We just got Florida’s equivalent of Minnesota’s Truth-in-Taxation statement (i.e., how much next year’s tax will be under the taxing jurisdictions’ proposed levies) for the condo my wife inherited on her mother’s death last year.
The notice contained a surprising revelation. Florida provides a special property tax exemption for widows and widowers, which of course we will be losing. Back when I was working, I spent time thinking and writing about income tax marriage penalties and bonuses. But one built into the property tax and limited to surviving spouses was a new to me. Or maybe this is a special form of a single bonus? (The income tax does have a one-year surviving spouse status that confers bonuses on widows and widowers.) The exemption amount is a trivial but was just increased by the Florida legislature. I guess widows have a lobby in Florida.
A much more generous homestead exemption is provided to resident homeowners, which I knew about and knew we would be losing. That’s no surprise and is common in many states. Minnesota has a more generous one, albeit (of course for Minnesota) value limited. Florida’s predictably is a flat amount ($50,000 of value) for any home, regardless of its total value. Mar Largo probably qualifies if part of it is deemed a home. We’re in some of the same taxing districts.
The nastier surprise the notice contained was the fallout from Florida’s version of limited market value, which caps the annual value increase at 3% for homesteads and 10% for non-homestead property. A transfer allows an increase to full value. In our case, that meant a near 4X increase in value with an equivalent effect on tax. Welcome stranger.
That underlines the fundamental unfairness and distortions caused by provisions like Minnesota’s old limited market value law and the current version in Florida, as well as California’s Proposition 13. For years many other property owners were unnecessarily subsidizing my mother-in-law. Now, we’re on the other side of the equation. Over long periods of time, the distortions keep multiplying. Prop 13’s distortions are mindboggling. Value caps are very popular politically, of course, and extraordinarily difficult to undo.
This post is not SALT related. I have slid into occasionally blogging about the opioid epidemic via book reports on Deaths of Despair and Empire of Pain. As a result, I now tend to take more notice of items related to the epidemic, which appears to be increasingly infecting Minnesota. This post reports on two items that caught my attention.
Supreme Court review of the Sacklers’ personal liability?
When I wrote my report on Empire of Pain, I assumed that the Second Circuit decision, In re Purdue Pharma, LP, 22-110(bk) (2nd Cir. May 30, 2023), upholding the bankruptcy court’s release of the Sacklers from personal liability beyond their $6 billion contribution would be the final word. Supreme Court review seemed unlikely, even though there is a split in the circuits as to whether the bankruptcy code allows it.
The Solicitor General has, however, filed a request for a stay with the Supreme Court in order to file a petition for cert on behalf of the US Trustee. I assume that materially increases the chances for Supreme Court review. Traditionally that is the case when the Solicitor General weighs in on a case. After I wrote this, but before posting, SCOTUS granted the stay. The Court’s order treats the stay as a grant of cert.
I know nothing about the merits, although I did read this piece by two Alabama bankruptcy judges summarizing the issues. It suggests there is more authority supporting the release than Empire of Pain suggested, at least as I recall. (Aside: Based on that piece, John Oliver did a show on the issue. I missed that since my television watching is limited to NBA and MLB games and PBS. It must reflect that the legal issue has become modestly high-profile in some circles, at least for something that esoteric legally.)
If the Court grants review, it will be a case worth watching. The text of the Code does not explicitly authorize it, so authority is derived from the general grant of authority (the statute’s “necessary or appropriate” clause). One might assume that will cause soul searching by textualists and/or justices who don’t want to imply powers from broad general grants when major questions are involved. Perhaps that will not be an issue, because here it requires implying powers to be exercised by the bankruptcy court, not an administrative agency. Strictly speaking (IMO) it should not matter whether the grant is to an administrative agency (i.e., Chevron deference to an expert administrative agency) or a judicial entity (bankruptcy court). But I doubt conservative justices worry much about the courts (themselves) usurping Congress’s responsibility.
Epidemic benefits the GOP?
The jarring – at least to me – findings of a draft research piece caught my eye in a Thomas Edsall NY Times column. Carolina Arteaga and Victoria Barone, Democracy and the Opioid Epidemic (July 24, 2023). The authors assert that “the opioid epidemic substantially increased the Republican vote share [in congressional and presidential elections].” Page 3. The basis for such a seemingly outlandish assertion by academic economists (at the University of Toronto and Norte Dame) intrigued me so much that I had to read the piece.
As a preliminary matter, I’m skeptical when economists apply their methods outside traditional areas for economic analysis (here political science). In my view, behavioral economics has called some of those efforts into question, such as some of Gary Becker’s work, despite his Nobel Prize. For example, it seems questionable whether decisions to commit crimes or to consume highly addictive drugs, as a general matter, are driven by homo economicus type calculations. (Disclosure: In another life, I fell into the thrall of Becker’s approach in writing a senior seminar paper on crime.)
Here the authors are using econometrics (i.e., statistical techniques) to measure whether the geographic areas that were more affected by the opioid epidemic showed changes in their partisan voting behavior. Analyzing such a question requires creativity in using data, similar to examples in the popular book, Freakonomics. The authors rely on Purdue Pharma’s strategy of initially marketing OxyContin to the cancer pain market and, then, to prescribers treating chronic, rather than mortal, pain in those same geographic areas. That strategy concentrated initial use and abuse of the drug in geographic areas with high cancer mortality. Other research has shown that those areas are strongly correlated with opioid prescription levels and overdose mortality. Thus, cancer mortality by geographic areas provides a way to identify geographic areas in the before times (pre-OxyContin) to test the effects of the epidemic on voting behavior. Clever idea.
The authors find a big effect on voting behavior – increasing the Republican vote in presidential and House races – after a lag. Figure 3(a) from their paper (copied below) shows the quite dramatic correlation. CZ in the title refers to commuting zones, the term for the authors’ constructed geographic areas where they measured cancer mortality, opioid prescriptions, drug overdose mortality, and voting behavior. OxyContin was introduced in 1996 and the effect starts being statistically significant in 2002 but becomes most dramatic in 2010, which was a Republican wave election, and persisting thereafter.
The relationship’s ability to predict the probability of Republican wins, per the authors’ statistical analysis, only starts in 2012. According to them, that may be because the affected areas were not in the baseline “swing” political areas, requiring more vote changing to yield wins in many cases.
The effect is quite strong, as the graph visually suggests. As they state:
We estimate that an increase of one standard deviation in cancer mortality in the baseline period [1982-1996] increased the share of votes for a Republican candidate in a presidential election by 12 percentage points.
The obvious concern with efforts like these is to make sure that correlations are not spurious or random. While that doesn’t ensure the relationship is causative, it increases the chances. Two strategies are to (1) make sure that there is a solid theoretical reason to posit a causal relationship and (2) use various statistical methods and tests that decrease the chance you’re measuring spurious correlation or using bad data. Both are necessary and neither is foolproof, of course.
Theoretical basis for a relationship
The rationale for requiring a social science based or logical rationale for causation is obvious. The world is full of random correlations. Consider the long running trope about the relationship between Super Bowl winners and stock market performance that the media regularly reports on. Obviously random but still a correlation.
One easily can assume logically that the adverse social effects of the opioid epidemic had political repercussions. It has and is causing a lot of deaths (700,000 nationally according to the CDC) in addition to adverse health, economic, and social effects on families and communities. It seems reasonable that could affect political behavior. I suppose, it’s a small step to conclude that may take the form of a reactionary turn to the right and, thus, Republican support. The authors cite to a small literature (3 studies) finding such effects: two showing that the severity the 1918-19 flu pandemic in German and Italian areas correlated with increased support for Fascists and the other that areas with more incidence of the Black Death in the Middle Ages had increased antisemitism.
Statistical tests
Caveat: I’m not a statistician, so the following observations are just amateur guesses. The authors appear to me to do their best to apply statistical tests of reliability but face some challenges. Two key assumptions underpin their analysis (p. 9): (1) that cancer mortality rates are a good predictor of higher opioid abuse because of Purdue Pharma’s marketing and (2) absent that marketing and abuse, voting behavior in the impacted areas would have been about the same, on average, is in unimpacted areas.
The first of these isn’t very difficult for me to accept. The causative relationship seems pretty clear. The Sackler’s marketing was effective, and abuse and death rates followed by most accounts. You can see this in their Figure 2 (p. 20, not copied) and it is detailed in Empire of Pain.
The second, the link to political/voting behavior, is where there is more uncertainty in my view. The authors strain to find an appropriate placebo check, using diabetes and flu, which is not too convincing to me for rejecting that cancer incidence is not a proxy for a vector of demographic and economic variables that are the real explanation (more of my thoughts below). They test and statistically reject two common explanations for the increasing Republican vote share – the Fox effect and areas particularly hit by the last decades’ growth in Chinese imports. Yes, there is research that shows that relatively more exposure to Fox News increases Republican vote shares. That was another instance of clever use of data (channel numbers used by the local cable carriers).
My take
I have long been puzzled about the cause of or explanation for the increased dominance of Republicans in rural areas, both in Minnesota and nationally. That is partially what generated my interest in the paper and its potential piece to resolving that puzzle. But I wish the authors had tested whether average education levels in their commuting zone (geo areas) explain some of the increased Republican vote share.
Pollsters and political scientists have pointed out the correlation (at least in the last few elections) between educational attainment and the Republican vote. More specifically, white college educated voters are trending away from voting Republican, while white voters with only high school educations, especially males, are trending Republican. Second, Case and Deaton, Deaths of Despair, points out that a prime antidote to deaths of despair (suicides, drug overdoses, and alcoholic cirrhosis) is a college education. That raises in my mind whether that is some or much of what the authors are picking up in their analysis. It would be nice to see how many of their affected areas have variations in those measures (prevalence of college degrees and being targeted by the Purdue Pharma marketing), which may allow sussing out the differential effects. More generally if the epidemic is hitting white rural areas heavily (it is) and those areas are trending Republican for an array of reasons, the incidence of the epidemic just be a convenient proxy. That’s my nagging concern, anyway.
My bottom line is that the study is intriguing and, at a bare minimum, plausible but I remain less than convinced.
The BBC reports that three firms paid one-third of Ireland’s corporate tax from 2017 through 2021. This is based on public financial reporting data aggregated by the Irish Fiscal Advisory Council, an Irish governmental entity. Apple is likely one of the firms, since it claims to be Ireland’s largest taxpayer according to the BBC story. The IFAC paper itself (p. 22) does not reveal the identities of the corporate groups. The other two may also be U.S. multinational corporations (MNCs).
The 2017 Tax Cuts and Jobs Act’s (TCJA’s) international tax rules, specifically GILTI’s minimum tax, applied for 4 of the 5 years (2018- 2021). Graphs in the IFAC paper show a sizable jump in Irish tax paid by the top 10 corporate payors in 2018 and again in 2021. I assume the first reflects TCJA’s effects, since 2018 was GILTI’s first year in effect. I haven’t paid enough attention to foreign countries’ adoption of BEPS rules but that may explain the 2021 jump (or not).
The net result, according to the BBC article, is a big revenue windfall for Ireland. As the BBC story reports:
Last year Ireland raised €22.6bn (£20bn) in corporation tax, 182% more than the €8bn (£7.08bn) it took in just five years ago.
The corporation tax revenues are so large they are enabling the Irish government to run a budget surplus.
The government has acknowledged that that is likely to be an unsustainable windfall and is planning to use the additional revenue to establish a sovereign wealth fund.
GILTI and its foreign tax credit (FTC) rules might partially explain this phenomenon. TCJA eliminated full deferral of the foreign earnings of US MNCs in favor of immediate, but partial, taxation under GILTI’s minimum tax rules. Those rules encourage paying more foreign tax than full deferral under the old regime because of the way GILTI works.
Pure tax havens like the Caymans, which impose almost no tax, are likely hurt and partial tax havens like Ireland, which imposes a modest tax (about GILTI level), win because of the GILTI’s exemption and foreign tax credit (FTC), I think. If my instincts are right, one effect of TCJA’s new international tax rules was to increase Irish tax revenues.
