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This Federal Reserve Board discussion paper, Political Connections, Allocation of Stimulus Spending, and the Jobs Multiplier by Joonkyu Choi, Veronika Penciakova, Felipe Saffie, reaches some striking conclusions about the correlation between political contributions to state legislators, the likelihood of getting grants under the 2009 Obama stimulus legislation (ARRA), and their employment effects. Two authors are economists who work for the federal reserve system and the third for the University of Virginia.

Here’s the abstract which succinctly captures their research and findings:

Using American Recovery and Reinvestment Act (ARRA) data, we show that firms lever their political connections to win stimulus grants and public expenditure channeled through politically connected firms hinders job creation. We build a unique database that links campaign contributions and state legislative election outcomes to ARRA grant allocation. Using exogenous variation in political connections based on ex-post close elections held before ARRA, we causally show that politically connected firms are 64 percent more likely to secure a grant. Based on an instrumental variable approach, we also establish that state-level employment creation associated with grants channeled through politically connected firms is nil. Therefore, the impact of fiscal stimulus is not only determined by how much is spent, but also by how the expenditure is allocated across recipients.

Political Connections, Allocation of Stimulus Spending, and the Jobs Multiplier

The paper is timely with the enactment of the $1.9 trillion American Recovery Plan Act (ARPA), which is being partially sold as stimulus, and with Biden proposing spending another couple trillion on an “infrastructure” plan. If political connections (campaign contributions is their measure) yield materially more grants, that certainly raises ethical concerns. It’s even worse, if shoveling money to those firms yields suboptimal outcomes, which they define as stimulating employment (that is a secondary reason for infrastructure projects obviously – the main goal is to construct useful facilities).

So, how did they do empirical analysis to measure these effects and how much credibility should we put in the findings? I’m not competent to address the latter question, so I’ll punt on that beyond making a couple of observations. I am modestly skeptical but their findings are still concerning.

Structure of the research

There were two elements to their research:

1. Determining if “politically connected” firms got more grants because of their campaign contributions.
2. Measuring whether giving those firms more money affected the outcomes – i.e., the number of jobs created relative to the dollars granted to other firms.

What they found

Part 1: Do campaign contributions yield more grants?

The authors used data on grants to businesses from the 2009 Obama stimulus (ARRA) program to determine whether making more campaign contributions enabled firms to get more grants. Obviously, some sorts of sophisticated controls are necessary to avoid picking up random noise or spurious correlations, rather than likely causal relationships. They did that (or attempted to, anyway) using several techniques:

• They assembled a data base that combined ARRA’s data on the firms that received grants directly from states (“prime” vendors, not sub-vendors, or vendors getting contracts from prime vendors or grants from sub-grantees, such as cities) that they matched with campaign contributions made by the firms to legislators in the states making the grants. The campaign finance data was from 2006-08, the period immediately before ARRA was enacted, and was limited to contributions to legislators serving during 2009-10, when the grants were made. The campaign finance data was from National Institute of Money in Politics. They report that firms made 16% of campaign contributions (28% on a dollar-basis). That was a surprise to me, since I had thought businesses directly contributing was rare and more typically owners and employees contributed. But I have never been involved in campaign finance in any capacity and my knowledge is limited to Minnesota. They point out that campaign contributions are predominately made by small and medium sized businesses and those were also the firms that got most of the ARRA grants (see graph on page 10).
• To add a randomization factor – this is key to avoid measuring spurious correlation – they focused on a narrower category of campaign contributions, ones made to legislative candidates in races that turned out to be close (i.e., a 5% or smaller margin of victory) – about 10% of elections in the sample. Their assumption is that for such close elections, the result is effectively random or unpredictable and that will control for other factors (endogenous factors) that could skew the results.
• The dependent variable (what they are trying to measure the effects of) is the ratio of contributions made to winning candidates in close elections to total contributions made in close elections (pp. 12 -13). Firms whose contributions in close elections went 50% or more to winners are “treatment firms.” Thus, they’re measuring whether those firms were more likely to get ARRA grants than firms whose contribution recipients (again, only in close elections) did not win. To avoid distortions by comparing unlike firms, they created pairs of firms (i.e., a treatment and a nontreatment firm) based on the number of campaign contributions made in close races and by industry sector.
• They also added controls for the number of contributions made, firm size, and firm age.

Results. They found that the politically connected firms (i.e., those who contributed to more winning legislative candidates in close races) were 64% more likely to get an ARRA grant. Controlling for the size of the firm, whether it had its headquarters in the state, or how long it had been in existence did not change the regression results. To test for a placebo effect (essentially a correlation caused by something else), they checked and found the treatment firms did not get more ARRA grants in other states or as sub-vendors in the same state. They did several other statistical tests that I won’t summarize to rule out mismeasurement.

