the reference baseline) as a tax expenditure, but does not. As the TPC Report notes apportionment rules is a topic on which where there is no policy consensus on what the baseline or reference tax base should be.
The Minnesota numbers do not reflect the 2019 tax bill, as noted by the TPC report. That tax bill, because the major changes it made (going to TCJA’s higher standard deduction, its limits on itemized deductions for taxes and mortgage interest, a modest rate reduction, etc.) likely will make some material changes in the estimates in the 2020. There is no way TPC could deal with that but it will be interesting to see how much it changes the numbers – probably by quite a bit for a few provisions.
Differences in using direct versus tax expenditures. A constant issue for policy makers is whether to use a tax expenditure versus a direct expenditure for a new or existing program. The TPC Report is not intended to deal with that issue, but rather is about improved reporting and oversight of tax expenditures. However, it does obliquely engage the point with regard to film production incentives. Most states do that with tax credits. (The Report says that Georgia’s tax credit has an estimated cost of $500 million, which is shockingly high to me and I assume why the referred to it.) The Report correctly notes Minnesota’s on-again, off-again film production incentive is done as a direct expenditure (page 10’s reference to the Snowbate program). However, it passed up the chance to identify a much bigger difference among the reports – Minnesota has a very generous property tax refund program for both homeowners and renters. Minnesota’s FY 2020 expenditures on this program are estimated to be over $780 million. Because this program is administered separately, not as an income tax credit, the Minnesota budget treats it as a direct expenditure. (In the past, it was an income tax credit for renters and senior homeowners, but the state dropped that to realize one-time budget savings by paying/administering it separately which allowed deferring recognition of its cost until the next fiscal year.) Functionally, the program is little different than a tax credit, but it shows up in the regular budget. California’s, Massachusetts’, and DC’s programs are all tax expenditures because they are administered under their income taxes. The TPC Report is about tax expenditure reporting but failing to highlight this big difference seems like a missed opportunity. It clearly distorts financial reporting of spending (and Census reporting of state tax levels) slightly.
I do wonder whether differences in operating and budgeting for these programs – as direct expenditures by Minnesota and tax expenditures by California, Massachusetts, and D.C. – makes any difference in how much review and oversight they get by their respective legislatures. The conventional wisdom is that tax expenditures are hidden spending that is subject to much less scrutiny than direct spending. That seems like a subtext of the TPC Report and is an inference I generally agree with based on my many years working in the Minnesota legislature. But in the context of relatively high profile programs like renters credits and circuit breakers, I have my doubts. This general topic seems like a fruitful area for public finance economists to study. I have often thought the mixed practice of states in providing college savings incentives – both as tax deductions and credits for 529 plan contributions (tax expenditures) and matching 529 plan contributions (direct expenditures) would provide a good natural experiment to study, since there a multiple states offering both types of programs (in some cases both types in one state). Minnesota has alternated between both approaches over the last 20 years.
Bottom line: The TPC Report is a good start at comparing state tax expenditures and is worth reading. It certainly would be nice if states moved to more consistent and robust reporting, as recommended by the Report. The Report shows just how variable and weak that reporting is now even among states with supposedly very good reports. One baby step (not suggested by the report) might be for the financial accounting standards board to require reporting in CAFRs of the refundable amounts of tax expenditures. In my view, it is only through federal mandates (e.g., Census Bureau reporting) or FASB requirements that there will be any consistency allowing reliable cross state comparisons. If any such mandate were proposed for tax expenditures generally (i.e., beyond the refundable portion), the hue and cry of opposition from the states would be deafening and the complexity of writing the rules, mind boggling. Just doing something on the refundability portion would be a daunting task. Pity.
I have previously suggested that TCJA’s $10K limit on the deductibility of state and local taxes would likely stoke demand for tax exempt bonds -i.e., double tax exempt bonds that are also exempt from the investor’s state income taxes. Morningstar reports that in 2019 inflows to tax exempt bond funds and ETFs were $105 billion, an all time record. The next highest year, 2009, was $75 billion.
This, of course, is only indirect evidence that investors were seeking to buy in-state bonds that are exempt from the issuing state’s income tax, but I think that is probably a reasonable inference. If Morningstar broke those numbers down between single state and multistate funds, that would provide more direct evidence. (Most states, like Minnesota, only exempt bonds issued by themselves or their local governments from their state income taxes, so investors need to buy single state mutual funds for their state of residence to get an exemption.) It probably does that for business subscribers, but I don’t have access to that detail unfortunately. The article does report that 90% of the money went into actively managed funds and all of the single state funds (I believe) are actively managed, but of course most of the multistate funds are too.
STRIB has a new story on the MOA Waterpark saga indicating the negotiations between Triple 5 and the city are taking longer than expected.
That is no surprise given the complexities involved and the tight rope that the city must walk, meeting Triple 5’s business demands while satisfying the federal tax law requirements for the use of 501(c)(3) tax exempt bonds. Just to review:
MOA’s interests and role. Triple 5 (MOA’s owner) obviously wants (1) to put as little of its own capital as possible into the Waterpark and (2) the park to be operated as a successful feeder of customers to MOA and its tenants. This has led Triple 5 to retain ownership of the land, leasing it to the nonprofit that will operate the park, and to manage the waterpark through an affiliate (I assume to ensure that it functions according to MOA’s interests). In essence, the park is really just part of MOA’s overall business plan – they hatched the idea to make Phase II work. But MOA’s owners want to reduce their capital costs by borrowing (real estate entities are almost always highly leveraged) the project costs at tax exempt rates, necessitating use of an “independent” nonprofit and governmental bond issuer.
Bloomington’s interests and role. The city’s interests are linked to MOA. The linkage was effectively locked in 35 years ago when the city opted to go with the megamall plan for the site. As the article reveals, MOA is now 10% of the city’s property tax base. But it is a risky 10% given the shaky state of business of operating shopping malls these days. MOA’s success so far is, in part, due to the city’s partnership (paying for the parking ramps and other infrastructure with TIF). But, as I suggested in another post, the city is riding on the back of a tiger – there really is no easy way to get off. It MOA fails, the city will have a big mess on its hands. So it wants the waterpark to succeed; the city is on the hook to build, own, and operate a big parking ramp for the facility. But city also wants to minimize its exposure if the waterpark isn’t successful (i.e., fails to breaks even or worse). Hence, the city’s decision to put as much distance as possible between itself and the tax exempt bonds – i.e., the decision to use an Arizona entity to issue the bonds – which may (or may not) help minimize the halo effect on the city’s own credit if the waterpark’s finances go south. Nevertheless, it probably would prefer MOA put more money into the waterpark, rather than less, because failure of the waterpark part of the project probably has more negative ramifications for the city than MOA having financial trouble with its lenders or a lower return on equity.