A separate BBC story reports:
Ireland has long featured in the tax planning of multinational companies, often as a conduit for shifting money around.
But in the middle of the last decade some of the world’s biggest companies began to reorganise their affairs in a way which meant they would pay a lot more tax in Ireland.
Ironically this was partially a response to the pressure on big companies to clean up their act on tax.
The principle was that companies should declare profits in locations where they have substantial real operations or activities rather than just a low-tax location where they happen to have an office with few employees.
Ireland fitted the bill – it was a tax-friendly jurisdiction but companies like Apple had long had real operations in the country, employing thousands of people.
The net result is that TCJA encouraged moving some operations offshore. Locating more actual operations offshore and paying a modest amount of tax offsets GILTI through the FTC. As a side effect, Ireland and other countries (Belgium, e.g.) get infusions of revenues (de facto foreign aid). Ireland appears to think this will be a temporary phenomenon and plans to put some of the money in reserve, i.e., a sovereign wealth fund, as noted in the first BBC quote above. It’s unclear to me why they think it will not last – too good to be true and other countries wise up?
Why does TCJA encourage moving production to Ireland or other foreign countries with similar tax rules? The answer lies in GILTI’s rules.
Old regime. Under the pre-TCJA regime, US MNCs could artificially shift US profits to foreign tax havens and defer US tax more or less forever. Artificially shifting as much profit as legally possible to pure tax havens like the Caymans increased de facto after-tax profits. GAAP required reporting these as deferred taxes and they were “trapped” offshore. I used scare quotes because the corporations could borrow against those profits to pay dividends or buy back shares. So, financial markets recognized that they were not really trapped (technically, subject to paying full GAAP deferred taxes to repatriate). That was why policy proposals that relied on repatriation of those profits to stimulate US investment were probably dubious, if the premise was that they would increase U.S. investment.
TCJA. GILTI eliminated deferral by providing a low-rate tax (less than one-half TCJA’s new lower regular rate of 21%) applies immediately (another TCJA provision exempted foreign dividends from tax). To target artificially shifted profits, GILTI has two features. First, it exempts a 10% return on income derived from actual operations (i.e., physical plant and equipment located offshore). Most income shifting is done by locating intellectual property or other intangibles in tax havens and booking the income there. So, Congress wanted to exempt income from real operations, like plants, earned by foreign subsidiaries of US firms from the GILTI. Ten percent must have been thought to be reasonable rule of thumb for a rate of return. That focused the tax on income from intangibles as GILTI’s name implies. Second, to prevent double taxation of the remaining income, an FTC was allowed to reduce GILTI. So, if the MNC pays foreign tax that reduces GILTI. The FTC is not country specific, so tax paid to any foreign country offsets GILTI.
So, to repeat the question, how or why does this encourage moving actual operations offshore? Taken by itself the FTC is neutral. MNCs will not care if they pay GILTI or an equal tax to Ireland because the FTC just makes sure they don’t pay twice or double the amount. But that will not be the case if their preexisting foreign operations do not generate enough foreign tax to benefit from GILTI’s exemption for the 10% return on physical investment. This can be illustrated with an extreme example (that may be close to legally impossible but helps to illustrate the concept). Assume before TCJA, Acme Pharma developed and produced its drugs in the US but sold a substantial share of them internationally. It located its IP in the Caymans and booked a high percentage of its profits there. GILTI would tax this income, albeit at a low rate. Because Acme’s actual foreign operations (other than sales) were minimal, it would have a minimal FTC and would get little benefit from the 10% exemption for return on physical operations. If now it moves some production of its drugs to Ireland, it will pay Irish tax equal to about GILTI’s rate (Ireland has a 12.5% rate, a little higher than GILTI’s effective rate) on income from the production, its GILTI will go down (because of the exemption), and it can use Irish tax as an FTC to reduce GILTI attributable to the Cayman income. So, the main effect is to reduce GILTI, essentially incentivizing offshore investment. Boiling this down, the flaw is that foreign tax paid on income exempt from GILTI reduces GILTI via the combined effect of the exemption and the FTC.
This is a result of flawed design of the FTC which also allows tax paid to foreign countries with higher rates (e.g., Germany) to reduce GILTI on income shifted to tax havens.
Brad Setser’s testimony before the Senate Finance Committee provides detail on how TCJA encouraged Big Pharma to move production offshore. His written testimony includes striking graphs (see especially the one on page 5) revealing the incongruity of the fact that drug prices are the highest in the US (by a lot), which is also where the research and development of drugs is largely done, but the industry profits are very low. Their US operations appear to be about one-ninth as profitable as their foreign operations, despite being able to sell in the US at much higher prices. The only logical explanation is artificial shifting of profits. That’s bad. Moving actual operations and jobs is worse. According to Setser’s data, TCJA resulted in more production moving offshore (i.e., more US drugs being imported):
[E]xcluding the special case of vaccines, which were produced under U.S. government contracts that often required U.S. production, the U.S. trade deficit in pharmaceuticals has increased steadily after the passage of the Tax Cuts and Jobs Act. The United States now imports a bit over $150 billion of pharmaceutical products other than biologics, while exporting a bit under $60 billion – with imports almost doubling since the passage of the Trump corporate tax cuts.
Back in 2018 when I was still working, a Minnesota tax lawyer who does international tax work made the same observation to me. That was an offhand comment during a CLE break about planning discussions with unidentified clients. I didn’t put much stock in it. Setser’s data suggests it was a harbinger. I hope that Congress recognizes this and makes adjustments. I’m not holding my breath.
When it was first enacted, academic reaction to TCJA’s international provisions was mixed. Compared with its obvious bad policies, like QBI, the international changes appeared to move in a positive direction. A few modest fixes in the international provisions are likely all that is needed. Seem e.g.., Reuven S. Avi-Yonah, The Baby and the Bathwater: Reflections on the TCJA’s International Provisions Tax Notes (June 7, 2021).
On reflection, the initial semi-positive reaction was probably too charitable. It’s now six years later, including two years when the Democrats were in total control and proposed changes, but nothing has been done. I assume that is because Manchin and/or Sinema take their tax advice from the corporate lobbyists and would not agree to the changes to fund the IRA. It points out the political reality that recognized bad policy can endure for long periods when getting rid of is opposed by entrenched interests and/or is a tax increase. (Syndicated conservation easements are a similar example that was finally fixed, sort of.)
How something this flawed was enacted is a good question. Academic papers came out in early 2018 (just after TCJA’s enactment) pointing out this flaw. See here (“Thus, one of the inefficiencies created by the GILTI tax is that US MNCs become tax favored buyers of routine foreign tangible assets.” p. 13) Enacting a business tax cut (JCT’s scoring of TCJA’s permanent international provisions show they reduced tax revenues) that encourages offshore investment is policy malpractice. Thank you, Paul Ryan, Kevin Brady, and Chuck Grassley. I do wonder if that is because they relied too heavily on lobbyists and corporate interests for their policy advice and assume academic and government experts are unreliable lefties. Maybe they were just acting too quickly. Probably both were factors.
Will Minnesota’s conforming to GILTI add to these incentive effects, even if just a very small amount? The answer to that is no because the state will be purely taxing GILTI income without allowing an FTC. The perverse federal incentives come from the combination of the FTC and the exemption for the 10% return on physical assets. As an aside, it makes no policy sense for a state corporate tax to allow an FTC. By design, a state corporate tax is a territorial tax and if apportionment works correctly, it prevents double taxation. By contrast, a tax imposed on worldwide income (not worldwide apportionment, just to be clear) like the pre-TCJA federal regime requires an FTC to prevent double taxation. Of course, states do not all use the same apportionment rules and inconsistencies can result in double taxation, but the converse (inconsistencies resulting in no taxation) occurs as frequently or more so.
Updating my post on the Florida edition of Dumb tax policy, Governor DeSantis signed the Florida tax bill and his sales tax exemption for gas stoves survived. Axios story. At least, the legislature had the sense to make it a 1-year provision. Once DeSantis’s presidential campaign is over, normality can perhaps return. In a salvo from the other side, New York state’s budget bans gas stoves in most new construction. CNN story. That will be permanent but doesn’t start to take effect until 2026.
In yet another dumb tax policy that I had not noticed before, the new Florida law adds a second sales tax holiday period from January 1st to 14th for back-to-school purchases. Florida also has sales tax holidays for disaster preparedness and outdoor recreation and entertainment from Memorial through Labor Days. You can buy concert tickets tax free if you’re willing to endure the heat, humidity, and hurricane risk. I’ll pass for a Minnesota summer.
It is all but inevitable that the 2023 legislature will exempt more social security benefits from taxation. Thankfully, it appears it will not exempt all benefits, limiting the exemption (technically a subtraction) to filers with no more than low-six-figure incomes. It’s probably the best one could hope for under the political circumstances. But that’s not the end of it.
Because the subtraction favors one class of taxpayers (seniors) with one type of income (social security benefits), it leads or will lead to similarly situated taxpayers crying foul and pleading for comparable treatment.
First in that queue are governmental retirees who are covered by pension plans that are exempt from social security. They’re stuck paying taxes on all their retirement income. Unfair. The main categories of those pensions are public safety retirees (federal, state, and local) and legacy CSRS federal retirees (some covered by CSRS are still working, of course). Both tax bills preemptively address those claims by extending the bad policy of exempting SS benefits via a qualified retirement subtraction for those public pensions that very roughly mirrors the expanded social security subtraction. H.F. 1938, art. 1 § 22 (third engrossment); H.F. 1938, art. 1 § 22 (1st unofficial engrossment).
These provisions allow a married joint filer with a qualifying public pension to exempt up to $25,000 of it ($12,500 for a single filer), subject to an income phase-out that parallels that under the social security subtraction. I did not carefully compare the House and Senate language, but the provisions appear identical. It seems inevitable that the provision will be in the final tax bill.
A few observations about this exercise:
The best policy would be to ignore the pleas. My mother used to tell me that two wrongs do not make a right. I get that their claims are hard to ignore, especially since many are cops and firefighters – favored public employees for both political parties. Federal law compels giving equal treatment to federal pensioners, so federal retirees cannot be left behind if Minnesota pensions are exempted.
The complicated and unique nature of the social security program makes it impossible to create an exemption for these recipients that provides identical treatment to the social security subtraction. These pensions are designed to replace the equivalent of social security benefits and a standard pension that is coordinated with social security. Calculating what part of their pension replaces social security is not feasible and, in any case, would be maddingly complicated. That is why (I assume) the designers of this opted for a lower dollar limit ($25,000 annual is much lower than the maximum social security benefit – my benefit is over $50,000, e.g., and is not the maximum). It’s a rough compromise. But it overcompensates those with small pensions.
No effort is made to coordinate this subtraction with the social security exemption. Many/most of these recipients will also collect social security, either because they had covered employment or receive spousal benefits. Married couples may have one spouse with social security covered employment and one with a qualifying pension. These individuals will be able to claim both subtractions. Options to coordinate the two could be done by: (1) requiring filers to opt for one or the other or (2) reducing the social security exemption by any amount excluded under the qualified retirement contribution or vice versa. A coordinating provision would reduce the cost of the provisions obviously.
The higher limit for married filers is independent of who receives the pension. In most cases, one spouse will have earned the pension. Death will cut the survivor’s subtraction potentially in half.
No age restriction applies. Old age social security benefits cannot be collected before age 62. Imposing a similar age restriction (other than for pensions based on disabled status) would seem to provide some equivalence. Of course, a prime reason that cops and firefighters have resisted pensions that are coordinated with social security is that they want to retire early (e.g., well before age 62) with unreduced pensions, when social security benefits are unavailable. But that doesn’t mean we have to give them more beneficial tax treatment too.
Recipients of pensions from non-Minnesota state and local governments are denied the subtraction unless their state provides similar treatment to Minnesota pensions. I’m not sure about the rationale for this and wonder if it violates the Commerce Clause. Retaliation and reciprocity rules in state insurance taxation are constitutional because Congress authorized them under the McCarron Ferguson Act. Without such authority, I doubt a reciprocity requirement is constitutional because appears to discriminate against interstate commerce (pension income earned in another state). But I have never had cause to research the issue.