My take

I started reading this with a healthy dose of skepticism – it seemed to me that there is a lot of potential for unobserved factors, loosely correlated with making campaign contributions, driving the results. But re-reading and thinking about their research dispelled much of that skepticism. They were careful to develop techniques to screen out that risk. My one lingering concern is that elections in the 2006 to 2008 period (their sample) were Democratic wave elections. So, they may be picking up firms that tend to give more to Democratic candidates and that may not be as random as they think the results in close elections are. But that probably isn’t as much a factor/concern given the results in red states where the Democratic-friendly political environment just made Republican wins closer.

Part 2: Employment outcomes

Their next task was to determine whether skewing grants to firms that made fortuitous campaign contributions mattered – i.e., did it adversely affect the number of jobs created, the primary goal of the ARRA stimulus. To answer this question, the authors turned to an economics literature that I was ignorant of (even though I am familiar with some its authors).The literature analyzes the regional variation in the employment outcomes of the 2009 stimulus to see whether it was effective in stimulating job creation. Put another way, this literature tests whether states that got more money per capita created more jobs, when other relevant factors that differ by state are controlled for. The authors repeat this analysis but divide the grant allocations into those going to politically connected firms and to non-connected firms (again based on contributing to winning state legislative candidates in close elections).

To apply this approach, they use variations across states – essentially categorizing states by how much of their grants went to politically connected firms to test the results. There is quite a lot of variation in the state levels (no surprise) – see Figure 4, p. 21. That variation enables them to do their statistical analysis. The prior literature controlled for economic conditions (obviously, more ARRA grants were likely to go to states that were more severely affected by the Great Recession) and quality of state management (also may attract more grants by making better applications to the feds). That leaves them the task of randomly controlling for political factors; those too may be correlated with the likelihood of getting more grants (being endogenous) or other confounding factors.

They used two factors – whether a state allows corporations to make campaign contributions and the size of its legislature – to measure variation in states’ steering grants to political favorites. In their view, states with more legislators (per capita obviously) have more possible recipients to give to and (hope to) influence. Allowing corporate contributions evidences more opportunity for businesses (corporations anyway) to contribute.

Their analysis confirms the findings of the prior literature – i.e., that the stimulus grants increased employment (about 13 jobs per $1 million) – when the grants were made to firms without political connections. That was not true for states where more money went to politically connected firms. In their words:

In fact, according to our estimates, 21 percent more jobs were created or saved in a state like Pennsylvania, in which only 2.1 percent of ARRA spending went to politically connected firms, than in a state like Illinois, in which 22.7 percent of ARRA spending went to these firms.

Political Connections, Allocation of Stimulus Spending, and the Jobs Multiplier p. 27

This is consistent with other empirical literature that finds inefficiencies in government contracting with politically connected firms (another literature I was unaware of). They conduct several tests to validate that their findings are robust, controlling for various factors (industry composition, flexibility of labor, firm specific factors, etc.) that they think could skew the results.  None of those tests undercuts their confidence in the findings that:

[N]onpolitically connected firms create 13 jobs per million dollars, while the employment multiplier associated with grants to politically connected firms is not significantly different from zero.

Political Connections, Allocation of Stimulus Spending, and the Jobs Multiplier p. 3

My take

I have much more difficulty with the second part of their analysis, although my competence to judge it is thin. I have not read the background literature – either that assessing the effectiveness of the stimulus or on effect of political favoritism on the efficiency of government grants and contracting. But two factors give me pause:

• Their two variables strike me as perhaps tenuous as measures of the potential for campaign contributions to influence decisions. Yes, the law allowing corporate campaign contributions likely is somewhat reflective of a state’s political culture. But I assume most of those laws were enacted generations ago – probably during the Progressive Era at the beginning of the 20^th century. How reflective is that now of a state’s political culture? I get that they think the ability to contribute is the key thing – it’s all about opportunity. But my feeling is that a culture of accepting political steering of grants to political favorites is a big deal. But maybe stuff like that is persistent. Illinois has been corruption-friendly for years; nothing changes?  The size of the legislature variable also strikes me as problematic, since my instinct is that political power and influence is concentrated in a small number of legislators regardless of a body’s size. If that is so, it would not matter so much that contributors have more targets for their contributions and potential influence. Moreover, in Minnesota distributing federal grants is largely an executive branch function and my impression is that legislators have little influence over that, but maybe I am just oblivious or naïve. Practices and rules (regarding legisaltive involvement) obviously may differ. In any case, these are little more than instincts and suppositions on my part. My skepticism, perhaps, should be discounted by their finding of strong statistical correlations?
• I’m a bit more perplexed by their finding that grants given to politically connected firms had no employment effect. That does not seem to square with what I would expect based on the underlying economic theory of Keynesian multipliers. I had thought the whole theory was simply to pump money out into the economy via government spending that results in the hiring of workers who will, in turn, spend the wages and stimulate more employment. (Recall that Keynes famously suggested hiring workers to dig and fill holes would work.) Having absolutely no effect (“nil” is their term) implies the politically connected firms are somehow keeping most of the money from going into incremental spending (putting it in bank accounts, buying existing stocks and bonds, etc.). Okay, I get that is likely to happen at the margin – they do it with some of the grant money – but to have no effect at all? Yeah, yeah, I remember shoebox scandal in Illinois and yes, some of grants probably end up as kickbacks, bribes, etc. that go into shoeboxes or offshore bank accounts. But even so, their results are so surprisingly bad that they verge on the implausible to me. If they created one-third or one-quarter of the jobs, that would make more sense. Of course, measurement of this type is always imprecise.