Demands of the tax law. By using tax exempt bonds for a 501(c)(3) entity (the Louisiana nonprofit that will own the waterpark), the deal/project must thread a needle that is complicated by its close linkage to MOA, a for-profit business. Federal tax law says the project must be under either a 10-percent “use” or 10-percent”security interest” threshold test to avoid making the bonds taxable. Those tests essentially say a for-profit business (MOA obviously or related entities) cannot constitute more than 10 percent of the security for the bonds (i.e., either pay them or comprise property that bondholders could look to for payment) and use of the project. I assume that the project llunks the use tax because the business arrangements make MOA a de facto user of the park. The security interest test means land rent and management fees must be set at close to fair market amounts (arms length deals) to be sure that MOA is not subsidizing the waterpark with the subsidies that count toward either of the 10-percent thresholds.
Louisiana nonprofit and Arizona governmental bond issuer interests and role. One might assume that these two entities are just sort of straw men or hired service providers that are totally under the thumbs of Bloomington and MOA, the entities that are driving the deal and are putting up the equity capital for the project (to the extent there is any). But I assume that the two entities actually are independent actors (or this won’t work legally) with their own interests. I assume they have their own lawyers and maybe financial advisers. The Arizona bond issuer is responsible for ensuring that the bond issue complies with the requirements of the federal tax law – not just when the bonds are issued but for as long as they are outstanding. That is a big responsibility with important consequences if the bonds flunk (they retroactively become taxable and bond covenants will likely be violated). Among many other things, it means policing the security interest test described above. This will have long term implications for the ongoing operations of the waterpark as I note below. The Louisiana nonprofit has some similar interests, as well as its business reputation.
What doesn’t compute to me. The STRIB story says that the federal tax law limits MOA’s ability to make donations to the waterpark. I understand that if it means that MOA cannot make ad hoc contributions that would establish a pattern of MOA propping up or supporting the parks operation or, worse, be done under a binding legal commitment to subsidize the park under specified conditions. Either would likely be counted against the security interest thresholds. It would seem to me, though, that MOA could make an initial “no strings” contribution or donation to the water park (i.e., the Louisiana nonprofit entity), such as giving it the land outright so (with more equity and no need to pay $2 million in rent) it is more likely to operate in the black. That would not mean that MOA is either securing the project; it’s a one-time fully completed transaction that occurred before operations or financing of the waterpark began. Maybe I’m wrong, but it seems fishy to me.. Rather, I would speculate that MOA chose not to do that because (1) it wants to keep the land on its balance sheet and the rent on its P/L statement and/or (2) if the waterpark fails financially, MOA wants to control or have a say in what happens, which owning the land will allow it to do. I’m guessing it is mainly (1), but some of (2)..
Longer run issues. If the waterpark flops financially or even more likely just struggles a bit, this financing arrangement has important consequences for the city, I think. The strictures of the federal tax law essentially can be argued to insulate MOA and its owners from chipping in to make the park work. That is so because they can argue (accurately!) that doing so may cause the bonds to be taxable. Those limits will not apply to Bloomington, because it is a governmental entity. You can see how that dynamic is likely to play out. Of course, the city’s ace in the hole would be to insist on triggering the goofy MOA sales tax (see here for my discussion of that), which apparently the lawyers think will count as government revenue and not violate the tests.
My policy take-aways:
The lack of a national interest in permitting these sorts of uses of tax exempt bonds for essentially a private, for-profit business operation, even though it is operated through a nonprofit shell seems clear. Congress needs to tighten these rules up so that nonprofit bonds are limited to colleges, hospitals, and other functions with clear public benefits. This is as bad as building pro sports facilities (like US Bank Stadium to name one) with tax exempt bonds.
We can be thankful that these bonds will apparently not be exempt from Minnesota income tax because they will be issued by an Arizona governmental unit.
Bloomington’s ongoing saga in dealing with MOA should be a cautionary lesson for other cities and counties thinking about signing on with private developers for big signature and risky developments. Decades later you may be de facto on the hook to ante up more and more, as compared with leaving real estate development to the private market and providing actual city public services.
This is another installment in my effort to think through the debate over highway funding. WARNING: THIS IS LONG AND BORING; IF YOU DECIDE TO PROCEED, YOU MAY WISH TO HAVE A MUG OF ESPRESSO HANDY.
There appears to be a bipartisan consensus that the state needs more money for highways (and for transit, although Republicans see little need for that, I’d guess), raising an obvious question:
Should the gas tax or tab fees (registration tax) be increased or should revenues from general fund taxes be reallocated to highways? The state has been consistently running general fund surpluses; why not use some of that money?
This question is complicated by Minnesota’s long tradition of using dedicated funding for highways and to a lesser extent and for a shorter period transit. It has done that mainly through constitutional dedications for highways and roads, starting in the 1920s and modified by several constitutional amendments over the years. Constitutional dedications require the legislature to use gas tax and the motor vehicle registration tax (tab fees) revenues only for state highways and for aids to counties and cities for local highways, streets, and roads. Since 2008, the sales tax on motor vehicle purchases has been dedicated to transportation (not just highways, at least 40% must go for transit). The legislature has occasionally supplemented the constitutional dedication with statutory dedications; currently some of the sales tax on auto parts is dedicated by statute to highways and roads. Since it is a statutory dedication that the legislature could always change; the Republicans, as a result, want to write it into the constitution making sure a future legislature can’t.
This practice of using dedicated funds for transportation channels much of the debate into questions of whether the dedicated taxes should be raised or if general fund taxes/money should be redirected to transportation. Obviously, Republicans with their strong tax aversion routinely advocate for redirecting existing taxes. Democrats, by contrast, typically advocate raising the already dedicated taxes – e.g., Governor Walz and House Democrats both supported large gas tax increases in the 2019 legislative session – although they are conflicted by the fact that the dedicated taxes are regressive, violating their norm of favoring progressive taxation.
Given Minnesota’s long tradition of funding transportation heavily through dedicated funds, I see little value in spending time on the merits of that. As an aside, in the lead up to consideration of the Legacy funding constitutional amendment in 2008, I wrote a publication on earmarking taxes, which I subsequently updated in 2015. It discusses these issues in some detail, so I would also be needlessly re-ploughing old ground. In any case, it is a given that almost all of state highway funding in Minnesota will be done through dedicated funds.1
The more important question is whether any increase in funding should come from user fees and benefit taxes or from general tax revenues (e.g., by earmarking existing taxes for highways). I think a strong case can made for providing any increased state funding for highways and roads through user charges or benefit taxes, rather than taking more general revenue taxes and using them for highways. This post explains my thinking.2
As an initial matter, it is useful to state how I think about the difference between a user charge or benefit tax and general tax revenues. Here, I’m talking about functional, economic, or practical distinctions, not legal distinctions. Any tax can legally be earmarked or dedicated and, then, it becomes part of the dedicated fund. But that legal status does not make it either a user charge or benefit tax, even if the tax is somehow closely or loosely related to transportation or whatever function the dedication relates to.