Complicated mess. After the 2023 tax bill is enacted, Minnesota will have four special income tax preferences for senior taxpayers:
The social security subtraction
The qualified retirement subtraction
The higher standard deduction for seniors
The subtraction for elderly and disabled
A better approach? These provisions overlap and none is coordinated with any of the others. A better approach would be to forgo the subtraction for qualified retirement income and to combine ## 3 – 4 into one comprehensive subtraction for seniors that is reduced by any subtraction allowed for social security. One way to do that would be to:
Increase the additional standard deduction dollar amount (by $5k to $10k, for example);
Subtract from the higher additional standard deduction the social security benefits that are exempt from Minnesota tax (other than 15% rule); and
Further reduce the additional standard deduction by AGI (and probably add tax exempt interest for good measure) over specified thresholds that vary by filing status.
The goal would be to set the dollar amounts so that the total costs equal that for the existing additional standard deduction for seniors, the proposed qualified retirement subtraction, and the existing subtraction for elderly and disabled. That would be simpler and fairer. It would raise taxes on some higher income seniors (like me) who will lose their additional standard deduction. It would treat seniors regardless of whether they derive their income from pensions, earnings, or taxable investment income more equally.
A comparison of two similar senior taxpayers illustrates why I think the tax bill provisions are unfair: Taxpayer #1 is a 70-year-old widow who cannot live on her $12,000 in social security benefits so she supplements that by working as a cashier, earning an additional $25,000 in wages for total income of $37,000. (I often see folks working in retail stores who I imagine are in this situation.) Her social security benefits are entirely exempt, but she must pay over $500 in Minnesota income taxes on her wages. By contrast, Taxpayer #2 has a $32,500 public pension that qualifies for the new qualified retirement subtraction and collects $5,000 in social security benefits based on his covered work or his spouse’s. (These benefits are subject to reduction called windfall elimination program. That is designed to prevent these recipients from falsely looking like they had low lifetime earnings, when they were working in uncovered employment, for purposes of social security’s redistributionist benefit structure. A similar rule, called GPO, reduces spousal benefits.) Taxpayer #2 pays no Minnesota tax despite having the same income as Taxpayer #1. To add insult to injury, Taxpayer #1 pays federal income tax and FICA. So, she has less after-tax income than Taxpayer #2 and must pay non-deductible work-related expenses, such as commuting and clothing.
At this point in the process, it is obviously too late to redesign these provisions (a project for the 2024 session?). But the subtraction for elderly and disabled should be reduced by the amount social security benefits that are nontaxable under the Minnesota subtraction, rather than just the federal exemption as it is now, and by the amount subtracted under the new qualified retirement subtraction. That would save a trivial amount of revenue and would prevent double dipping.
This is another in my series of bad high school book reports on nonfiction books that I have read. I write them to memorialize my thoughts in the vain hope I will remember a bit more of what I read.
Author and book
Patrick Radden Keefe, Empire of Pain (Penquin Random House 2021)
Why I read it
Previous reading (e.g., Deaths of Despair) convinced me that the opioid epidemic has had profound effects on America – economic effects (like reduced labor participation) and decreases in life expectancy (Atlantic), human aguish, and more. Media stories, including Keefe’s New Yorker article, made me aware that Purdue Pharma and the Sacklers were central players in these developments, if not the primary culprits. The incongruity of their philanthropy and inhumane callousness, along with the charitable contribution tax issues and others’ recommendations, sealed the deal.
It’s an easy and gripping read: three flight cancellations and an unplanned night in the O’Hare Holiday Inn Express was all it took. I didn’t make notes, so am doing this from memory.
What I found interesting
As often seems to be the case, the actual details provide an interesting story on multiple levels. It’s a classic American rags-to-riches story of three brothers, second generation Jewish immigrants, who grew up in poverty in the Bronx and all became entrepreneurially minded physicians who made their money peddling/manufacturing drugs.
The brothers for many years were a collaborative trio who followed the lead of the oldest, Arthur, into psychiatry and transitioning into advertising, manufacturing, and selling drugs. The family ultimately splintered into two branches, reflected by the two drugs, Valium and OxyContin that were the main sources of their wealth.
Selling drugs
Arthur was the patriarch and motor behind their initial success. He made his money from Valium via his ad agency and other mechanisms. That financial success funded the purchase of Purdue Pharma, an obscure company that made its money selling over-the-counter laxatives, for his brothers. They converted the company into the powerhouse seller of pain killers. Arthur remained a passive owner until his relatively early death, which caused the Arthur branch to sell its stake. The other two brothers, Mortimer and Raymond, ran Purdue Pharma and made their money from its sale of OxyContin.
In both cases, the story is largely one of navigating (gaming might be more accurate) drug regulation and relentlessly overselling the benefits of the drugs, while minimizing the undesirable side effects to the point that they were virtually invisible. This was bad enough with Valium, but became a societal disaster with OxyContin, causing death and destruction across a large swath of America.
At the governmental level it is a story of regulatory failure and borderline, if not outright, corruption that enabled this to occur in both cases. On a business level, it is an ethical failure – they used secrecy to avoid conflict of interest rules, misleading (to put the best construction on it) marketing, and on and on. On a personal level, it shows a complete moral failure – the pursuit of and preservation of wealth without regard to the effects on human beings. How the latter occurred is unclear – whether a true lack of any moral compass or simply the ability of the human mind to rationalize what is in one’s personal interest.
I don’t recommend reading this book, if you’re susceptible to conspiracy theories on how the system is rigged by political elites. It will surely cause you to descend farther down that rabbit hole. I’m always skeptical of purveyors of such explanations, but the book shows a kernel of truth underlies the instinct to believe the system is rigged.
The Sacklers strategically used their wealth to buy reputation, political influence, and (of course) make more money, while avoiding legal consequences for bending/breaking legal rules in doing so. Big law firms, lobbyists, PR firms, and various string pullers intervene at crucial points to avoid both criminal and financial liability (beyond trimming a few billion off their net worths). Two examples:
Avoiding criminal liability. During the latter days of the second Bush administration, a top political appointment in the DOJ truncated a long-running criminal investigation by the US attorney for West Virginia. That resulted in pleas by employees to lesser charges that prevented holding the Sackler family members themselves accountable. The details are naturally obscure, but Keefe paints a picture that makes it clear that their money and political connections were instrumental in stopping the traditional legal squeeze to get employees to testify against higher-ups (i.e., the Sacklers themselves here). The vast trove of evidence amassed is convincing in demonstrating that family members were themselves driving the bus.
Minimizing financial liability. Their blue-chip lawyers hand-picked a judge who used the corporate bankruptcy proceeding to protect the family’s personal fortunes in the state lawsuits seeking to hold the company and them personally liable. That was done even though the family members were not part of the bankruptcy case, had systematically extracted billions from the company when the litigation risk became apparent, and very well may have been personally liable under tort law. As a lawyer I can understand intellectually how that case can be made but it seems a perversion of the bankruptcy process to shield a non-party from personal liability for actions. According to the book, there is only one other similar case (the Dalkon Shield bankruptcy involving the defective IUD, which is well known to Minnesotans).
Art collecting and philanthropy
Arthur became an uber art collector serendipitously (stimulated by buying a Chinese table for his new house from a collector) and pursued it obsessively. This led to him to amass a stupendous collection of objects and to the family’s quirky and fraught relationship with the Metropolitan Museum of Art. When Arthur died, he held one of the largest private collections of Asian art, some of which was housed in a private enclave at the Met.
The family used charitable gifts to arts, medical, and higher educational institutions to build/buy their reputations. That they were buying reputation is obvious from their insistence of extracting naming rights at every turn. Anyone who has visited east coast museums knows that to be the case; Sackler galleries, buildings, and similar are ubiquitous. Their central role in the opioid crisis has caused many of these institutions to now refuse their money and to go through the legally difficult task of removing their names from galleries, buildings, hospitals, and so forth. The book documents much of this exercise and the activists, some of whom were recovered addicts, who pushed for this (e.g., the book recounts in detail the efforts of artist Nan Goldin).
Tax angle
The Sackler story has a few interesting tax angles. Their abuse of charitable contribution incentives is a recurring theme. A central element of the deduction for charitable contributions is the concept of “disinterested generosity”; most of their contributions likely flunked this test. Their actions and private correspondence make it clear that many of their contributions were really a matter of building business and personal reputations, neither disinterested nor generous.
Arthur’s 1960s transaction with the Met reveals how they pushed the legal envelope to and likely beyond its limits. It also reveals the complicity of elite charities in fleecing the government. (A reality that comes through too often in my reading of Tax Court cases.) In this transaction, the Met sold Arthur some of its Asian collection at the prices it acquired them for in the 1920s, in other words, at a bargain basement price. He, in turn, gave them back to the Met and claimed a deduction for their current fair market value. As part of the deal, he received the right to store some of his collection at the Met in a private, locked enclave. The Met obviously hoped this was a prelude to donation of the stored objects in the future. This transaction is questionable on several levels – whether it was a charitable gift at all, the value given, whether he realized income in return, etc. I do wonder if he and/or the Met got a tax lawyer to sign off on it. In my view, it barely passes the straight-face test, but I can imagine that analyzing each step separately one could strain to say it might be legal. As an aside, I can’t recall seeing (e.g., in a tax court case) the IRS apply the step transaction doctrine to a charitable contribution case. This arrangement would seem to call for it.
Mortimer renounced his US citizenship, apparently for tax reasons.
Finally, the family extracted billions in dividends and other distributions from Purdue Pharma, when the legal liability handwriting was on the wall, and sent much of it to classic tax havens. That was likely intended primarily to hide or immunize the assets from legal liability, given the pending and prospective civil litigation, but I expect that tax avoidance was also a secondary motivation.
What disappointed me
The biggest disappointment is that the book does not provide much insight into the psychological basis for their decisions. How could they put the relentless pursuit of profits – including from obvious illegal activity (pill mills) that they were aware of and chose not to report to the DEA or police – over the destruction of human lives. On the surface, their values look amazingly close to those of an organized crime family, but with expensive consultants and lawyers who ensure that their actions have either a patina of legality or the ability to have underlings take the fall.
Keefe could not answer the basic questions about their psychological motivations because the family members would not talk with him, and he had little access to their private papers. He did have access to extensive emails that litigation generated. Those emails revealed that key family members (not just company employees) knew what was going on in detail and encouraged it. They don’t seem to break from a creed that pain relief through highly addictive opioids was beneficial and that a small minority of abusers (whether because of moral or genetic factors) were acceptable collateral damage. (Even that most optimistic construction does not get to profiting from massive sales, maybe 10% of the total, to pill mills, in my mind.) If that truly is what they believe, it is a conclusion only a self-motivated, super-rationalizer could reach, probably because of the insulation from reality that being surrounded by a layer of sycophants provides.
The book’s account of their never ending pursuit of ever more wealth combined with use of that wealth to fund reputation building philanthropy proved to me the validity of Schopenhauer’s famous quote:
Wealth is like sea-water; the more we drink, the thirstier we become; and the same is true of fame.
SALT connection
The book simply solidified my view that the charitable contribution incentives need major reforms. Hard to tell how much was made with appreciated assets, since Keefe did have or did not report on that detail.
Update – 5/30/2023
The Second Circuit upheld the bankruptcy court’s decision to extend Purdue Pharma’s chapter 11 case to provide civil immunity for the Sacklers in return for their fixed monetary contribution, preserving most of their wealth. NY Times story. I assume that this will end the saga, since the Supreme Court seems unlikely to hear the case if an appeal is pursued and it’s not apparent anyone will attempt to do so. My knowledge of bankruptcy is limited to one law school course, but this strikes me as an area that could be addressed.
Timothy Taylor has an excellent Strib column (Carbon tax medicine is a better Rx than green subsidy sugar) on the policy benefits a Pigouvian tax on activities that impose public costs (externalities) over subsidizing behaviors that avoid those costs (e.g., the superiority of a carbon tax over credits for EVs and heat pumps).