In any case, the paper is interesting, and its findings are concerning. I’m not sure – assuming one is confident in their results – what policy solution could address the problem. It’s not practical for federal civil servants to hand out the grants and at the state level it is hard to imagine a way to devise a formulaic type mechanism for doing so (e.g., similar to using competitive bidding for procurement contracts). But grant making has never been something I have focused on, so there probably are innovative ways to help insulate the function from politics a bit.

I spent way too much time during my life as a legislative tax staffer trying to figure out what did and did not violate Grover Norquist’s “no-new-taxes” pledge. That pledge was signed onto by nearly all elected Republicans staring in the early 1990s. It hamstrung their ability to make sensible tax and budget policy decisions. Ultimately, some of them (e.g., Governor Pawlenty) got up the courage to look the other way on a few minor measures during very tight budgets (e.g., he agreed to partially close the FOC loophole in the corporate tax to raise a small amount of revenue).

In theory, the Norquist pledge allows revenue neutral tax changes. So, that should allow classic tax reforms that expand the base and make offsetting changes, such as cutting rates. Revenue neutral tax reforms require strong doses of political courage because their inherent dynamic creates concentrated groups of losers (from repealing deductions and credits) that benefit a diffuse group of winner (almost everybody benefits from rate cuts). Any politico knows that will typically not turn out well: an energized group of losers ends up hating you while a big group of beneficiaries doesn’t even know you helped them. To make matters worse, the political aura created by the pledge effectively demonized (in most elected Republican officials’ minds) tax changes that raise anybody’s taxes even if they didn’t raise net revenues. Of course, the most compelling reason to make tax changes is to provide revenues to pay for government services. After all, that is the function of taxes, which everyone understands. But that is precisely what Norquist’s pledge prohibits.

It is not just Republicans that make dumb campaign tax pledges. Joe Biden made a potentially even worse one during his campaign – that no one making less that $400,000 would have their taxes raised. Len Burman, a guy with Minnesota connections (he got his PhD from the U’s econ department), has a great TPC post that explains how Biden’s post – if he follows it – will thwart good tax policy and fulfilling some of his other promises.

On some levels, Biden’s is worse than the Norquist pledge because it blocks cleaning up senseless tax expenditures and prevents user-like taxes. For example, my view is that funding highway and road improvements should be done mainly with user-related taxes. The natural way to do that is with a hefty increase in the gas tax and some sort of alternative fee for EVs. That would have the environmental benefit of mildly discouraging fossil fuel use and linking beneficiaries of the spending with the payers. That is not permitted under the Biden pledge, as Burman’s post makes clear.

Instead Biden’s actual plan funds highways and road with corporate tax revenues and encourages EV use by subsidizing their purchases and charging stations. A gas tax increase would likely be more effective in encouraging EV use. I get that it is a hard political sell because people dislike obvious pain and opponents can easily demonize it. This TPC post points out: “The motor fuels tax has been frozen since 1993 and is the lowest in the OECD.  At 18.4 cents per gallon, it imposes a price of about $18 per ton of carbon dioxide emissions, far below the Administration’s own estimate that the social cost of carbon is around $51 per ton.” So, gas tax funding has the inherent advantage of user financing and is environmentally friendly (a classic Pigouvian tax). But the Biden tax pledge makes it a no-go.

[Note: After I wrote this but before posting it, Howard Gleckman makes a similar point that Biden’s pledge eliminates the best alternative for combatting climate change, a carbon tax. That’s a somewhat more complex issue. The general demonization of all taxes has effectively made an explicit carbon tax essentially a no-go, despite the preference of most economists – and me – for that approach.]

Len’s post is worth reading. I hope it is one campaign promise that Biden abandons. There are a host of changes that would be good to make in the federal tax structure on a revenue neutral basis or that may be the best way to raise revenues to pay for his initiatives, but neither can be done under pledge to immunize anyone making less than $400k/year.

As Len says, “Tax pledges are terrible policy and dubious politics. Politicians of both parties should pledge not to handcuff themselves by making stupid pledges.”