A user charge or a benefit tax should satisfy two criteria:
It needs to be over and above the taxes that generally apply to most similar activities for general government funding and
The amount should be closely correlated to consumption of or benefit from the funded government service.
A true user charge would vary by the amount of the service consumed or used; if you use more, you pay more and ideally would be voluntary. By contrast, a benefit tax just needs to be collected from the group of individuals or entities that particularly benefit from the service.
Note the effects of this definition: Dedicating part of the proceeds of a general revenue tax does not qualify. For example, taking the sales taxes paid by trucking companies and dedicating it to highways and roads is not a benefit tax or user charge. Those taxes are levied on all businesses and individuals to pay for the general cost of government. It flunks criteria #1 and is not charging users or beneficiaries of a government service additional amounts because of that status. This distinction explains why the sales tax on purchases of vehicles or auto part are neither user charges nor benefit taxes. They are just taking or appropriating general tax revenues and legally earmarking them for transportation.
In a separate post, I go through Minnesota’s funding of highways and roads and attempt very roughly to identify how much comes from user charges and benefit taxes versus general government revenues. In broad strokes, the motor vehicle registration tax is a benefit tax and a portion of the gas tax is a user charge. The rest of highway and road funding comes from state or local general revenues – property taxes or state aid that locals opt to use for roads or general sales taxes that have been legally earmarked for highways. Based on my calculations, about 59% of highway and road costs are paid with general revenues. Somebody with better analytical skills, access to and understanding of the data, and more time could estimate a more accurate number; mine is just a back-of-the-envelope effort. I do think it is a conservative estimate of the general revenue share; the actual share likely is higher.
So, why do I think increasing user charges (lets be transparent, the gas tax) is the best way to provide more state funding for highways and roads? I have two prime rationales which are related to each other, in addition to a third, more minor but not inconsequential, reason for liking a gas tax increase. After I describe why I favor a gas tax, I’ll explain why I think the common objections to or concerns about the gas tax should not disqualify it as the principal funding source for additional highway funding:
First, basic economics – it is consistent with fundamental tax principles and helps a market economy function better. The common metrics public finance economists use to evaluate a tax are equity, efficiency, and simplicity. (Unlike the public and most elected officials, those are also the criteria I use in judging whether a tax proposal is sensible. I’ll get to political feasibility issues a little bit later.) My premise in applying these principles is that the gas tax is a rough user charge, a characteristic widely recognized by tax policy experts. It is an effective user charge because the amount of tax paid is strongly correlated with how much one uses highways and roads – the more gas purchased for highway vehicles, the more miles that are driven. (It’s important to also note that the tax is also borne by those who do not own vehicles or purchase gas, because its burden is passed along in the transportation costs embedded in the goods and services that they do purchase. This is actually a large portion of the burden of the tax – about one-third according to the Minnesota Tax Incidence Study.) It’s true that that correlation is not perfect, because of variation in fuel efficiency of vehicles, more all electric vehicles, and the road damage done by heavy vehicles (the latter two concerns I discuss below). But fundamentally it is a workable way to charge for relative road use by most. Moreover, there is a sort of default rule that when user charges are practical and easy to impose, that is the preferred way to finance a government service, unless doing so would undercut the fundamental purpose of the government program. In any case, this is how I apply those three basic tax policy principles to the gas tax:
It’s obvious the gas tax scores well under the simplicity principle: the tax has been around forever, is easily understood (cents/gallon used for roads – what could be clearer?), is easy to collect from a relative handful of taxpayers (petroleum distributors), and one main compliance issue (the exemption of diesel fuel used off road) was fixed 30+ years ago with the innovation of dyed fuel.
The tax increases efficiency because it encourages people to make economic decisions (where to live, what car to buy, etc.) that reflect the costs of constructing and maintaining public roads. The tax makes the market work better – the price of gas (and transportation costs more generally) will reflect more closely the public’s costs to build and maintain roads. This will flow through to decisions about where to live (how long/expensive a commute will I have?), what vehicle to buy, and so forth. If you, as I do, think the market is the best way for a society to decide how to allocate goods and services, a user charge for public highways is the way to go. And the gas tax is now the easiest way to do that.
On the surface, it might appear that the equity principle is a harder nut to crack because the tax is regressive, the metric most often used in evaluating tax fairness. I have two basic responses to that concern. First, user charges, like the purchase of private goods and services, are fair because you’re paying for what you use. Here, it makes sense for the government to be the service provider because we want to provide open and easy access to the road network and private roads are not practicable. Putting aside that the government is delivering the service, charging for highways isn’t really all that different than individuals buying food, housing or other essential items in the private market, all of which have a regressive distribution (lower income folks spend higher percentages of their incomes on consumption). Second, the distributional effects are not that different than a general consumption tax, like the sales tax which is typically presented as the prime alternative funding mechanism. (The Minnesota Tax Incidence Study reports a Suits Index for the gas tax that is about one-third lower or more regressive than for the general sales tax.) And if regressivity is a killing concern, it can be addressed through supplemental mechanisms (see below), rather than forgoing a good funding source altogether.
Second, political economy considerations – relying on user charges could help make decisions that get beyond the pro- and anti-government budget debate we now seem to be mired in. Much of the discussion under the previous bullet represents conventional wisdom in the policy community. The views I’m expressing here are not but reflect my experience working in the legislature over the last 15+ years and how I think the budget and tax policy debate in the Minnesota legislature has been hijacked by the polarization and rote repetition of little more than partisan talking points. During that period, I found that the budget debate has devolved into largely meaningless sloganeering on the size of government and whether (GOP mantra) taxes are driving businesses, investment, and people out of Minnesota or whether (DFL mantra) the tax structure is allowing the affluent to avoid paying their fair share.
The Republicans have largely become a party whose primary (almost exclusive) budget policy is to propose tax cuts. There are a few areas in which they want to spend more money (i.e., beyond current services levels), but they can always propose reallocating money away from other programs with heavy DFL or urban constituencies to do so. That’s fine, but it also creates a “free lunch” element to their arguments: they’re for more limited government and tax cuts, except when the spending is popular with their constituencies, in which case they say the spending increases can easily be accommodated by reducing spending on DFL/urban type programs (center city LGA being the obvious target). What’s been unclear to me, because the GOP has never controlled the governorship, House, and Senate when I was around, is whether that is just a negotiating ploy or whether they really would do it.