Taylor is a Mac econ prof and the editor of Journal of Economic Perspectives, an AEA journal that is pitched at a level that a college econ major can understand (versus AER which requires a facility with math and more willingness to slog through equations). He has a blog, the Conversable Economist, which I read regularly, and is great at explaining economic concepts and research for lay readers. I recommend him highly.
The column is based on a Brookings Economics Study Paper (summary, full paper) evaluating the Inflation Reduction Act, which is an uber example of green subsidies. The authors estimate that the incentives will be more effective than the government economists estimate (i.e., they will reduce taxes by a lot more than the Joint Committee estimates suggest). FWIW, they still think those higher costs exceed the social costs of carbon emissions by almost two and a half times. Taylor’s point is that we could have the same benefit at a much lower cost with a carbon tax.
It takes him until midway through the column to get to what I consider a, if not the, key point:
Both carbon taxes and green energy subsidies provide an incentive for a shift from carbon-heavy to lower-carbon or non-carbon sources. However, carbon taxes also encourage conservation of fossil fuels by raising their price. Subsidies for green energy will not have this added conservation effect. [Emphasis added.]
Timothy Taylor, Carbon tax medicine is a better Rx than green subsidy sugar STRIB (May 3, 2023)
That is a huge advantage. It makes the incentive effects much more effective because they directly reduce the undesired activity. The Brookings Paper estimates that using subsidies is 5X more expensive than a carbon tax for equivalent carbon emission reductions. (See section 6.5 of the full paper, pp. 48 – 50, for the numbers Taylor cites.) Let that sink in an 80% off sale.
Subsidizing green activity is very much a second-best approach. To illustrate why, consider the EV subsidies that go to altruistic environmentalists. Pejoratively they may buy an EV as much to demonstrate their green bona fides as to actually reduce carbon emissions. For example, someone who trades in a Prius that they don’t drive very much for a Tesla. That may not be a total waste of public money, but it would be much more effective for someone who drives a gas guzzler a lot to ditch it for an EV. Or more simply for everyone who buys gas to pay the full price, including the external social costs, so their decisions are aligned with their preferences, enhancing general welfare. The paper addresses the much more complicated situations with electric generation. Incentives for wind and solar do nothing, for example, to distinguish between the higher carbon emissions of coal versus natural gas they displace. The former should be discouraged more than the latter.
The fundamental problem is (at least) twofold:
Human nature prefers positive incentives (subsidies) to negative incentives. This is Taylor’s main point (Mary Poppins’ spoonful of sugar helping the medicine go down in his column). That flows through to politics and is also reflected in the old adage about catching more flies with honey than vinegar.
Our politics have demonized taxes. This manifests itself in Grover Norquist’s tax pledge, which I have routinely inveigled against, and the GOP’s reflexive endorsement of constantly cutting taxes and against ever increasing them. It’s mindless but has proven to be politically successful enough to scare many Democrats into supporting only taxes that they can claim most voters won’t ever pay (e.g., people who make more than $400,000 in the case of Biden).
That tax aversion has our politics in a veritable death grip is a longstanding pet peeve of mine. Taxes are simply a means to an end. Primarily, they are the necessary price of public goods and services, government. Taxes can also function as useful public policy tools as Taylor’s column points out. Tax aversion has become so engrained that the term “tax” has sloughed into close to a synonym for penalty or punishment in the popular lexicon.
I may be making too much of the role of the tax pledge and the GOP’s demonization of taxes as responsible for taking Pigouvian taxes off the policy table. After all, the de facto GOP position is that climate change isn’t a problem. Even if then, the factors that Taylor talks about might prevent enactment of a carbon tax anyway.
Glimmer of Hope
Since I take heart at the appearance of the smallest of cracks in the tax pledge, the House GOP’s debt ceiling bill provides a glimmer of hope. Per Howard Gleckman (Forbes):
House Republicans have, at least temporarily, redefined what they mean by a tax increase. By doing so, they have turned their backs on their decades-old pledge to never, ever, not under any circumstances, raise taxes. * * *
The crack in the GOP’s implacable opposition to tax hikes came in the Limit, Save, and Grow (LSG) deficit reduction and debt limit bill the House passed on April 26. Nearly all of the bill’s $4.8 trillion in deficit reduction would come from spending cuts. But, according to the congressional Joint Committee on Taxation, the bill also would reduce the deficit by about $515 billion over the next decade by repealing the green energy tax credits that were included in last year’s Inflation Reduction Act * * *.
Howard Gleckman, House Republicans Rethink Tax Increases, At Least For A Minute (Forbes May 4, 2023).
Progress would be to replace the green tax credits with a very modest carbon tax – one that would raise maybe $100 billion as a tradeoff. Thus, getting the same reduction in carbon emissions (per the Brookings Paper), while reducing the debt by $600 billion ($100 billion from the carbon tax revenues and $500 billion from ditching the green tax credits). I like to dream. It’s impossible to even increase the gas tax to recover the user cost of the road system incurred by fossil fuel burning cars. Any carbon tax is a pipe dream, unfortunately.
Of course, the House GOP debt ceiling bill also repeals IRA funding for the IRS, thereby adding to the deficit and abetting noncompliance.
Update: 5/24/2023
After posting this, I came across this article in Roll Call (thanks to Bruce Bartlett’s Senate testimony on the debt ceiling). The article is based on an interview of Grover Norquist and explains how he twisted himself into a pretzel to agree that House’s debt ceiling legislation’ does not violate ATR’s pledge to never increase taxes, even though it repeals IRA’s green tax credits. According to the article (not my checking of ATR’s website), 189 GOP House members signed the pledge. So, if the legislation violated the pledge, it obviously never could have passed the House.
The article is worth reading, if only to see the very tendentious reasoning Norquist went through. His rationalizations include (1) rejecting the official JCT score in favor of assurances by GOP leadership as to the effects, (2) treating the legislation’s repeal of expanded IRS funding as a tax cut (me: not paying legally owed taxes has become a tax cut!), and (3) concluding that the D’s would never agree to repeal of the credits anyway in a final deal, so it doesn’t matter. You can’t make this stuff up.
According to the article despite JCT saying it would increase taxes:
Norquist relied largely on an informal analysis of the bill by GOP leaders who said they believed it would reduce taxes. He said the tax impact of the debt limit bill is murkier than is usually the case because the estimated cost of the energy tax credits has been rising, and some of the credits are refundable or transferable.
Roll Call, Tax pledge’s father bestows blessing on GOP debt limit package
Jason Smith, chair of Ways & Means, provided the necessary assurances, as described in the article (my emphasis added):
Smith wrote to McCarthy that the bill “will yield a reduction in taxes for the actual American taxpayers” even though JCT said it would increase revenue.
“With ‘direct pay’ and ‘transferability’ features, Democrats designed this ‘green’ corporate welfare to function like direct government spending, rather than traditional tax credits that reduce taxes owed,” Smith wrote. He added that “much of this can and should be treated as direct outlays to the federal government.”
Smith didn’t say how much of the “score” should be reclassified as outlays. But he added the bill’s cost estimate may also undershoot actual real revenue reduction from other provisions in the bill, namely the $191 billion projected loss from repealing new mandatory IRS tax collection funds.
Id.
But treating the refundable and transferable credits as outlays (JCT does that only for the refundable component) and using CBO’s estimates of how much revenue the expanded IRS funding would raise (i.e., treating the resulting noncompliance as a tax cut) still was enough to offset the cost of the credit repeal. So, Smith had to turn to the administration’s talking points on how CBO’s numbers were too low:
Smith pointed to prior White House budget office and Treasury estimates that the IRS funding could yield $296 billion in direct revenue collections, rising to as much as $440 billion when accounting for indirect effects like the deterrent effect on tax avoidance.
Taking the high end of the administration estimates would negate much of the revenue gain from the energy tax credit repeals, even before any reclassification as outlays, Norquist and top Republicans argue.
Id.
I should not be surprised with either ATR or GOP. Upon emerging from the debt ceiling negotiations with the White House, GOP leadership’s constant manta is “spending is the problem” and, thus, they will never consider revenue increases, including tax expenditure cuts beyond the green credits. This is from the folks who when they were in full control constantly cut taxes (e.g., Bush 1, Bush 2, and TCJA, as well as repealing some of the ACA’s payfor taxes) and never cut spending (in fact, they increased it in multiple ways, including two wars, No Child Left Behind, and Medicare Part D to take a few bigger examples). If spending is really the problem, what the heck were they doing? Waiting for bipartisan cover for unpopular spending cuts, perhaps?
The DFL legislature is looking for politically acceptable ways to increase state tax revenues that align with their values (mainly progressivity in the tax arena). Their search is driven by the reality that most of the big surplus is onetime and their spending ambitions for both new and existing programs outstrip the forecast of permanent revenues.
Given that, I expected them to turn to the corporate tax. As an invisible tax, it scores well politically. I have been told that it does about as well as any tax increase in private polling. No surprise, Joe and Jane Public aren’t corporations, don’t own or run corporations, and probably don’t think they pay. Tax shifting is out of most minds. With regard to progressivity, the 2021 Tax Incidence Study scores the corporate tax as a regressive but not overly so (its Suits Index is higher or less regressive than the general sales tax, for example). The more important incidence of incremental changes (see Figure 4-6, p. 70) is not much different.
The House tax bill confirmed my expectations by including a large corporate tax increase. I was surprised by how it did it, that is, adopting full-blown worldwide combined reporting. Now the Senate DFL appears to be onboard.
An oversimplified explanation of the change: Minnesota now uses waters-edge apportionment. That means a multinational corporation (MNC) determines its Minnesota income using formula apportionment (MN sales/total sales) for all its US chartered corporations that are part of the unitary business. By contrast, earnings from the MNC’s foreign corporations without Minnesota nexus are taxable only when the MNC repatriates them and, then, as dividends (20% taxable multiplied by the MN apportionment percentage and tax rate). Worldwide combined reporting uses formula apportionment for all the corporations in the MNC’s unitary business. So, the business no longer controls when it repatriates foreign earnings and formula apportionment, rather than accounting rules, determines the source of profits (i.e., the amount to be apportioned to Minnesota).
A few of my reactions (sorry, stream-of-consciousness, no organization):
It is constitutional since the Supreme Court has blessed the approach. Barclays Bank PLC v. Franchise Tax Board, 512 U.S. 298 (1994). Hewing close the lines of the old California tax and/or Multistate Tax Compact’s (MTC) model statute would be a good legal strategy. There still will be many legal disputes and litigation around its application, such as whether corporations are part of the unitary business, nexus, and similar.
From a theoretical perspective for a tax that relies on formula apportionment, like Minnesota’s corporate franchise tax, worldwide combined apportionment is the appropriate way to address the problem of firms artificially shifting their profits to low-tax foreign jurisdictions. (Just to be clear, there is a lot of shifting. See this Table 4 on page 19 of this 2022 Congressional Research Report for some eye-popping numbers.) It gets rid of the weird hybrid of relying on formula apportionment for income earned by domestic corporations and separate accounting (largely policed by the IRS through the link to federal taxable income) for foreign corporations that are part of a unitary business with elective deferral of the earnings. But …
Minnesota would be the only state using worldwide combined reporting. That is an uncomfortable place to be for a small state like Minnesota, given the enforcement challenges. The federal government during the Reagan administration coerced states to abandon the approach in the 1980s under pressure from MNCs and European governments. All states did so. (Promises were made to curb income shifting that were never kept. It took enactment of the TJCA for the feds to do anything and for entirely different reasons, to offset federal corporate rate cuts. I wonder if Paul Marquart will get a call from Janet Yellen, if Minnesota enacts this.) Before that many MTC states (mainly in the west including California) used it. Minnesota never did, though. It is always helpful to have a well-resourced and administratively competent state, like California, or a group of states as compatriots in imposing complex tax provisions. It’s possible, of course, that Minnesota adopting the tax will give other states the incentive and courage to do so. California has a big budget deficit that could be reduced by reenacting worldwide combined reporting. Of course, the state’s constitution makes it difficult to raise taxes.