They, of course, stem from the age-old desire to convince people by offering them a free lunch. Human nature abhors a budget constraint; free stuff is compelling. Like all such ploys they are fundamentally based on misrepresentation or deception, which comes in two different flavors depending upon the party:

• Democratic flavor – we can tax somebody else (the “rich” or those making > $400k in this instance) to pay for all the government service we promise and that you want.
• Republican flavor – we can cut taxes without cutting government services that you want. This is slightly more complex but runs something like taxes are already high enough to finance all the government services you want (never mind that the federal government is running massive deficits and state taxes do not keep pace with population, inflation, and economic growth) and, in fact, are now paying for services you do not want. The latter is a deception because they are rarely forthcoming about what services they would cut and their failure to follow through implicitly says voters do want those services. Like the Democrats (with taxing the rich), Republicans in Minnesota try to justify their assertions about cutting spending by identifying programs that are perceived to not benefit their voters (e.g., LGA for center cities and similar).

Unlike Len, I am not convinced that either approach is bad (“dubious” in his terms) politics if the measure of good politics is electoral success. I find it difficult to argue with the political appeal of pitches the parties have now made for decades. Moreover, these “free lunch” pitches follow the approach many businesses successfully used to play on the foibles of human behavior (luring customers with “free” offers, highly misleading pricing, etc.) to sell their products and services. What I find incontestable is that they make for bad governance and they are sold based on some form of misrepresentation.

Of course, tax pledges are not binding contracts or laws. So, the real issue is how much they actually change politicians’ behavior. How willing are they to just look the other way or to say circumstances have changed since the campaign? We know that most Republicans take their pledges very seriously – probably thanks to what Pat Buchanan did to Bush 41 after he abandoned his “read my lips” pledge. The fealty of Dems to their “we’ll only tax high income folks” is somewhat less clear, although we have evidence many of them pretty much honor it (ignoring the economic incidence of corporate taxes partially falling on consumers and recasting sin taxes as something else). Here’s hoping they’re willing to move on or forget their pledges, but I am not optimistic.

As I noted in my book report on Ezra Klein’s book, Why We’re Polarized, I have been watching for years with trepidation the growing political polarization. My former vantage point as a legislative staffer provided a view of how the trend was manifesting itself in the behavior of legislators: more strident views, less working across the aisle even on issues that traditionally were not partisan, less willingness to compromise, fewer centrist members, and so forth.

To try and better understand this phenomenon I have been engaged in a reading project on what’s going on the Republican Party because my perception is that the right (Newt Gingrich, Pat Buchanan, and Trump as prime examples) has been driving the trend. Of course, action sparks reaction, so it’s a bipartisan phenomenon. The right was just the initial and bigger mover. I’ve been in engaged in the reading project for months (January 6th obviously heightens the relevance) and may do a multi-book report (the count is at 5: Max Boot, The Corrosion of Conservatism; John Fea, Believe Me The Evangelicals Road to Donald Trump; David French, Divided We Fall; Robert F. Saldin and Steven Teles, Never Trump; Stuart Stevens, It Was All a Lie; with a couple more on my list to go). Or more likely not, since contemplating going over my notes and collecting my thoughts is too depressing and so far I do not have any special insights. My reading has mainly reinforced my prior perceptions and observations. As an aside, I found the Saldin and Teles book the most interesting with more information new to me. Stevens’ is the most brutally honest about the GOP dynamics by a high level insider that I have read.

I have tended to view the problems of polarization as mainly a matter of politics and effective governance. That is sobering enough since the country increasingly appears ungovernable, given a constitutional structure based heavily on checks and balances with multiple minority vetoes and how closely divided the country is. See the collections of academics’ opinions in this piece by Thomas Edsall in the NYT on ungovernability.

What is really scary to me is this piece at 538, Maggie Koerth and Amelia Thomson-DeVeaux, Our Radicalized Republic, suggesting the polarization goes deeper than what I think of as politics. Rather than being about policy or controlling government, it’s a matter of tribalism, identity, and stuff that is harder to “fix” or change. I really hope that thesis is wrong (probably not) or at least overly alarmists about how bad things are (maybe). The thought that we may be in self-reinforcing feedback loops is particularly frightening. As sociologists have observed when two groups have multiple factors that distinguish them from one another (race, language, religion, cultural traditions, and so forth) the potential for those factors reinforcing each other and leading to conflict, potentially violent, escalates. That may be where we’re going with partisan identity playing a key role. Gives a whole new meaning to “identity politics” – something Klein points out but in a somewhat more benign context and way.

Some telling quotes (to me anyway) from their article:

In this study and others, Mason [Lilliana Mason, a University of Maryland political scientist whose work the article leads with and heavily relies on] found that the increasingly neat alignment between our party loyalties and other parts of our identity — race, religion, education — has made politics an integral part of the way we perceive our own moral character and that of others. [Me: in other words, the “other guys” are immoral!]