In any case, transportation is one of the areas – I assume because it is a core government function and because it has a heavy rural focus (the GOP is fundamentally a rural and exurban party in Minnesota) – in which the Republicans do advocate for spending more (at least relative to what the inelastic dedicated funding sources produce). Their natural response is to make a sort of free lunch argument – sure the dedicated funding sources are not generating enough, but we can easily reallocate general fund sources to make up the difference. And to be consistent with Minnesota’s earmarking practices, we’ll do that permanently and submit it to the voters to enshrine in the constitution.3
To me these arguments undercut the debate over how much more to spend on highways, given our history of using dedicated funding, a substantial portion of which comes from de facto user charges and benefit taxes. A primary benefit of relying on user charges and benefit taxes is that increased spending comes at the price of paying more in user charges and benefit taxes (i.e., increasing the gas tax or tab fees). That is a more honest frame of reference for the public to consider how much they want more spending on highways and roads. Permanently reallocating general fund revenues (especially by constitutional amendment) reflects a judgment that the general fund does not need all its current revenues over the long run (not just when we have a surplus, like we do now). I don’t think there is a good case to be made for that – the median Minnesota voter has too much of a taste for government for that to be true.
My bottom line: Linking spending and taxing directly, as Minnesota traditionally has done for highway spending, is good political economy. I would limit this practice to areas where the linkage is relatively easy to implement and clear, such as highways. (I’m hard put to think of many other big areas.) The long history of that linkage working (until the 1990s) is a compelling reason for sticking with it. Maintaining the linkage tells voters that if they advocate for or expect more highway spending, the consequences will be paying more gas tax or higher tab fees. That is likely to lead, in my view, to better decisions about how much to spend.
Third, climate change considerations supportincreasing the gas tax; it is a mini-carbon tax or, at least, does not encourage more carbon emissions, as financing more highway expenditures with general revenue sources would. The gas tax is a carbon tax, since it is imposed on the use of fossil fuels. Of course, its low level and application only to highway fuels makes it a relatively minor tax. The fact that its revenues are used for highway construction and maintenance (spending which stimulates carbon emissions by encouraging more road use) makes its effects ambiguous. But compared to using general revenue taxes for roads, such as dedicating more general sales taxes, a gas tax is preferable if a secondary policy goal is to discourage carbon emissions.4
My responses to the common objections that are made to gas tax increases. Many arguments against increasing the gas tax are typically made during legislative debates. In my judgment, none of them, singly or together, are sufficient to overcome the case for the gas tax. The main arguments that I have heard and how I would respond are:
It’s regressive, unfair to the poor (the prime Democratic objection). The gas tax is more regressive than the sales tax. But contrary to the apparent DFL mode for evaluating taxes, that should not be the only criteria to use in deciding among taxes. Its other advantages, in my opinion, outweigh that disadvantage. User charges meet a very basic element of fairness – expecting people to pay for costs they impose or what they use. Moreover, other more progressive taxes in the general fund portfolio (i.e., the individual income tax) help to offset that disadvantage. Not every tax needs to be progressive if it has other attractive attributes.
A low-income credit, either tied specifically to the gas tax or as part of a more comprehensive credit to offset other regressive taxes, could be adopted to address this concern. The 2008 increase in the tax bill did precisely this to gain a handful of votes (primarily Tom Rukavina’s but others as well) necessary for the required supermajority to override the governor’s veto. The provision lasted only one tax year, however, as Governor Pawlenty and some DFL legislators united to repeal it and use the revenues for other purposes.5 The 2008 credit was poorly designed, and its effects were very modest at best. A better approach probably would be to convert the property tax refund into a comprehensive low-income tax credit/refund to offset a portion of the average property, sales, and excise taxes borne by low-income households. That has been discussed with some regularity and elected officials have shown little interest.
We have plenty of general fund revenues, so we can simply use more of them for a core government function like highways and roads (the prime Republican objection). I outlined my main reasons for rejecting this above. I would add that given the GOP’s persistent advocacy for tax cuts in all circumstances (even in 2011 with a $6 billion difference between projected revenues and expenditures!), they should recognize that reallocating general fund money to highway really reduces their ability to cut general fund taxes. At least that would seem to be the logic to me, and it undercuts their implicit “it won’t cost you anything” argument for using general fund revenues.
Trucks damage the roads more, but don’t use enough more fuel to offset that damage. This statement is (I assume) true and is a mild objection to the present excise tax; a more accurate user charge on heavy trucks and similar vehicles would be scaled to recover more fully the costs they impose on the road system. Because heavy vehicles are not very fuel efficient, they do pay more per mile in gas tax, but likely not enough to pay for the damage. (I have not attempted to research the magnitude of the difference, and I know a large share of the cost of Minnesota road maintenance is driven by our harsh climate, which subjects concrete and asphalt to breakup from frequent freezing and thawing.)
A simple fix would be to impose a higher rate of tax on diesel fuel, since almost all heavy vehicles run on diesel and very few cars do.6 Some states already do that. I’m not sure why Minnesota does not or if it has ever considered it. I’m sure the trucking and business lobbies would oppose it and that alone may make it politically infeasible. In any case, the objection of too favorable treatment of heavy vehicles is not a good argument for not continuing to use the gas tax as a cornerstone of our highway finance system and to raise any needed new revenues from it, rather than using general revenues. It’s a minor objection that could be easily fixed, if policy makers think it is a serious flaw and have the will to do so.
Electric vehicles (EVs) don’t pay tax and they comprise a growing share of the fleet of highway users. This statement is also true, but I don’t think it is a good reason for not using the gas tax as the prime source of added highway revenue. First, EVs comprise a trivial portion of the fleet using Minnesota highways and roads. I do not know what percentage EVs are of the fleet, but they are less than 1% of new vehicle purchases in Minnesota. That a very small share of the fleet uses electricity as power does not undercut that the gas tax still functions very well as an easy-to-administer, user charge on 99%+ of Minnesota vehicles.
Second, the government is trying to encourage purchase of EVs for environmental reasons by offering tax credits against their purchase price and by imposing fleet mileage requirements on automakers. A better way to encourage EV adoption and use is simply to push the price of petroleum-based fuels higher by raising the gas tax, rather than to push down the price of EVs with tax credits or by regulating what automakers can seller. Doing that targets the incentive to those we would most want to incent, i.e., heavy users of petroleum fuels, not those who have the income/wealth and the predilection to buy a Tesla (for status, feel-good green vibes, or whatever reason).