There must be a high level of uncertainty about the amount and timing of the resulting revenues. Given the lack of direct federal tax data (e.g., which CFCs are unitary under state law concepts) and the inferences required, I assume there is a large confidence interval around the revenue estimates. DOR’s estimate is based on a report by ITEP, a left-leaning advocacy group, on tax havens with a low assumption about Minnesota’s share (1%) of the national amount. Minnesota’s actual share of profits may be closer to 1.5% or 2%. The legislature uses DOR’s point estimates under its budget rules, and my experience is that legislators give close to zero considerations to the variances in uncertainty around individual point estimates. It’s process and political irrationality, of course, but reality.
Given the revenues involved (about $350 million/year), it will further increase the volatility of state revenues. If it modestly reduces the volatility of corporate revenues because foreign profits are diversifying, the high overall volatility of corporate revenues will swamp that effect (if it even exists). Profits nosedive during recessions and corporate revenues with them. Minnesota experienced > 40% year-to-year drops in corporate collections a couple of times during my work tenure. More volatility is not what the state revenue portfolio needs, in my opinion. But those types of considerations are typically small beer to legislators.
DOR’s administrative costs will be steep, I assume. Implementation won’t be easy, especially with a tax year 2024 effective date, only half a year to prepare.
The additional tax burden will be focused, almost by definition, on big MNCs, probably many of them with excess returns. That may affect its incidence or who bears the burden. Just a wild guess – see my musing below.
It is likely to put more stress on application of the murky nexus rules for DOR and taxpayers. The fact that Minnesota uses the Finnigan rule (adopted 10 years ago during the last DFL trifecta) should help minimize the number of disputes, since nexus by any member of the unitary group will be sufficient. But it is still important from a compliance and enforcement perspective I’d think.
State corporate taxes remain deductible federally. That means some of the increased burden of the tax will be offset by reduced federal taxes. TCJA’s big rate reduction (35% dropped to 21%) means that discount is smaller than it was, but it still is material. Because of TCJA’s cap on the SALT deduction, that would not be true of an individual income tax increase (i.e., the House bill’s new 5th tier). However, to the extent it falls on pass-through entities (PTEs) that elect the new entity tax, the SALT cap is avoided. (Does that suggest an alternative strategy of focusing more of the burden on them as an alternative? Maybe.)
In my experience, provisions are occasionally included in initial tax bills to satisfy the budget resolution and get to conference committee with the author (tax committee chair) not really expecting the provision to survive conference committee or a governor’s veto. I have no idea, but that might be a possibility for this provision. Since the senate’s proposed tax bill also contains it, opposition would need to come from the administration and/or second thoughts on how much additional revenue is needed.
In any case if the agreed budget includes a significant tax increase, I expect some form of corporate increase is a high probability. More modest fallback alternatives could include:
Conforming to or taxing GILTI in some way or another. That has been proposed in the past and seems less radical than full worldwide combined reporting. A few other states have done this in various ways. The revenue yield would be much lower, though.
Coming up with a whole new proposal with only two weeks or so to go in the session is highly unlikely, of course.
Incidence Musings
The incidence of the federal corporate tax is a matter of longstanding debate among public finance economists. See, e.g., Dan Shaviro, Bittker’s Pendulum and the Taxation of Multinationals Tax Notes Federal (2021), which I previously discussed here including thinking about the SALT implications. Shaviro discusses the incidence for MNCs (the focus here but at the state level) and how the thinking on that has changed over time (in particular, the two iterations of Harberger’s theorizing). Also see Gale and Thorpe, Rethinking the incidence of the corporate income tax (Brookings 2022) for a recent entry in the debate (suggesting the share of tax allocated to workers may be more progressive because more of it falls on top executives). The focus in both cases is on the tax’s application to excess returns (economist-speak for profits derived from monopoly like features, such as patents, imperfect markets, and similar that yield profits above the normal or competitive market rate of return). Because the firms have already wrung all the monopoly profits out of the market imperfections, it seems unlikely that they can move capital around to avoid tax (to oversimplify matters).
The incidence of state taxes differs from the federal because states are small open economies, making geographic tax shifting easier. I won’t repeat my comments in the earlier post but will waste some time thinking about how they might apply to adopting worldwide apportionment. (As an aside, my policy priors put much more weight on the other tax principles in this context, especially given the murkiness of the incidence effects and the clearer effects elsewhere – on revenue volatility and complexity, for example. But it is a big deal to many DFL legislators.)
As a start, it’s useful to review where revenues from adopting worldwide combined reporting come from to judge the potential incidence of the tax. They differ from simply increasing the corporate tax rate and thus the incidence effects could differ.
Minnesota is a 100% sales apportionment state. That means that the corporate tax base is a function of:
Factor 1: the corporation’s profits or more specifically its taxable income, largely federally taxable income (FTI) plus Minnesota adjustments
Factor 2: the percentage its Minnesota sales comprise of its total sales (i.e., apportionment rule that is used to determine how much of its FTI can be fairly apportioned to Minnesota).
So, what does worldwide combined reporting do and where do the increased revenues come from? The change affects both factors. By bringing in all an MNC’s income/profits earned by its foreign subsidiary or affiliated corporations, FTI or Factor #1 rises. Second, the sales of those foreign corporations are added to the numerator and denominator of the fraction used to calculate the apportionment percentage. The net effect is to reduce the Minnesota percentage because the Minnesota sales added to the numerator will be typically close to zero. So, while FTI rises, the Minnesota percentage drops. Revenues rise because the FTI increase (Factor #1) is proportionally much higher than the drop in the Minnesota sales percentage (Factor #2). That is so because MNCs systematically jigger their accounting to locate as much of profit as possible in low-tax foreign jurisdictions (a/k/a tax havens). As an aside, this is why worldwide combination combats tax shifting – it substitutes a harder to manipulate formula (where sales are located) for accounting legerdemain (prices for goods and services charged by a business to itself thereby moving profits around) that is hopeless to police, even if Congress had not starved the IRS. It also gets rid of deferral of foreign earnings. (Note: the disappearance of repatriated dividends, taxed at an 80% discount, offsets this effect a bit. TCJA probably encouraged a bit more repatriation.)
Tax incidence is a question of how the business responds to the increased taxes. Corporations and business firms don’t bear the burden of taxes; they’re legal constructs or intermediaries. Somehow, the tax will be absorbed or passed on through (1) higher prices (consumers), (2) lower pay (workers), and/or (3) lower returns to capital (shareholders). Because it is a subnational or state tax, the second question is whether those effects will be focused on Minnesota or across the whole business or nation. So, there are two effects – the allocation (1) among consumers, workers, and owners and (2) Minnesota versus national/international.
Legislators typically care most about the second question – how much of the tax increase will be borne by Minnesotans. They may profess to care a lot about progressivity, but if a regressive tax can be exported, they aren’t as concerned. (Solicitude for low-income or less fortunate individuals seems to end at the state border.) For the Minnesota-component, progressives strongly prefer to avoid regressive taxes.
I’ll muse about each element in turn. Caveat: this stuff is very complicated and requires computer modelling of big data sets. So my intuitive inferences based on economic theory are speculative and simplistic. I’m not listing all the relevant factors.
How much of the effect is Minnesota-specific? Because Minnesota uses 100% sales apportionment, the only easy way to insulate its shareholders and contain the effect to Minnesota is to increase prices for Minnesota buyers. Relocating employees or property outside of Minnesota has no effect (see above on what determines calculation of the tax base). The businesses affected by the change are typically large MNCs. I am highly skeptical of their ability and willingness to adjust Minnesota-specific prices to recover the tax. Markets for more goods are national now and for local markets, competitors without international operations are unaffected and PTEs don’t pay the corporate tax at all. That may make it hard for them to raise Minnesota prices even if the market is pretty much local. Note that there is a feedback effect of a Minnesota-specific price increase. By increasing Minnesota sales, it apportions more income to Minnesota by raising the sales percentage and raises Minnesota tax, requiring higher price increases to recover the tax increase. My intuition is that any price effect would be mostly national.
How progressive are the national effects? To the extent the tax is shifted to national consumers, it will tend to be regressive. The national effect should be comparable to an increase in the federal corporate tax, except focused on multinationals that have shifted income to tax havens. Based on the more recent consensus, I would assume the issue would be how much of the tax falls on corporations with excess returns. In that case, more likely falls on shareholders or highly compensated employees (per Gale and Thorpe) and would be more progressive. My instinct is that MNCs that most heavily engage in profit shifting to tax havens (i.,e., those who will be hardest hit by worldwide combination) are those with more excess returns. Income from intangible assets (patents, trademarks, and so forth) are the easiest to shift through transfer pricing shenanigans.
Again, all of this is pure speculation. When I was working, I would have tested propositions like this by running it by Bob Cline or Paul Wilson. They would typically point out the flaws in my thinking (mainly that I had overlooked effects). Now that I’m retired, I can’t do that.
Competitive effects
The business community and Republicans are certain to claim that adopting worldwide combination will undercut Minnesota’s tax competitiveness. That is, it will cause some of the affected corporations to move operations out of Minnesota or to decide not to make new investments in Minnesota as a result. Media reports (MinnPost story) indicate that those claims are already being made.
Economic theory suggests that is not the case. Because of 100% sales apportionment, where property (offices, plants, and equipment) and employees are located has no effect on the amount of tax. Only the location of sales and overall profit levels do. A rational business would not want to forgo profitable Minnesota sales just because a 9.8% tax slightly reduces profits. Put another way, few think a retail sales tax deters business investment and a 100% sales apportioned business tax has close to the same economic effect. Thus, a purely rational decision-maker (business owner or manager) would ignore the tax and simply make an investment where the expected long-run rate of return is highest.
So, does that mean the competitiveness claims have no validity? I would be reluctant to put a high degree of confidence in that conclusion for two reasons. First, empirical testing too often shows that humans do not always act the way economic theory projects. Second and more important, there is an immense number of assumptions that need to be made in estimating long-run rates of return for alternative investments. The resulting estimates are highly uncertain. If the people making those estimates and the managers making decisions based on them think a state’s tax policy is unfavorable there is a good probability that either the estimates or the decisions based on them will be affected. Therefore, despite economic theory, I would not discount the possibility of adverse effects – especially if businesses perceive that worldwide combination signals Minnesota is a state that is unfavorable to business. Perceptions, often not grounded in reality or outright irrational, drive all too many decisions.
That is the sort of wishy-washy, two-handed advice that I used to routinely give legislators. But it is the reality of a highly uncertain and complex world.
This is another of my long discursive posts, a lament on the ugly policy effects of dedicated highway funding, flawed tax design, and the tax pledge. Great, if you like bad roads and encouraging carbon emissions:
The forecast good times for the general fund surplus do not extend to the dedicated highway funds. The February forecast predicts highway revenues will decline in real terms for the FY 2017 to 2027 period.
Failure to index the gas tax is a big deal. In real terms (adjusting for inflation), its rate is at a historical low point, rivaled only by the period before the 2008 rate increase. If the legislature had indexed 1988 rate for CPI inflation, the highway funds would have collected over $6 billion more in revenues through FY 2022. It would have been unnecessary to raise the rate in 2008 (the enacted increase would have been a cut). FY 2022 revenues would have been about a half billion dollars higher.
For decades dedicated highway funding worked well with grudging bipartisan support for periodically raising the gas tax to keep pace with inflation and highway needs. That ended when Grover Norquist’s tax pledge became the core fiscal principle of the Republican Party.
A natural political impulse is to divert general revenues, like the motor vehicle sales tax, to the highway funds. That undercuts the rationale behind user funding and has still been insufficient to meet the needs.
The political prospects for a sensible solution are grim. Hello more deferred road maintenance and higher carbon emissions.
Because 38% of the dedicated revenues go to counties and cities, the state legislature bears much of the responsibility for poor local roads in places like St. Paul, not just local decision makers.
I wrote the initial draft of this before Representative Elkins wrote his Strib Op-Ed and Bill Lindeke his MinnPost column on why Minnesota streets are underfunded. Their views on the gas tax largely algin with mine and are more concise and to the point.