Despite that, the way we all think about public disagreement has shifted, said Jennifer McCoy, a professor of political science at Georgia State University. There’s a difference between “I don’t like your ideas” and “I don’t like you.” There’s also a difference between “I don’t like you” and “You have no legitimate claim to political power and don’t deserve it.” Eventually, you get to a place where fewer and fewer people believe in government by and for all the people.

Of course, this deeply personal form of polarization has developed alongside other divisive trends we talked about earlier, like deepening social segregation and isolation, rising income inequality and eroding trust in institutions. Americans’ political identities were being fed by — and, in a sense, absorbing — those changes.

A nation divided into Hatfields and McCoys largely by geography (e.g., urban v. rural) and segregated social groups engaged in political and social war over often irrational and irreconcilable disputes and potentially willing to fight about it (even physically as suggested by January 6th) is not a recipe for a healthy society. Matters of race, of course, play a central role as the article makes clear. Frightening and depressing thoughts.

The worst part is the article’s last section which they title “No Way Out” and which makes clear the difficulty of righting the ship. As far as I’m aware, there is no example of a large multi-racial, multi-cultural democratic society elsewhere in the world to serve as a template.

My initial and now abandoned reaction was primarily to blame Republican elites (particularly the 2016 presidential candidates) who failed to adequately respond to Trump’s candidacy in a way that put leadership and moral values above their own interests. (I recognize and understand that they legitimately underestimated his threat, because I did too. But I would have thought they would know the dynamics of the Republican base better than I or than they obviously did. Politicians, especially at the level occupied by presidential candidates and their consultants, must be more out-touch than I judged – spending too much time with donors rather than their voters. Some of the problem is wishful thinking, obviously. Stuart Stevens’ book, It Was All a Lie is instructive on this dimension.) This is deeper than Trump; he was merely a symptom or the latest manifestation. Yes, he was a major accelerant who put us in a much deeper hole than we were in, but we were in a hole before he ramped up the birther nonsense and ultimately took over the GOP (temporarily, I hope). More fundamentally, it is unclear if actions by a goodly number of elite Republicans would matter – the reaction to Liz Cheney (or Mitt Romney etc.) is telling (re: Cheney see this Politico story the implication of which I take to be that elites are pretty powerless and will end up like Jeff Flake and Bob Corker). There’s a strong element of antiestablishment (w/o regard to party) and even more tellingly “Mason’s research found that people who saw the opposing party as evil were three times as likely to wish death on opponents within their own party.” Yikes. The tendency of most elected congressional Republicans to just keep their heads down and hope this passes (someone else or events fix the problem) is understandable but deeply regrettable and pathetic.

On the bright side, things were much worse before the Civil War, because slavery created a massive policy and economic division and the country was divided neatly by geography (the Mason-Dixon line). Now, the policy differences are relatively minor (in fact, one can make the case that Trump succeeded, in part, because his campaign abandoned Republican orthodoxy on trade and immigration – unfortunately, in my view) and geographical divisions are more like a marble cake across the entire country with sizable minorities of the the other party’s partisans in all states, no matter how red or blue they are. I don’t think we’re headed to another civil war or a breakup as some think, but that’s little comfort.

538 also has a podcast episode (“Partisans Don’t Just Disagree, They Hate One Another”), which includes Nate Silver and Perry Bacon as well as the two authors of the article. It provides some additional color and detail. The discussion of polarization starts at about the 18 minute mark.

Update note: Political and economic events often cause whatever slight value there is in a presentation like this to decay quickly. The November forecast, congressional decisions on a COVID relief package, and similar often may make economic and financial assumptions obsolete. Political events similarly may shift the context. The Senate majority’s announcement that Senator Carla Nelson will chair the taxes committee may fall in the latter category. It was made a few days after the presentation and could suggest a more moderate or pragmatic approach to tax policy issues and/or the potential need for revenue increases than I assumed (or not). As an interesting aside, the two tax chairs (Representative Marquart is the presumptive House chair) represent their caucus’s districts that voted most heavily for the opposition’s presidential candidate. Biden carried Nelson’s district by more than a 9-percentage point margin, while Trump carried Marquart’s by over 18 percentage points. That reality probably partially explains their more moderate views and may bode well for reaching compromises. The reality, however, is that big decisions (such whether to increase taxes and how) are now made by caucus leaders, not tax chairs.