Ultimately, a system for imposing a user charge on EVs will need to be designed and implemented, because they will become a large part of the fleet. But that likely will take some time to occur and the surcharge on the tab fee that applies now helps somewhat make EVs pay their fair share. When the EV fleet becomes large enough, I assume it will be feasible to impose some sort of mileage charge on EVs, administered using a technological solution (GPS transponder attached to every EV?). Because EVs are all relatively new and expensive vehicles, it seems easier to implement a mileage charge for them, as compared with implementing such a user charge for all vehicles. The latter (ditching the gas tax in favor of a mileage fee for all vehicles) has always struck me as pie-in-sky and/or a clever way to thwart the sensible policy of just raising the gas tax.
The gas tax is unfair to owners of gas guzzlers, particularly those who are poor and/or don’t drive much (e.g., compared with high income owners of hybrids who drive a lot). This is essentially an argument that the gas tax is a flawed user charge or another version of the regressivity argument. My general response is that the tax is a pretty good user charge and falling for arguments like this allows the perfect to be the enemy of the good.
The gas tax is unfair to Greater Minnesota. This objection is based on the reality that a resident outside of the 7-county metro area typically drives more miles than a metro area resident – both because of geography and because the lack of density limits transit options outside the Twin Cities. I have two responses to this – one is politically unpalatable but reflects reality. Geography makes it more expensive to construct and maintain a road system in Greater Minnesota, not just for residents to drive and pay for gas. That reality must be reflected somewhat in how much residents of the region pay in tax; they can’t expect their metro aunts and uncles to neutralize this reality can they?
The second response is that a look at the numbers reveals that the situation is not that bleak. Yes, more gas tax is collected in the 80 non-metro counties (about 52.5%) than in the 7 metro counties. (For context, the 7 metro counties pay about 54% of the other state sources of highway finance revenues – tab fees and motor vehicle sales tax – counterbalancing that somewhat.) That is a relatively small difference. But the more important fact is that even more of the spending goes to the nonmetro area. About 40% of the state highway revenues are paid as state aid to local government. This aid goes heavily (about 65%) to the nonmetro counties (see the graph below). These numbers are from the House Research publication, Major State Aids and Taxes and are for 2015.
I could not find easy access to data on the geographic distribution of direct state highway spending; I’m sure that the metro/nonmetro breakdown varies from year to year. There are many more miles of state highway in the nonmetro counties, but maintenance and construction cost/mile is undoubtedly higher in the metro. Over the long run, I’d guess that number of miles outweighs the higher metro costs. (Maybe MNDOT puts out this type of breakdown, but I couldn’t quickly find it.)
The bottom line is that residents of Greater Minnesota enjoy a balance of payments that provides them comfortably more in spending than they pay in gas taxes. The balance payments is even more favorable when tab fees and motor vehicle sales taxes are taken into account. It’s unclear to me how this is an unfair situation. Of course, politicians representing rural areas can easily conjure up arguments with superficial appeal – typically focusing on what a rural voter would consider to be frivolous or wasteful general fund spending that occurs in the metro area. This “what-aboutism” muddles the issue in my view and is a prime reason why I favor a user charge that as much as possible links beneficiaries and payers, as I suggest above.
A per mile user fee (administered with transponders on every vehicle) would allow imposing a better more accurate user charge to replace or supplement the gas tax. I discussed this above under EVs. It just doesn’t seem very practical at this point to use as a replacement for the gas tax; I could see it as a supplement for EVs and hybrids along with a gas tax increase. It is just the latest shiny new object distracting from tried-and-true financing policies. In the long run (10 to 20 years), some sort of solution like this will need to be implemented and I think it will be driven by how fast we convert to EVs and driverless vehicles. Of course, there is a very good chance I’m wrong about all of this. A 2016 article, Jerome Dumortier, Fengxiu Zhang, and John Marron, State and federal fuel taxes: The road ahead for U.S. infrastructure funding, makes the case that the need for some sort of funding source beside the gas tax is coming much sooner than I think. It also provides evidence as to the effects of the lack of indexing of the gas tax that I like harp on.
I’m skeptical of how practical (including politically) a mileage charge is, based on the little I know about it. Minnesota would be the first state to adopt one (other than as a pilot project), which says a lot. This piece (Information Technology & Innovation Foundation, A Policymaker’s Guide to Road User Charges), makes the case for Congress enacting a national user charge now. Besides my skepticism about the practicalities and politics, I strongly prefer the gas tax because of my perception that it will better help address climate change. Of course, a mileage charge system would be better than dedicating part of the general sales tax on that score.
Notes
I had thought no one read my earmarking publication, based on the very few hits it got on the House Research website, so I was surprised in 2018 when the North Carolina governor’s office scheduled a conference call with me to discuss earmarking. Apparently NASBO referred them to me based on the publication, suggesting someone must have read it. ↩︎
I think it is fine for locals to use and increase property taxes for streets and roads, since there is clear benefit linkage between property ownership and construction and maintenance of roads. That seems better than the apparent growing urge, led by Duluth, to use local sales taxes. St Paul apparently wants to follow Duluth’s lead. Here, I’m confining my discussion to state funding issues, although increasing state funding through the highway user trust fund materially would reduce some of the pressures on local financing because it automatically yields more city and county aid. ↩︎
I’m sure the voters would approve, just as they did in 2006 with the motor vehicle sales tax, because there is a strong political constituency for highway spending. They would probably approve a tax increase if submitted – given how voters responded in 2008 to the Legacy Amendment, easily approving a tax increase for what I perceive to be less popular spending. ↩︎
I don’t want to underestimate the effects of maintaining a robust gas tax on carbon emissions. Based on my calculations if the gas tax had been indexed for inflation when it was increased in 1988 to 20 cents/gallon, the state would have collected about $6.5 billion more revenue (assuming little or no behavioral response to the higher tax rates). Had it done so, it is reasonable to conclude that it would have caused some behavioral response (less driving or a more efficient fleet) that would have lowered carbon emissions somewhat. ↩︎
To me that suggests that the concerns about its regressivity are not really strongly held. ↩︎
Diesel vehicles typically generate more pollution, so a differential rate might be justified on that basis as well. ↩︎
I regularly read John Rekenthaler’s Morningstar column, largely because he is very good writer and often has interesting insights into investing and the financial industry (mainly mutual funds). He and other Morningstar commentators occasionally lapse into writing about public policy – mainly retirement, financial regulation, and taxation of mutual funds. I find that their policy prescriptions miss the mark (in my view) as often as they hit, mainly I think because they come at it from a different frame of reference than I do.