Introduction
Three recent events caused to me reflect on the varying fortunes of the general and highway funds:
The February forecast predictions of $750 million more general fund revenues following on the November surfeit
St. Paul’s request to increase its city sales tax to pay for streets (Strib story, bill)
A Republican legislator borrowing from a star Democrat, Gretchen Whitmer, in tweeting at the St. Paul mayor about the need to spend more on city streets (MinnPost story)
General fund revenues surge; highway fund lags
The 10-year growth of the general fund is twice that of the highway user tax distribution fund (HUTDF), based on actual data and the February forecast through FY 2027. See the graph below. When stating the growth in inflation-adjusted terms, the general fund growth looks more normal (about 15% for the period or a 1.5% annual real growth rate) and the highway fund is shrinking in real terms, thanks to inflation (I used IHS’s estimates for future inflation). Because much of the difference is attributed to the gas tax, I included its growth rate separately. As the graph shows it’s shrinking even in nominal dollars. I assume that is because of estimated growth of EVs. Whether that actually happens is probably open to question.
The varying fortunes of the two funds by biennium (same data) are shown in the next graph. The pandemic dip in driving’s effect on gas tax revenues is clear in 2020-21.
A political perception problem
This is a political problem because public expectations are not nicely sorted into fund buckets, mirroring legal budget rules. When general fund resources are flush, the public thinks all is good fiscally. Legislators can fall into this trap too, as evidenced by Representative Franson’s tweet. There is a tendency to forget that 38% of state highway fund revenues go to cities and counties for their roads. So, the state is partially culpable for inadequate city streets.
Given that reality, it is useful to review some of the underlying realities of Minnesota’s financing for roads. The basic story is that highway financing relies on dedicated, inelastic taxes that are difficult to increase politically to keep pace with spending needs. Putting that in layperson’s speak, highway fund revenues do not keep pace with either inflation or economic growth. That is especially true for the gas tax, which is set in cents per gallon. As a result, revenues lag expectations for highway and road spending, even by limited government, anti-tax Republicans. Constantly making do with less shows up in lower quality services (read, potholes, congestion, more dangerous intersections, etc.).
The worst of fiscal worlds
The practical effect is an unholy combination – underfunding of highways and roads while stimulating more demand for them by holding down gas prices. (As an aside, this cheap gas policy is also a federal feature; Congress has not increased the federal gas tax since 1993 and administrations, Democratic and Republican, use executive actions to hold down oil prices in various ways, recently by easing environmental restrictions on fracking, management of the petroleum reserve and authorizing Alaskan drilling.) That makes nobody happy – neither those of us concerned about climate change and want the existing system maintained nor deniers who want to drive big vehicles farther on better roads.
The big general fund surplus – much of it one-time – will lead to more demand to shift highway funding to general revenues. That has been the trend over the last 30+ years. A couple years ago, I did some basic math to document how much of highway funding comes from general revenues, not user charges or benefit taxes, here. Almost 60% of highway and road funding comes from general revenues (FY 2018 data), like sales and property taxes. That situation is only getting worse.
In praise of user-based highway financing
Before getting into why the system is breaking down, it is useful to briefly consider the benefits of a system of user-based financing. None of us, whether you’re a small government conservative or a proponent of more expansive government, should be happy with slouching away from that system. It helps ensure a right-sized and adequately funded road system, something that is essential to a robust state economy, when it operates as intended as it typically did during its first 70 years.
Since the 1920s, Minnesota has relied on constitutionally dedicated taxes to fund highways, streets, and roads. The centerpieces of that funding are gas and license taxes. We are now approaching about a century of using that model in various configurations. During most of the history, the motor fuels or gas tax was the workhorse, providing most of the revenues.
Dedicated funding provides insulation from the overall budget allocation decisions, while largely ensuring that users of highways and roads pay their own way. It was partially premised on a political expectation that if the public wanted better or more highways and roads, they should be expected to pay more in user and benefit taxes. Reasonable tradeoffs, I think.
The system worked well for decades with increasing purchases of cars, trucks, and fuels and the legislature periodically raising tax rates to keep pace with inflation and highway use. At times, the gas tax worked so well that the legislature tried to divert its revenues to nonroad uses. There is a line of Minnesota Supreme Court cases on this issue from the mid-20th century that curbed those efforts.
This is a virtuous system, if you believe (as I do) that the market is the best way to assess what people want and/or are concerned about climate change. Paying for highways and roads is embedded in fuel prices and that helps people choose where they should live and work, what vehicles to buy (Hummer or Prius?), how much they should drive, whether to ship by rail or truck, etc. That encourages better (more efficient in economic terms) decisions. It also is a mini-carbon tax that ever so slightly internalizes the external costs of burning fossil fuels.
Yes, the taxes are somewhat regressive, but that’s okay for user-based taxes and can be offset by other progressive taxes, like the income and estate taxes, and by the progressive benefits of much other state spending (education, health, and social services) to the extent financed with regressive state taxes, like the sales and excise taxes.
Politics expose structural flaws
That system began unraveling in the 1990s. An apparent political consensus no longer expects highway and road users to pay, but instead favors more reliance on general revenues. But the constitutional and statutory structure was stuck in dedicated funding mode. The natural response of highway and road supporters was to advocate dedication of new, but general revenue, sources. (To be fair, many advocates supported gas tax increases, only turning to general revenues when that proved politically impossible.) Elected officials responded to these entreaties – by submitting a 2006 constitutional amendment to the voters, which was approved and dedicated 60% of the sales tax on vehicles for highways and roads, and by statutorily dedicating other bits and pieces of the sales tax.
Aside on why the motor vehicle sales tax is not a user fee or benefit tax. The sales tax is a broad-based consumption tax that goes to the general fund. Revenues from the sale of one or few commodities are not a user charge or benefit tax for government services related to those commodities. That would be like dedicating the sales tax on residential building materials to housing programs and claiming doing so is a user charge or benefit tax. Dedicating the sales tax on cars simply diverted general revenues to highway uses. Imposing a higher sales tax rate on car purchases and dedicating the resulting revenue, though, would be a type of benefit tax.
To get to the point, why did this occur? Two basic factors caused this turn of fiscal events:
Structural flaws in the gas tax, the principal source of highway funding for decades
The takeover of the Republican Party’s fiscal agenda by Grover Norquist’s tax pledge
Factor #1: Flaws in the gas tax structure
Taxes classically are evaluated against a benchmark of principles – equity, efficiency, simplicity, and revenue adequacy. With respect to equity, the gas tax is regressive but as a user charge or benefit tax it is still fair. This may be hard for progressive types to accept if they don’t accept the principle of user financing. I don’t argue with the underlying values favoring progressivity, but I would observe that the highway and road system can be analogized to municipal utility charges – most would not think its rate structure should be progressive (e.g., based on users’ incomes, rather how much electricity, water, or gas they use). The same general concept applies to the road system. Put another way, dealing with income distribution problems can be more effectively dealt with in other ways than highway funding.
With regard to efficiency (as economists use that term), user-based charges are the gold standard since they are calibrated to the use of the funded services and mirror efficient market allocations. The gas tax also scores highly under simplicity and ease of compliance and administration. It’s easy to impose and collect from a small number of wholesalers.
But when it comes to revenue adequacy and the details of how it functions as a de facto user charge, its flaws appear:
Autopilot tax cuts. The tax is expressed as a fixed dollar amount per gallon. Because this dollar amount is not indexed for inflation, inflation erodes revenues. Essentially, it provides tax cuts on autopilot. That is a very bad thing when highway and road quality depends on it.
Unadjusted for changes in fuel efficiency. Fuel consumption is strongly correlated with use and thus the gas tax works as a de facto user fee. But it needs to be adjusted for changes in fleet fuel economy. It never is. So, as fleet economy has improved markedly – partially because the feds mandated it – users drive more miles without paying more. Moreover, as users switch to EVs, the tax fails altogether as a user fee. (That can be fixed easily with some sort of separate charge for EVs; there already is a modest annual amount. It could be increased or scaled to actual use by mandating use of a mileage transponder.)
Too low for trucks, buses, and other heavy vehicles. Fuel usage is correlated with vehicle weight (heavier vehicles use more fuel), but not nearly enough. So, very heavy vehicles (trucks and so forth) do not pay enough for the damage they cause to highways and roads. Vehicles cause a lot more road damage as weight increases. Taxing diesel, typically used by heavy vehicles and containing more energy than gasoline, at the same rate as gas makes this worse. The tax on diesel should be higher than on gasoline to compensate for the damage done by heavy trucks. A fair number of states and federal government already do that. There is a good policy basis for it.
Over time, the first two flaws, combined with legislative reluctance to raise the tax rate, have been deadly for the adequacy of highway and road financing, while they encourage more consumption of fossil fuels and CO2 emissions. The latter effects are hard to reverse because they become embedded in long-run commitments that cannot be easily reversed – where housing is built relative to jobs, the contours of the vehicle fleet, and similar.
Failure to index the tax rate
The failure to index the tax for inflation is the biggest problem. It means the legislature must go through the politically fraught task of regularly enacting tax increases. It did that for years until appearance of extreme polarization and tax aversion (mainly by Republicans but infecting the entire body politic) starting in the late 1980s. This has resulted in systematic erosion of tax revenues.
I went through two simple exercises to illustrate the erosion:
Estimating how much revenue would have been collected if the 1988 gas tax increase had been indexed for inflation; and
Recalculating what all the previous gas tax rate increases would be in 2022 dollars.
Both exercises show the big effects that inflation’s auto-pilot tax cuts have had on the revenue adequacy of the gas tax.
Indexing the 1988 rate increase. The 1988 rate increase was the one last enacted before Grove Norquist’s anti-tax shtick overtook the GOP fiscal agenda. The DFL did have trifecta control in 1988, so Republican votes were not needed to pass the increase. But after the 1990 election, the DFL did not regain full control until the 2011 legislative session and by that point an intervening gas tax increase had been enacted over Tim Pawlenty’s veto with some GOP support. But it was insufficient to restore the rate to its real (inflation adjusted) 1988 level.
To estimate the lost revenues, I went through a simple arithmetic recalculation of each year’s revenue: (1) indexing the 1988 rate indexed to the general CPI, (2) multiplying by the number of taxable gallons, and (3) subtracting the actual collections. Because this simple calculation ignores the effects on demand of imposing higher tax rates (i.e., the desired side effect of lower consumption and carbon emissions), the estimate is an upper bound. I don’t have a feel for how much demands would be dampened, but I would guess the difference would be material but not dramatically different (whatever that word salad means). By contrast, the reduced revenues are quite dramatic. Expressing it two different ways:
The highway funds (FY 1990 to FY 2021) would have collected $6.7 billion more.
In FY 2021 the highway fund would have collected $500 million more.
Those revenues would have made a big difference in state and local highway spending and quality. $6 billion more in spending (cutting back the estimate of consumption by 10%) would have allowed rebuilding a lot of roads, fixing dangerous intersections and stretches of highways, and similar. At the same time, it would have modestly reduced CO2 emissions and global warming. The 2008 rate increase would have been unnecessary; the enacted 29 cent/gallon rate would have been a cut, not an increase.
Restating past rate increases in 2022 dollars. The table below shows the years in which the gas tax rates were increased and what the rate would be in 2022 dollars. It shows how low the current gas tax rate is. To put a fine point on it, the real rate has only been lower before the 2008 rate increase.
Per gallon gas tax rates – as enacted & in 2022 $
Year of rate increase
Tax rate when enacted
Tax rate in 2022 dollars
1925
0.02
0.34
1929
0.03
0.52
1941
0.04
0.81
1949
0.05
0.63
1963
0.06
0.58
1967
0.07
0.62
1975
0.09
0.50
1980
0.11
0.40
1981
0.13
0.43
1983
0.16
0.48
1984
0.17
0.49
1988
0.20
0.50
2008
0.29
0.39
The 1949 and 1962 rate increases imposed an effective tax rate that was twice as high as the current 29 cents/gallon rate. (I’m ignoring the 1941 rate increase as an outlier reflecting the anomalies of the Great Depression.) I would also observe that (1) Minnesotan’s incomes were much lower back then and (2) the vehicles had much lower fuel efficiencies, so they were burning many more gallons to go the same number of miles we do now. This underlines how light or easy the gas tax burden is now. You would never believe it based on the political rhetoric.