Predicting what the legislature will do is a fool’s errand, which is likely why they asked me to talk today. As always, outcomes of the Minnesota tax legislative process will be determined by:

• The fiscal and economic environment: the size of the budget gap (deficit) and the spending imperatives/demands – e.g., the perceived need for the state to respond to COVID-19 and its other more usual priorities.
• The political environment: the split legislature means both parties will need to reach agreement to enact a budget. 2019 provided evidence that that can be done when there is a budget surplus, since the parties can agree to divide the surplus dollar between each of their preferred priorities (GOP = tax cuts; DFL = more spending). The one recent experience with a large budget gap (2011-12) does not bode well for reaching agreement easily and on time. There now are different political actors (new Governor and legislative leaders), but it’s unclear how much personalities, rather than the character of the parties themselves and their differing policy views, drove the difficulty of resolving matters. The ongoing fights over the Governor’s emergency powers and COVID-19 executive orders surely will make reaching agreement more difficult.

Political Environment: How can the two parties find agreement?

Mark Haveman’s presentation covered the fiscal and economic environment – more of an objective exercise; I’ll move into the subjective realm of politics and guessing what the legislature will do in response. If economic forecasting is a fraught with uncertainty, then forecasting politics is a hopeless waste of time. But it’s fun or, at least, it was a frequent topic of conversation with my former legislative staffer colleagues over lunch or at happy hours. Despite being insiders and working for key actors in the process, our predictions were little better than chance. Having lost the advantage of being an insider, my predictions likely will be worse than chance. Don’t say you weren’t warned.

What does the election tell us about the political environment?

When asked to do this presentation, one of the suggested topics was to assess the impact of the election on tax legislation in the 2021-22 session.

The Election Results. All legislators were on the ballot but no state executive branch officers (e.g., governor, AG, etc.) were. The election resulted in little change in the partisan balance of power:

• The DFL picked up one net Senate seat, but the GOP still retains the slimmest of majorities (34-33). Breaking news as of yesterday, Senators Bakk and Tomassoni broke away from the DFL caucus to form their own moderate caucus, so the split is now 34-31-2.
• The GOP gained 5 net House seats but the DFL retains a slim majority (70-34). The House GOP also has a rump caucus, but it is to the right of the main caucus, not a centrist affair like the new Senate caucus. So, it’s not an opportunity for the DFL to coopt and does not obviously weaken the GOP caucus’s bargaining position.

Tentative reflections on the potential general impact of the election results

Split control makes major tax and other policy changes unlikely. I think it is fair to say (without any inside knowledge) that the DFL had high hopes of gaining control of the Senate. That would have enabled them to close the budget gap and potentially fund new initiatives with tax increases. Retention of GOP control makes that improbable if not impossible. A variety of tax increases may have been possible and certainly some were likely under full DFL control (see below for my speculation as to what shape that may have taken); they are no longer. More likely, little will happen – in terms of material tax increases.

The GOP did quite well nationally and almost as well as in Minnesota (ignoring the elephant in the room, the presidency). This likely will make Republican legislators less willing to compromise on taxes and more willing to “roll the dice” waiting to see what the voters do in 2022 when everyone, including the governor, is on the ballot. It is likely to make moderate DFLers more reluctant to take risks (e.g., vote for tax increases as bargaining positions in the legislative poker game). This will be especially true for those with “swingier” or red districts (and remember this is a redistricting year, so some suburban and rural members may not know the exact political complexions of their districts). For example: Paul Marquart, the current and likely 2021-22 House tax chair, represents a bright red district that Trump carried by a wide margin. He will be instrumental in formulating House DFL tax positions.

Primary challenges eliminated a few moderate DFL members in safe districts. The general election also eliminated a few DLFers in swing districts. That combination is likely to make reaching deals with the GOP harder for the DFL caucuses, since one would guess the replacement members (fewer moderates) will be less willing to compromise. The new two-member Senate moderate caucus is a further reflection of that trend.

The election has further sorted the parties geographically. The DFL more heavily represents center cities, inner ring suburbs. and college towns in Greater Minnesota – the seats the DFL lost were mainly rural or exurban. (The one House exception was the South Saint Paul and Cottage Grove seat the DFL lost. The Senate DFLers picked up a St. Cloud seat.) By contrast, the GOP more heavily represents rural and exurban areas and gained seats there. (That leaves the outer suburbs and the Iron Range as the battle grounds, for whatever that is worth.) The creation of the new Senate moderate caucus is another data point in that trend. It may reflect that the Iron Range is ultimately destined to go Republican, contrary to its longstanding historical roots, making it consistent with the rest of rural Minnesota and overcoming its unique industrial labor history that created a strong affinity for the DFL Party. For those interested in the details of this geographic political split, I recommend listening to Todd Rapp’s fascinating presentation at the MCFE November Policy Forum, available online here (Todd’s presentation begins at the 1:34 mark) to MCFE members or reading Peter Callaghan’s MinnPost story based on that presentation.  As a demographic matter, the GOP voters appear to be whiter, older, and less educated while the average DFL voter is younger, browner, and more highly educated.