Rekenthaler’s last two columns address a public policy issue he has been visiting over the years – problems with America’s retirement system reliance on 401(k) and similar plans (e.g., 403(b)s) as its core source of retirement income (beyond Social Security, of course) – but now he actually is proposing a number of fixes or solutions, rather than just pointing out problems and flaws. I have generally agreed with his criticisms and now find his proposed solutions to be sensible, as far as they go (not very). Unfortunately, the hyper-partisan gridlock that defines Congress is likely to prevent any measured consideration and discussion of his or similar improvements. So, we are likely to continue to muddle along with accidental policy (401(k)’s, as Rek points out were a policy accident that employers hopped onto) that is a mess, at best.
In my view, using voluntary defined contribution plans, like 401(k)s and 403(b)s, as a basic building block of a national retirement system has two huge flaws:
They depend upon voluntary, regular saving for the distant future – consistently setting aside a portion of earnings to be used often decades later. Many/most humans are not psychologically set up to do that; deferred gratification is not easy evenif the payoff is in the near term.
They require individuals themselves to do the investing in a way that realizes a reasonable rate of return. That is an immensely complex task that the vast majority of people do not want to undertake, even if they were intellectually capable of doing so (and many/most are not). Of course, a vast pool of people/entities is out there and more than happy to do that for a fee. Unfortunately many of them are either incompetent or charge high fees or both, making it much more difficult to earn the necessary reasonable rate of return on those savings.
Thus, in my view, a voluntary, defined contribution system faces the basic problem that it must swim against strong currents of human psychology and behavior that make it difficult to save consistently and invest intelligently. The expected result is what we have for the generation that is dependent on these plans – many people have saved little or nothing and those that have saved often realize below market returns, either because they were lured into high-fee plans or bought high and sold low.
These are only the big problems; there are plethora of smaller ones with the current system. However, the mobility of employees more or less dictates a defined contribution structure. Even if employers wanted to provide defined benefit plans and they obviously don’t, that model only works for long-term employees. The practice of working for one employer for your whole career is now the exception, not the rule. And as a society, we should encourage or make it easy for people to change employers and careers. Multi-employer plans have been an abject failure – witness the problems with the plans covering miners and truckers. (Watching The Irishman gives you one idea of the problem, but not the real one.) So, we should to fix the 401(k) system.
Rek’s proposed improvements all make sense to me. They are largely based on systems in other countries, so he concludes (correctly, I think) that they are workable. His proposed changes include (read the column for the full view):
Delinking access from your employer’s choice to offer a plan – currently many employers (mostly smaller ones) do not offer 401(k) plans forcing their employees to use IRAs. Rek would take employers out of the picture altogether and create one national plan that everyone would have access to. That makes sense to me for many of the reasons he outlines.
Basic participation would be involuntary – you would be auto enrolled but could opt out of increases in contributions. He allows as how he’s not stuck on the involuntary element. Making participation mandatory would ensure that all workers accrue some retirement savings beyond social security; makes sense to me but I don’t see any Congress I can imagine going for it.
Stop leakage – do not allow assets to be withdrawn for anything other than retirement or disability. There is evidence of a lot of leakage – when people change jobs, to finance home purchases, etc. It is worth noting that preventing leakage seems to run counter to the thinking of some Republicans in Congress who are proposing to allow people to tap their social security benefits to pay for child care! I really don’t get that.
Mandating some sort of default, diversified investment options (undefined) that would insure a basic market return at low fee levels. Other countries apparently manage to do this.
You can debate whether America has a retirement crisis or not. I think it does, but it’s a slow decay, not a rapid burn. As a result, Congress is unlikely to address it. Congress should at least have the discussion Rek’s columns suggest but it likely won’t because it will inflame opposition from many quarters, I’m sure. It always does and that apparently freezes any meaningful congressional action. I expect that members of Congress will content themselves with doing more meaningless stuff like the SECURE Act. They won’t even discuss small bore issues like:
Why do we have both Roth and traditional IRAs, 401(k)s, etc.? The amount of needless time and energy spent by savers trying to divine which flavor IRA to use is staggering. Just Google “Should I contribute to a traditional or Roth IRA?” I may write a separate post that explains why I think Roths are the version that should go.
Along similar lines, why don’t we have one plan for the self-employed? Why should they need to figure out whether a SEP IRA, Simple IRA, a Keogh, etc. is better for them?
Are the tax benefits more generous than necessary to encourage funding a basic retirement? Does Mitt Romney really need to be allowed to have a $50+ million IRA? (How did he ever accumulate that much? He never released the relevant tax returns to allow determining that; a fact that now pales in the light of the current occupant of the office refusal to release any returns at all.) Or should there be a cap on contributions or IRA assets, just as there are limits on the benefits that can be paid under defined benefit plans? Obama proposed a $3.5 million cap, I think. That might be too low, but the concept sure seems reasonable.
There is a long litany of similar and even smaller-bore issue that should be addressed or at least debated.
After I initially posted this, Rekenthaler followed up with a third column/post that responds to criticisms or other feedback that he received about his proposal. This followup contains a useful summary of what he is proposing and made me think about another implication of his proposal, because he obliquely addresses it:
By going to one national plan (i.e., employers no longer would voluntarily decide whether or not offer 401(k)s to their employees), that opens up the possibility – indeed, it seems like a certain implication – that employers would no longer be constrained by nondiscrimination rules. Nondiscrimination rules likely drive many employers who do participate (particularly smaller one) to provide employee matches, because doing so is necessary to satisfy the nondiscrimination rules that allow participation and contributions by highly compensated employees and owners.
If that occurs and I’m sure it would, the system could tilt a little bit even more to favoring high income individuals. At least, I’m guessing that employer matches drive a lot of contributions. This offsets a bit the benefits of making access easier for employees of firms that don’t offer 401(k)s.
It’s unclear to me how to fix that in a sensible way, unless you mandate matches if owners and highly compensated employees participated at some level in the previous tax year. This could be done similar to the current nondiscrimination rules, I would suppose. The linkage would be less clear and harder for elected officials to justify I would think.
Robert Weinberger at TPC has more detail on the IRS funding woes here – specifically how the appropriations for the agency in the December funding deal simply continue the decade-long problem. Given the amount of added spending authorized in other areas, this is really concerning – it puts revenues at stake, customer service, and the very integrity of our tax system, in my opinion. Sad, as the President would say.
Minnesota pays for its highways, roads, streets, and bridges with dedicated funds. The state collects state taxes, deposits them in funds dedicated to highways and roads, and then uses those moneys for state highways and related costs or pays them to counties, cities, and towns to use for their streets and roads. Small amounts of general fund money are appropriated highways or to pay for state GO bonds that finance local roads and bridges (most state highway bonds are trunk highway bonds and are paid out of the trunk highway fund, a dedicated fund).