A general pattern of the rate increase is that most set the tax at about 50 cents/gallon in 2022 dollars. That’s the level proposed by Governor Walz in 2019, which was politically courageous (or naive) since the chances of enactment with a GOP Senate were essentially nil and the proposal would likely be a negative for his reelection campaign.
All the structural flaws in the tax could be easily fixed as a technical matter – the rate could be indexed for inflation, adjusted for changes in fleet fuel efficiency, and a higher rate imposed on diesel fuel as many states already do – if there was the political will do so. There isn’t, which is a segue to Factor #2.
Registration and sales taxes don’t help much
The other two main sources of dedicated highway do not have much of an indexing problem. The sales tax is a percentage of the purchase price and so rises with inflation. The license tax is a percentage of the manufacturer’s list prices, less an annual depreciation allowance. So, it also has a measure of inflation-proofing. However, the minimum amount that applies after a vehicle is fully depreciated is a fixed dollar amount. Thus, it erodes over time, a problem, since a lot of vehicles pay the minimum. I did not look up numbers, but the increased durability of cars and the rising prices of new vehicles mean that the average age of the vehicle fleet keeps increasing. That means more older vehicles paying the minimum fee are on the road. In any case, both taxes have elasticities below 1. That means they do not grow as overall economic growth or increases in incomes. Demand for roads is more sensitive to economic and income growth than price inflation.
Factor #2: The tax pledge
I have already extensively inveigled against the tax pledge (see here, e.g.), so I will focus on the gas tax.
The pledge. In the mid-1980s, Grover Norquist, the founder of Americans for Tax Reform (ATR), had the brilliant political (and awful policy) idea of getting politicians to sign a pledge that they would never raise taxes. The current version of it for state legislators is simple:
I pledge to the taxpayers of the state of [state name] that I will oppose and vote against any and all efforts to increase taxes.
The pledge has gone through different formulations but is ironclad. It allows for revenue neutral tax reforms, that is, raising one tax or a feature of a tax that is offset by cuts in that or another tax. It does not allow for increases to offset the effects of inflation. Thus, for a tax like the gas tax (or Minnesota’s excise taxes on alcohol and cigarettes) expressed in fixed dollar amounts, it is a pledge to cut taxes whenever there is inflation.
The pledge relatively quickly came to be adopted as an article of faith for Republican candidates for state office. As an aside, that should be somewhat surprising because it does not reflect the views of party’s supporters. Taxes pay for government. Unless taxes keep pace with economic growth, insisting not increasing them will shrink government, Norquist’s explicit goal, a commitment to fiscal libertarianism. Surveys shows that only a small percentage of Republicans buy into that view. Trump’s solid support by the GOP base, as a populist opposed to cutting entitlements, is another data point illustrating the lack of core party support, outside the likes of ATR, the Club for Growth, and the Koch network which are bastions of libertarianism. Of course, nobody wants to pay more, so it’s easy to buy into the pledge if you don’t think about the real consequences. Hence, Norquist’s political brilliance. I can’t say as much for the party’s elite, big donors and elected officials. Fiscal cynicism. intellectual insolvency, or something along those lines.
Starting in the 1990s, virtually all Republican general election candidates for the legislature (i.e., ones who survived the primary) signed the pledge. I could not find up-to-date data for that. ATR used to maintain a database of state legislators who signed the pledge. On its current website, I could only find databases for members of Congress and governors. No matter, it is widely recognized as a core principle, probably the core fiscal principle, of the GOP. Those who don’t sign typically act as if they had.
The gas tax and the pledge. Over the decades there was a sort of uneasy bipartisan, grudging acceptance of the gas tax that made dedicated funding work. Both parties recognized the need for ongoing and adequate support for the public road network. Democrats generally do not like the gas tax because it is regressive (typically their be-all-and-end-all tax policy principle) but accepted it because it was user based and Republicans would agree to it. Republicans accepted the need to increase the gas tax rate as a necessary evil because of the constitutionally mandated dedicated funding model. That uneasy bipartisan pattern can be seen in the table above documenting consistent rate increases over the years, almost always with some Republican support. Often, the GOP had trifecta control of Minnesota state government (for 4 out of the first 5 increases).
Republicans buying into the Norquist tax pledge broke that uneasy bipartisan alliance and put us in the soup we’re now in. The initial response, when Republicans controlled the governorship and the House, was to divert general fund money to highways and roads. That was done via the sales tax on motor vehicle constitutional amendment in 2006.
That diversion was not enough; general fund resources were extraordinarily tight with the slow recovery from the 2002 recession. That made finding new money, not just taking from the general fund, fiscally necessary and led to the one gas tax in the pledge era in 2008. That tax increase illustrates the difficulty of enacting increases to even partially offset inflation. It seems unlikely to be repeated unless something changes politically. Prospects for that do not look good.
In the 2008 session, Democrats had substantial, but not veto proof, majorities in both houses of the legislature. But Governor Pawlenty was a tax pledger and was plotting a presidential run. That meant a veto override was necessary. Highway advocates convinced 8 Republican legislators to buck the pledge and their governor, overriding his veto. MPR story. After the 2008 election, only one of them was reelected. The others either declined to run or lost in 2010, along with many DFLers who voted for the increase. That makes the likelihood of getting even a few Republicans to support a gas tax increase dismal. It was a nonstarter in 2019 with the GOP-controlled Senate. Impossible when the general fund is flush.
Most Democrats, as noted above, do not like the gas tax because it is regressive and they also know it is unpopular, especially with swing voters who they depend upon for their legislative majorities. The public is very sensitive to gas prices. They’re plastered on big signs on every gas station and there is no easy substitute for buying gas if you want to get to work, shop, go to school, etc. Furthermore, few connect paying higher prices via the gas tax with road quality. That makes Democrats unlikely to go it alone in passing gas tax increases. Even if they accept the compelling policy behind gas tax road funding, it will take immense political courage (kamikaze level for some) to do so. Republican candidates running against them in swing districts will relentlessly hammer them for doing it. Especially hard when the news is full of headlines about big budget surpluses. Hence, the reason why they are twisting themselves into pretzels, as Rep. Elkins describes it, to find other, more problematic, sources of funding. A fine mess you’ve gotten us into, Grover.
Two final political observations
Partisan geographic alignment compounds the problem. The GOP’s total dominance of rural and most exurban districts – where the burden of the gas tax is high because geography compels people to drive more (typically in less fuel-efficient vehicles) and general fund taxes are lower because their incomes are below average – will cause them to double down on opposing the tax, even beyond their baseline tax aversion. It’s in their prime constituency’s narrow financial interests to seek general fund subsidies not gas tax increases.
To be more specific, the gas tax is one of the few state taxes that bears more heavily on rural Minnesota taxpayers compared with their metropolitan area counterparts. It is worth noting, though, that Greater Minnesota still has a net positive balance of payments (positive spending net of gas tax paid of more than 10 percentage points) for its gas tax payments. The details, per House Research, are shown in the table. The spending is from state highway aid to cities and counties. The pattern of direct state highway spending by MNDOT on state trunk highways shows a similar pattern favoring Greater Minnesota. What the table makes obvious is that diverting more general fund revenues, such as sales or income taxes, would benefit rural Minnesota compared to a gas tax increase.
Tax or aid program
Greater MN %
Gas tax
52.5%
Income tax
30.5%
Sales tax
34.5%
State highway aid to local gov’ts (spending of gas tax and other HUDT revenues)
That fiscal pattern likely reinforces political instincts. I am not saying that these spreadsheet calculations of geographic winners and losers drive legislative policy decisions. They don’t. But they’re the background music for the Greek Chorus of rural Republicans chanting opposition to gas tax increases. Meanwhile, DFLers need a few rural and exurban districts to maintain any hope of legislative control. This makes them reluctant to support the necessary rate increases for fear of forfeiting any chance of winning those districts.
You will sometimes see a Washington journalist write a lazy sentence like, “Norquist has a similar stranglehold over most state legislatures.” But this is not remotely true.
The Right-Wing Zealot Who Wrecked the Budget Process and Made Washington Dysfunctional, New Republic (3/13/23).
His main evidence for that is that 47 states have raised (hold your breath) the gas tax over the last 30 years, i.e., during the pledge period. That includes Minnesota’s 2008 increase, which it is hard for me to imagine being repeated any time soon. He makes the leap from those 47 increases to make this assertion:
Why do these state legislators have such an apparently different view of the pledge from Washington counterparts? Because they live in the real world. They have to balance budgets, so they know that sometimes you have to increase a tax. It’s only in the fantasyland of Washington that Republicans can be so insanely irresponsible.
The Right-Wing Zealot Who Wrecked the Budget Process and Made Washington Dysfunctional, New Republic (3/13/23).
That, of course, does not square with my observations on the ground in Minnesota. So, I checked to see which states in the last decade or so have increased their gas taxes. An NCSL publication identified 33 increases from 2013 to 2021. Almost all of these were made in states that are either reliably red or blue where the consequences of doing so did not mean losing partisan control of state government. Only four of the states with increases are, like Minnesota, essentially purple with partisan control regularly up for grabs: Colorado, Michigan (reversed by voters which likely sent a strong political message), Pennsylvania, and Virginia. I think that dramatically undercuts the New Republic article’s point and supports mine. Where political survival is not at stake, politicians are more likely to make sensible policy and budget decisions. In purple states like Minnesota, it is much more difficult.
Bottom line: I do not see a path out of this mess. We’re cursed with subpar highways and roads, along with more carbon emissions. More general revenues, such as local sales and property taxes and state sales taxes, will go to pay for roads, while the state also patches gaps in funding with duct tape and paper clip solutions, like delivery fees.
Addendum: St. Paul’s situation
I live in St. Paul and drive and bike on its streets and so recognize the need for consistent, increased spending for street improvements. If the sales tax authorization survives the legislative gauntlet, I will probably grudgingly vote for it as a second or third best solution to a real problem.
Pledge a problem. As I argued above, the state’s failure to index or regularly raise the gas tax rate is partially culpable in the city’s deferred maintenance. I didn’t calculate how much more municipal state street aid the city would have gotten if the 1988 gas tax rate had been indexed. Aid to all cities would have been at least $500 million higher over 30+ year period. St. Paul’s share would have paid for a lot of street improvements.
The city’s failure to use its own funds is obviously a big part of the equation and the tax pledge played into that. Two mayors, Norm Coleman and Randy Kelly, refused to propose increases in the property tax levy, which resulted in deferred street maintenance. Coleman’s aspirations for statewide office as a Republican guaranteed his hewing to the pledge, of course. So, there is blame to go around with the pledge a central player at both the state and city levels.
LGA not the answer. City officials and others who blame inadequate funding of LGA get it wrong. If the state wants to help cities spend more on roads, it should be done through the highway funds and municipal state street aid, not LGA which is general purpose aid. (That would be yet another diversion of general revenues to roads.)
There also is a touch of cherry picking in their claims that LGA is underfunded. The advocates typically choose 2002 as their benchmark. That high water LGA mark reflects a large dollop of LGA sugar to help the 2001 property tax restructuring medicine go down the legislative gullet, not a considered judgment about the appropriate level of LGA. LGA was typically the go-to mechanism to fine-tune property tax restructurings and get them across the finish line. That was certainly the case in 2001 because the LGA increase (1) bought the support of the Coalition of Greater Minnesota Cities and key votes of rural legislators and (2) achieved the desired property tax burdens by small geographic areas on computer runs at the least state aid cost (compared with increasing county or school aid).
The Ladd Study and other neutral observers have concluded LGA is funded above the level necessary to ensure adequate municipal services. Moreover, in the state-local fiscal relationship, education and county (health, welfare, and social services) services have much higher priority in my book than municipal/city services. If anything, county aid is underfunded and city aid overfunded to my lights. Tolerance of choice and significant variation in the levels of municipal services is okay, unlike disparities in education, health, and welfare. LGA funding is neither the problem nor the solution.