An interesting question is whether this geographic and demographic sorting will influence tax policy positions – e.g., the design of state aid formulas and tax expenditures? Unclear, but I tend to think it is no accident that the GOP is such a strong proponent of exempting social security benefits from income taxation (its partisans are older and more likely to be collecting social security) and that they are willing to cut LGA which heavily goes to urban areas (on a dollar basis), areas they don’t represent. Will it affect support for student loan tax expenditures or other policies that have clear geographic or demographic beneficiaries (younger voters tend to vote DFL)? Hard to say; the effects are probably small and long run.

As an aside, rural Minnesota clearly benefits from a positive “balance-of-payments” from state government (i.e., these communities receive materially more in state aid and other state spending than they pay in state taxes). One might wonder how long that arrangement will persist if they remain solidly Republican and (if ever) the DFL regains control of both houses of the legislature and governorship for an extended period. That seems unlikely to occur for quite a while, given the geographical distribution of partisans (i.e., Todd Rapp’s point about the distribution of GOP voters making Republican legislative caucuses competitive for at least the next decade). Moreover, the DFL always holds hope of again competing for rural districts, so it will be reluctant to cut back on funding just because they solidly vote Republican. But without caucus members strongly advocating for rural interests, a natural tendency would be to prioritize other funding areas.

Will formation of the new Senate caucus affect the shape of a final budget deal, specifically with regard to the possibility of enacting tax increases? Off-the-top-of-my-head, I don’t think it will change that much. I simply cannot imagine the GOP majority moderating its tax aversion just because it has two moderate allies who are not actual caucus members. The bigger “what ifs” are what would have happened if the DFL had flipped the Senate with a one or two vote majority. In that instance, Senator Kent likely would have found that she was negotiating with Senator Bakk to keep him from defecting to a GOP-led form of coalition control, in which he would have had a central role in budget negotiations. It could become important if a vacancy occurs in the GOP Senate ranks, though.

Basic Tools for Closing a Budget Gap

There are four simple mechanisms that the governor and legislature typically use to close a budget gap:

• Spending reductions are an obvious first approach. The administration has announced it is already taking some baby steps in cutting state agency spending. But most state spending funds programs operated by schools, cities, and counties. Those amounts are set by statute, which the governor cannot unilaterally reduce so long as there is money in state coffers to fund them.  Reductions in these programs flow down to the local government budgets. They have some limited ability to offset reductions by using their reserves or raising local taxes – typically property taxes. So, state spending reductions can result in local tax increases. But that flexibility is limited in the short run, because of issues of timing and political acceptability.
• State tax increases come in two flavors – (1) temporary or (2) permanent. Temporary increases are useful or politically attractive, if the perception is that the drop in revenues is also temporary and IF you think that temporary tax increases will not become permanent.
• “Shifts” or deferrals of spending or acceleration of revenues – accelerating the collection of revenues/taxes or deferring spending until the next fiscal year. The most frequently used of these is to delay the payment of state aid to school districts. Flexibility in government accounting rules allows the state to increase its “settle-up” payment of aid to school districts (made after the end of the fiscal year when pupil counts and other factors that legally determine the final aid amounts are known) without accruing the liability. The normal settle-up payment is 10%. In the past, the legislature has more than tripled that percentage. That compels many schools to engage in cash flow borrowing, but not necessarily to cut their budgets beyond the small added interest cost of the borrowing. Increasing the school shift could conceivably be used to realize one-time budget savings of $1 billion to $3 billion. The shift is a “permanent” reduction in the level of aid (i.e., it doesn’t need to be “paid back”) until the settle-up percentage is reduced, either legislatively or by the statutory allocation of forecast surpluses.
• Using reserves or other set-aside moneys – this is the classic looking through the couch cushions for money. The current biennium is likely to burn through the basic reserves, but there are a variety of other moneys that have been set aside, such as the stadium reserve (to identify one that most will recognize but there are others) that legally can be tapped for general fund purposes.

To bracket the possibilities for the 2021 session, it is useful to think about what each party would do if they were in full control of all three entities (governorship, House, and Senate).

What would GOP do if it controlled?

The GOP has not simultaneously controlled all three entities since the 1960s, so we must rely upon what they proposed when they controlled one or two of the relevant entities – i.e., 2003-05 (House and governorship) and 2009-10 (governorship) and 2011-12 (House and Senate) – when there were large budget gaps or deficits. That’s not a totally reliable indication of what they would do if they were in full control or as an actual enacted change, since those positions are typically formulated as opening bids or bargaining positions for the legislative negotiations.  But it is the best indication that we have.  So, based on those experiences, the following seems likely.