The transportation financing debate at the capitol typically focuses on how to augment those dedicated transportation funds – either by increasing already dedicated taxes or by dedicating what are currently general fund revenues to the dedicated transportation funds. Put another way, the debate typically is between two options:
Should the gas or registration tax be increased? OR
Should the sales tax on car parts or other general fund revenues be redirected to transportation?
There are really two elements to this debate, which is rarely recognized:
Dedication simply puts a political and legal moat around the dedicated moneys, making it surer that they will be used for highways and roads.
The other question (and to me the more important question) is whether the dedicated taxes and revenues should be user charges or benefit taxes, revenue sources that put the onus of financing highways and roads directly on those who use or benefit from them. Or should the money come from general revenue taxes – broad taxes that are designed to finance public goods (e.g., public safety, environmental protection, and similar) or that are redistributive (e.g., education and human services funding) – things that it simply impractical or makes no policy sense to charge to those who use or benefit from them.
Another way to express the second question is how much highway funding should come from higher or special taxes on drivers and other users or beneficiaries of highways and roads, as compared with the amount everybody pays to fund the general cost of government? This is different from the first issue of whether highway and road funding should have special legal status that makes it harder for a legislature to use those revenues for another purpose. That may be justified to provide stability and reliability or by other considerations. But it is different from the question of who (which taxpayers) should pay for highways, which is what the second question mainly gets at and is always an issue when government activities are funded with dedicated revenues.
In a future post, I will discuss this concept in more detail and explain why I favor raising more money for highways and roads from either user charges (like the gas tax) or benefit taxes (like the registration and wheelage taxes) – preferably the former. However, in deciding whether that is the policy you prefer, it is useful to know how much of highway and road costs are now paid by user charges and benefit taxes versus general revenue sources.
I have not seen an analysis breaking down Minnesota’s highway and road funding along those lines – that is, distinguishing user charge and benefit tax sources from general purpose revenue sources. House Research has a publication that identifies the sources of revenue the state uses for highways, but it does not break those sources down by whether they are user charges or benefit taxes, rather than general revenue sources. Some other organization may have done that analysis, but couldn’t find it. To fill this gap, I did some back of the envelop calculations, using readily available data of these amounts, which are shown in the table below.
Disclosure: This is not my area of expertise. When I worked for House Research, I generally relied on transportation finance specialists or fiscal analysts (or DORReserch ) to do this type of analysis. If I undertook to do it myself (as I occasionally did to test the financial feasibility of policy options), the experts usually pointed out mistakes I had made because I didn’t understand the nuances of the data or rules. So, caveat emptor, but the purpose is just to provide a big picture impression. If I’m off by a $100 million or $200 million, it shouldn’t really matter much.
My tabulations (see below) suggest that Minnesota funds most of its highway and road costs (about 3/5th) with general purpose revenues, not user charges or benefit taxes. I think that augments the case for raising any new revenues from user charges or benefit taxes, preferably by increasing the gas tax. As I outlined in another post, the failure to index the gas tax has caused inflation to erode its revenues substantially, providing a mindless, auto-pilot tax cut. Since the 1988 increase in the gas tax rate, inflation has provided buyers of motor fuels over a $6 billion tax cut by my calculations!
Funding source
FY 2018 amount (millions)
% of total
General revenue sources
Motor vehicle sales tax
$463.4
15.6%
Sales tax – leased vehicles, repair parts, etc.
84.8
2.9%
Tax expenditure – motor fuels exemption from sales tax
475.6
16.0%
General fund appropriation
15.0
0.5%
Local property taxes
716.3
24.2%
State bonds (other than trunk highway)
NA
TOTAL
$1,755.1
59.2%
User charge and benefit tax sources
Motor fuels tax above value of sales tax exemption
427.1
14.4%
Registration (tab) tax
781.9
26.4%
County wheelage taxes
42.4
1.4%
TOTAL
$1,209.0
40.8%
My assumptions and how I did the calculations. Dedication of the motor vehicle sales tax (under a constitutional amendment approved by the voters in 2006) and of other components of the general sales tax (statutory dedications) are obviously general revenue sources, in my mind. That is so, because the sales tax is in principle a general consumption tax that funds the general government costs. Dedicating revenues from components that somehow relate to highway use (sales tax on vehicle purchases, for example) does not change the tax’s character as a general revenue tax. It would be like claiming the income taxes paid by Uber drivers are transportation benefit taxes or user charges; they obviously are not.
It’s worth noting that the statutory dedication of sales tax money was not fully phased in for FY 2018, so that will cause the FY 2020 general revenue share to rise a little bit compared to the percentages in the table for FY 2018, all else equal. The sales tax amount will probably double or close to it.
The tax expenditure for the sales tax exemption for motor fuels requires a little more explanation. When the gas tax was enacted in 1925, there was no general sales tax. At that point, the tax was entirely a user charge; it was an additional or special tax imposed on sales of fuels used in highway vehicles. Almost no other purchases were subject to a similar tax (exceptions: the sin taxes and insurance purchases). Because it was roughly proportionate to the miles driven (obviously varying based on the fuel efficiency), it can be fairly characterized as (and widely is characterized by public finance economists as) a user charge. But when the general sale tax was enacted – obviously as a broad-based revenue source to finance general government – the legislature exempted motor fuels that were subject to the excise tax from the sales tax. (Off-road purchases, such as for farm and construction equipment, were subject to the sales tax, not the gas tax.) At that point, some of the gas tax lost its character as a user charge – to wit, the value of sales tax exemption that was conferred by paying the tax. (There is a legal question whether revenues from imposing the sales tax on highway fuels would be subject to the constitutional dedication. That is a close question – the AG and legislative lawyers have reached differing opinions. But here I’m talking about economic and fundamental characteristics, not legal issues.) I calculated the amount in the table by taking the gross tax expenditure estimate from DOR’s Tax Expenditure Budget and adjusting it downward for the portion attributable to the Legacy Amendment tax (3/8 of 1%) and for the revenue neutral rate effect (i.e., I assumed taxing motor fuels would be used to reduce the general sales tax rate and revenue from the resulting rate differential should not be counted). This estimate ignores the fact that the exemption also reduces local sales taxes, so it is understated very slightly.
In estimating the property tax share, I took total spending reported by cities, counties, and towns for streets and roads from the state auditor’s reports – both spending for current operations and an allocated share of debt service (based on the share of total debt for streets and road bonds) – and, then, deducted the amount of state aid paid out of the highway funds to counties, cities, and towns. Thus, the assumption is that the residual road spending was funded with property taxes. Obviously, cities could use LGA and counties could use CPA rather than property taxes; since money is fungible, it really doesn’t matter. If they did, then general purpose state aid (funded through the state’s general fund) would have been used, rather than property taxes. In either case, the funding came from general revenues. In addition, I know that some local sales taxes are also fund highway and road improvements. But again, that is unimportant because all I am trying to do is separate revenue sources into two buckets and I believe that the wheelage tax is the only local benefit tax or user charge.