Links to a few random papers I have read recently, almost all irrelevant to SALT issues
NASCAR dumbed down students
This study found a 2007 change in NASCAR rules improved educational outcomes for children living near racetracks equal to “increasing school spending per pupil by $750; or 25% of the effect of avoiding an instructor with no previous teaching experience.” Econofact memo or full paper. (Irrelevant observation: kids living near IndyCar tracks had it better, thanks to the racecars burning various alcohol-based fuels since the series inception. Of course, those tracks likely hosted races by gasoline-fueled cars.) Another data point on why lead in the environment is such a big deal – think of the ubiquity of leaded gas and folks living next to busy streets and highways for many decades.
As an aside, Steven Johnson, The Brilliant Inventor Who Made Two of History’s Biggest Mistakes (NYTimes, paywall), recounts the history of the invention and industry’s adoption of leaded gasoline in an essay on unintended side effects of inventions. It turns out Big Corn, the ethanol lobby, appear a few decades too late to save us from a lot of lead poisoning.
Fixing social security’s finances
I had not heard of R. Douglas Arnold, a retired Princeton professor, but this excerpt (Milken Review) from his recent book, Fixing Social Security (Princeton U Press 2022), describes how Norquistian Republican tax aversion will makes fixing of social security’s finances extraordinarily difficult politically. (That will be so, even if Dems are in control and the filibuster disappears, I would observe.) Of course, predicting the political landscape in 2030s, when SS trust fund will be unable to pay full benefits, is a fraught exercise but extrapolating from the current situation, as Arnold does, presents a bleak picture on reasonable options. A looming disaster unless you’re one who believes unlimited deficit spending doesn’t matter (modern monetary theory anyone?). Meanwhile, Congress keeps pouring more tax expenditures (via Roth fiscal legerdemain and other fiscal tricks) into the private DC retirement system that principally benefits the more affluent.
Unexpected minimum wage effects
A Journal of Public Economics article, Fone, Sabia, & Cesur, The unintended effects of minimum wage increases on crime, finds that increasing the minimum wage also increases crime. Excerpt from abstract: “[W]e find that a 1 percent increase in the minimum wage is associated with a 0.2 to 0.3 percent increase in property crime arrests among 16-to-24-year-olds, an effect driven by an increase in larceny-related arrests. The magnitudes of our estimated elasticities suggest that a $15 Federal minimum wage, proposed as part of the Raise the Wage Act, could generate approximately 309,000 additional larcenies.” Thankfully, they found no impact on violent crime. The hope and common expectations were that an increase would reduce crime.
More minimum wage effects
Along similar lines but not as unexpected (at least to me), this paper from the Philly federal reserve bank, Agarwal, Ambrose, & Diop, Do Minimum Wage Increases Benefit Intended Households? Evidence from the Performance of Residential Leases (July 2019), suggests that landlords capture much of the benefit of minimum wage hikes. They found that landlords successfully capitalized minimum wage increases into higher rents, starting three months after the increases went into effect. For example, the authors estimated “the average of the 76 state-level minimum wage changes was $0.57/hour or 10% and ranged from 1.6% to 35% with the average increase in rents taking up 66.4% of the average income increase.” p. 12. This is consistent with similar research that shows employers capture a good share of the benefits of the earned income tax credits, as I have noted before. Trickle up economics.
Pricing the benefits of income tax simplification
I’ve long advocated simplifying the income tax, characterizing complexity as a hidden tax that yields the government no revenue but costs taxpayers a lot – some legislators probably considered me a nag for bringing it up in response to various of their ideas and proposals. This article, Choi & Kleiman, Subjective Costs of Tax Compliance (2/1/23), suggests that I may have been overvaluing the effects. Choi is a U law professor who I have neither met nor heard speak.
The article is based on an online discrete choice style survey (smallish with fewer than 250 responses used) that attempts to put a value, as the title indicates, on the “subjective” costs of compliance. Subjective refers to the value respondents placed on their time, rather than the traditionally used objective measures, like market prices for tax prep or estimates of respondents’ hourly wage rates. Put another way, subjective value is how the respondents value their leisure time that is consumed by tax compliance, rather than their out-of-pocket cost or foregone wages (if they could easily get paid for extra work hours). The authors found that subjective costs were lower than objective costs, traditionally used in cost-benefit analyses. I found some of the survey results interesting – e.g., respondents valued minimizing anxiety (e.g., about making a mistake) much more than aggravation. Some of the responses, of course, appear illogical at least on the surface.
The authors posit some interesting policy implications, but I would hesitate to recommend legislators make policy based on one survey, although some of them reflected common sense (focus efforts on lower income taxpayers and reducing mistakes rather than just time savings, etc.). The paper certainly is thought provoking and I hope stimulates more research, additional surveys or psychological lab experiments.
SEC rules, of course, require public disclosures by top executives who trade in the stocks of their own companies. The potential for insider trade (e.g., knowledge of private info about your own company) is obvious. Investment professionals scrutinize the SEC data for insights about companies – insiders buying and/or holding being a potential good sign and selling a potential bad sign for investing in a stock. No disclosure is require for trading in competitors’ stock, of course, even though sometimes one might have inside information, because of negotiations, contacts with suppliers, or similar.
Expanded 1099 information reporting on security sales allowed Pro Publica to look at executives who traded shares of their competitors. (As a shareholder, I would not like finding out that top executives have long positions in competitors’ share, FWIW.) They found suspicious examples:
“One executive, for example, sold more than $1 million worth of shares in a competitor’s stock the day before the company had its largest one-day price drop that year.”
“A Gulf of Mexico oil executive invested in one partner company the day before it announced good news about some of its wells.”
“A paper-industry executive made a 37% return in less than a week by buying shares of a competitor just before it was acquired by another company.”
None of that proves insider trading, of course; they are just interesting and suspicious anecdotes. Insider trading, as the article points out, is not easy to prove, especially for criminal convictions. Empirical measures of how common the suspicious practices are would be useful to judge how important a policy or enforcement problem this is.
An interesting question is whether Congress should allow IRS Form 1099 data on security sales to be shared with the SEC to enforce insider trader rules. Without researching the question, I’m quite sure that is not allowed now. I would guess it would provide good leads to the SEC and might deter illegal insider trading, just as information reporting improves tax compliance. Normally, tax administrators strongly oppose using tax data for unrelated purposes, mainly on the theory that it could undercut voluntary compliance. I don’t see that potential here, since the data is provided by third parties, securities brokers, not taxpayers. It seems like a potentially good idea.
GOP gerrymandering advantage gone
That appears to be true for congressional elections according to William Galston, The gerrymander myth(3/17/22) (Brookings). As his title suggests it is contrary to the typical narrative. His short blog post has the details, consistent with what I had casually observed. Republicans gained a huge gerrymandering advantage after the 2010 election and census. That has now evaporated. Two tables in Galston’s post compare the two eras and are convincing to me.
Thus, fixing gerrymandering will probably do little to help Dems politically to control the U.S. House during the rest of this decade.
Caveats. This analysis applies to congress nationally. Gerrymandering continues to distort congressional representation in individual states (for both parties, such as Ohio and Florida for R’s and Illinois for D’s) and in districting legislatures. Events in North Carolina, in which the GOP-controlled state supreme court appears likely to throw out the neutral plan used in 2022 for a GOP friendly plan, and elsewhere may change the equation slightly. (SCOTUS case is pending on the independent legislature theory but may be sent back to N.C. given the state court granted a rehearing likely mooting the controversial case.) Also, more blue states have commissions that yield neutral plans, so that is a long run disadvantage for Dems in the future unless something changes (and in politics, it always does).
Most importantly, gerrymandering is a problem that needs to be fixed, even if it does not systematically advantage one or the other party. Minnesota’s divided control over the last decades (other than Arne Carlson’s veto ineptitude) has allowed it largely to escape this problem. Adopting a constitutional amendment providing for a neutral commissioner would be a good insurance policy that that will continue and, as a bonus, would relieve the courts of a task that the folks who wrote the constitution never intended from them to carry out.
Advice for Dems on rural and white working-class voters
Anyone who has been paying attention recognizes the difficulties that Democrats are having winning in rural areas. As I have noted before, it’s almost as if they’re no longer competitive in rural Minnesota and with each election the effect appears more pronounced. In 2022 the Senate DFL caucus temporarily stopped the hemorrhaging, holding onto two or three rural seats by the slimmest of margins to win a one-vote majority. I would not bet on that continuing.
The Niskanen Center, a center Right outfit I associated with the GOP but not Trump which is officially nonpartisan as a 501(c)(3), published a report that documents that phenomenon, and the similar but lesser problem Dems are having with white working-class voters. Saldin & Munis, Faction is the (Only Viable) Future tor the Democratic Party (March 2023). The authors are two pol sci professors. It’s interesting reading for a political junky and seems a little unusual for conservatives to be serving political advice to Dems. The state of the newly populist Republican Party calls for desperate measures with no apparent home for principled, classic conservatives apparently.
This excerpt from an early paragraph in the report captures the problem the Democrats face, in the authors’ view:
Over the last couple decades, Democratic support in the countryside has cratered. As recently as 1996, President Bill Clinton won over 1,100 rural counties—roughly half the nation’s total. * * * [B]y 2020 Democrats barely had a pulse in rural American. Joe Biden only managed to win 194 rural counties, or about 17% of the party’s 1996 haul. And Democrats still might not have hit bottom. * * * Polling in the spring of 2022 showed the GOP with a whopping 34-point advantage in rural areas on the generic congressional ballot. These polls proved prescient, as preliminary analyses of election returns suggest that Democratic congressional candidates performed worse in rural areas in 2022 than in any year in the modern era, garnering less than 30% of the rural vote.
Faction is the (Only Viable) Future tor the Democratic Party, p. 3
They observe that (based on polling) that the problem is both a policy problem – on social and cultural issues and immigration – but more importantly a perception problem (“pervasive belief” in their words). As they put it:
In other words, the Democratic label/brand is associated with a 35-point handicap in rural areas, which cannot fully (or even largely) be attributed to policy disagreement.
The explanation for this gap is what scholars refer to as “rural resentment.” This concept is defined as a pervasive belief among rural Americans that they have been left behind, ignored, and looked down on by urbanites and the government and media elites who cater to them. Rural resentment has been shown to be strongly linked to voting for Republicans, even after accounting for partisanship, racial attitudes, ideology, gender, age, educational attainment, and other relevant factors.
The key takeaway of this research is that Democrats can’t fully fix their problems in rural areas by moderating on cultural issues (though this will surely help). They also need to be creative in building back the trust of rural communities who see them as elitists who view rural communities with contempt.
Faction is the (Only Viable) Future tor the Democratic Party, p. 6 [emphasis in original]
You need to read the whole first half of the piece to understand their view of how dire the situation is for the Democrats, especially in rural America but also among the white-working class. It seems convincing but I’m not a good judge as apolitical type.
Their solution is for Democrats to change their tactics, emulating the likes of Senator Jon Tester (D-Mont.) and to develop a separate faction in the party with a more conservative orientation. One of the authors is a professor in Montana; hence, the Tester example. They correctly point out that both major parties have often had distinctive factions that deviate somewhat from the national mode (Progressive Era Republicans or Southern Democrats in the post-FDR era as two examples) and allow them to better compete for votes in distinctive geographic areas and with different populations.
This is difficult to do (changing engrained perceptions constantly reenforced by social contacts and Fox News and the like) and is not something that a national party can order up but happens organically I would guess. I think there may be a sort of snowball effect. Once an area becomes solidly dominated by one party, social dynamics take over and make it very hard for the other party to compete. Think about the futility experienced by the Republican Party in the South for the century after the Civil War (admittedly, an extreme example). If there is any truth to that, it suggests the Dems need to act quickly or they may be in the rural wilderness for a very long time.
I’m highly skeptical about the author’s advice as a realistic game plan. But the piece is interesting and thoughtful.
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