For the wheelage tax, I could not find a state government source for this. The numbers are from a Transportation Alliance publication and are for FY 2019. This is obviously a pretty modest amount.
Note: There is a small (I assume) additional amount of state general fund support for local highways and roads that results from the issuance of regular state GO bonds for local road and bridge projects. The debt service on these bonds is paid out of the general fund. I did not attempt to track down how many of those bonds are outstanding or to estimate the debt service on them. Doing so would increase the general revenue share somewhat. Most state bonds are trunk highway bonds and are paid by the trunk highway fund, which is accounted on the revenue side.
Bottom line: Most public funding of highways, roads, and streets in Minnesota is done with general revenues. They are dedicated by law, but their fundamental economic character is as general purpose revenues, not higher or additional taxes that are imposed on users or beneficiaries of highways and roads.
Earlier this week the Taxpayer Advocate released her 2019 report, required reading for a tax nerd like me. As usual, it points out the top 10 “serious problems” with the tax system. The one of these that stands out to me as an existential threat is Congress’s continuing failure to adequately fund the IRS, since the Republicans took over the congressional purse strings in 2010.
Graphs from the report (see below) dramatically show what has been going on – the number of tax returns have gone up by 9%, while the number of employees has dropped by 20%.
Funding in real terms (that is, adjusted for inflation) has dropped by 20% over this period (see graph below).
This actually understates the effects, because the IRS has had in this period to deal with the added administrative burden put on it to largely administer both major parts of the ACA and the TCJA (Trump’s 2017 major tax rewrite). Although the TCJA may have simplified tax filing for many taxpayers through its expansion of the standard deduction, it constituted a large increase in complexity for the IRS and business taxpayers.
I considered this persistent failure to adequately fund the IRS an existential threat, because the long term effects will undercut (and undoubtedly already are undercutting) the collection of revenues needed to run government, while the degradation of taxpayer service and likely increased noncompliance erode public confidence in the fairness of the tax system. Because states are so dependent on the federal income and corporate taxes for their tax systems, these problems flow through to state and local taxes.
I know that Republicans largely have done this and may still be doing it (even though the GOP controls the executive branch) because they believe that the IRS inappropriately and illegally targeted Tea Party groups seeking tax exempt determination letters. Whether or not that is true is highly debatable. (I have spent a lot of time educating myself about the issue and am dubious as to whether to any great extent this wasn’t simply due to incompetence and bad management rather than playing partisan favorites. There are two IG reports (latest) and a Senate committee report that certainly do not make a strong case for partisan targeting as is assumed by the GOP.) In any case, I don’t see how it justifies putting the nation’s tax system at risk; rather it should have led to addressing the specific problem to the extent there is one. With Republican control of the executive branch (and for 2 years Congress) there is no longer any excuse, in my mind.
Defined benefit pension funding is in trouble all over, not just in Minnesota and many other states but in the private sector and Europe, according to this article in the Financial Times. FT considers the article (originally published in November) one of its 10 best big reads of 2019, so it’s not gated and is well worth reading.
The problem with Minnesota pension funding is obvious to anyone with a minor amount of financial savvy, a combination of (1) a failure to consistently (rarely) make ARCs (actuarial required contributions) and (2) unrealistically high rate of return assumptions that go into calculating the ARCs. That, of course, is not a sustainable situation, so at some point an unhappy day of reckoning will come and compromises will need to be made (some combination of additional contributions and benefit reductions).
The FT article points out a more generalized problem with defined benefit pension funding – that is, bond market returns that are low or nonexistent and (although not explicitly stated in the article, I think) a low or no inflation environment. Low bond returns make it very hard, even for prudently designed and managed pensions, to generate returns to match pension liabilities. This is especially a problem in Europe with its negative interest rates in some countries! The article mainly focuses on the issue of low bond yields. But I think my point (low or no inflation) is also a big component of the problem.
Low inflation is a problem because defined benefit pension plan liabilities are typically in nominal terms, that is they are not indexed to inflation. (There are important exceptions to this, such as the old federal CSRS and some states who foolishly have indexed their benefit formulas to inflation indexes. Minnesota fortunately does not, although it provides an annual, fixed (1% or 2%) benefit increase to retirees.) That means that a modest or greater amount of inflation can typically provide a margin for error, as inflation erodes the value of the benefit payment liabilities and makes it easier for plans to pay benefits.
Actuaries, of course, are aware of this and so attempt to account for inflation’s effects in their estimates either implicitly (in various growth assumptions and investment returns) or explicitly (less sure the extent to which they do that). So the real issue is whether inflation is exceeding the net effects of those actuarial assumptions.
The effects on actuarial estimates can move in both directions (e.g., benefits are based on wages, so wage inflation can drive up future benefits (liabilities), but inflation that increases inflation-adjusted investment returns and concurrently erodes the value of nominal benefits can may it easier to pay unindexed, current retiree benefits). My strong intuition (without attempting to dissect Minnesota’s actuarial formulas) is that a modest amount of inflation (3% to 5%) would materially help out Minnesota’s funding IF the investment return on stocks and bonds can come close to the rate of return estimate, on an inflation adjusted basis. That would provide a substantial discount in paying retiree benefits. Greater longevity means that the plans are paying benefits for longer periods, so inflation above the actuarial estimates should be a big help.
Another way to gain an insight about these effects is to consider the 1970s. With regard to investment returns, the 1970s were a lost decade of sorts – just plain awful for stock and bond returns. One would assume low investment returns would be really bad for pension funding and it sort of was. But rising inflation, although temporarily depressing bond values, providing an important offsetting effects by discounting fixed liabilities (i.e., amounts of future pension payments set in the previous low inflation environment) and by ramping up the nominal bond yields on new money or reinvested bond principal. That made it a much easier environment for defined benefit pension managers to deal with than the current environment.
In any case, interest rate policies in Europe and (to a lesser extent) in America have clearly hurt significantly the financial viability of defined benefit plans, as the FT article makes abundantly clear. This is an unintended side effect of low-interest macro-economic policies, I guess – particularly if they affect long bond rates, not just the short term rates that central banks are typically assumed to control. And the adverse effects on defined benefit pension funding is an unappreciated side effect of declining and/or persistently lower than expected inflation, which typically is widely perceived to be a good thing so long as deflation is avoided. Modest inflation provides a useful financial lubricant of sorts.
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