• Heavy reliance on shifts or deferrals – it seems likely that they will do the maximum feasible amount of shifts (not sure what that would be, but maybe $3 billion or more), since that is the path of least political resistance. The obvious big candidate is the school shift. Because few of the other previously enacted shifts have been reversed, there are not too many other options. One possibility would be to increase the June accelerated sales tax (e.g., slightly raising the percentage rate and/or adding excise taxes once again). There may be other minor spending side deferrals that are possible.
• Spending reductions would make up most of the rest. In the past, the GOP has proposed large cuts in human service and state agency spending and to not increase K-12 and transportation spending. I would expect that pattern to continue in the Senate’s proposals. They will likely also propose substantial cuts in aid to cities and counties, as well as in the property tax refund. The city and county aid cuts will focus on aid paid to urban cities (Minneapolis, St. Paul, and Duluth) and counties (Hennepin and Ramsey especially), since doing so has little effect on the districts they represent. On the property tax refund, I would expect that they will propose renter credit cuts with smaller cuts in the property tax refund if any (probably scaling it back so higher income homeowners get less). In 2011, they proposed significant renter credit cuts.
• Rummaging through the couch cushions will also be done. I would expect that this could be good for a modest amount (at best, somewhat over a $100 million or so).

Obviously missing here are tax increases. Governor Pawlenty proposed a cigarette tax (well, okay, fee with a fig leaf special fund) increase in 2005 that was enacted. But that was an 11^th hour proposal to reach a compromise and the GOP has stepped its tax aversion quite a bit in the 15 years since. Opposition to tax increases of any type defines the party’s brand; supporting tax increases is sure to earn an elected Republican the RINO (Republican In Name Only) moniker. As a result, and based on Senator Gazelka’s public statements, I think the GOP will strongly oppose closing the gap with virtually any tax increase. I’ll get into this a bit more below under the potential compromise or deal.

What would DFL do if it controlled?

The DFL was in control of both legislative bodies and the governorship in 2013-14 in a somewhat similar budget situation, so that provides a reasonable guide, along with what they have said on the record. Based on that and my own wild ideas:

• Modest reliance on shifts – during and in the aftermath of the 2002 recession and the Great Recession the DFL regularly railed against the heavy reliance on the school shift that was a legacy of the Pawlenty era, but I see no way that the Governor and House do not propose some version of it just to make the numbers work without a massive tax increase that they know (1) will not be agreed to under any scenario by the GOP and (2) would be a political liability in the 2022 election when the Governor and all legislators are up for election. I would guess that this number (pending the uncertainty about the size of the gap) will be in the $1 billion to $2 billion range.
• Small spending reductions – just as the GOP will not propose tax increases, the DFL will be reluctant to propose large spending reductions. They still will propose and agree to some. But we are here to talk about taxes.
• Heavy reliance on tax increases – I expect both the Governor and House to propose to close the gap heavily with tax increases. Based on 2013, the go-to options will be corporate, income taxes on high-income filers, tobacco taxes, and to a much lesser extent a collection of other taxes. I will speculate about that more below.
• Couch cushions – like the GOP this will be de rigor. Since MMB has the best knowledge about these options, the governor seems likely to take the lead. But some of them have already been tapped during the 2020 sessions and legislators are often willing to push the envelope more than governors. Legislators, however, tend to be willing to propose ones of more questionable practicality or legality to make their opening bids in the negotiations more politically palatable while still “balancing” (at least on paper).

Since this seminar is supposed to be about taxes, I’ll speculate about what sort of tax increases the Governor and House may consider including in their budget proposals and, then, further speculate about whether any of them could actually get enacted. Here is where I’m in really dicey territory – evidence-free, fake news, conspiracy theories, whatever you want to call my idle speculation. None of this is based on inside information. Except as otherwise specifically noted, I expect the GOP response to each of these options to be no. At the end, I will speculate possibility of a budget “deal” to end the (likely special) session.

Corporate tax possibilities

• Conform in some way to GILTI – Speaker Hortman has said this is likely option during campaign, probably similar to what the House proposed in 2019 would be a good guess; Governor likely will propose some other variant that is less aggressive than the House version. Taxing something called “foreign earnings” is attractive politically. Campaign literature that includes charges of “My opponent voted to tax the foreign earnings of multinational corporations” probably is not worth the cost of the paper and ink. In fact, it might cause some more reflective readers to wonder why you would prefer to cut education or other attractive state spending priorities instead.
• Partial tax on TCJA repatriation income – this has the feel of retroactivity, but the TCJA itself had a similar retroactive feel (i.e., tax applied to income earned potentially many years earlier, which federal law permitted to be permanently deferred; so, the repatriation tax repealed a de facto exemption of income earned many years earlier in some cases); federal tax applied in TY 2017 but is payable in 8 annual installments; state could take a parallel approach requiring recognition of federal repatriation amount in 2021 (i.e., taxing some percentage of the federal 2017 amount as a dividend, payable in tax years 2021- 24). State could argue it is conforming to TCJA’s deemed end of deferral, but with a bonus of four more years of interest-free deferral than allowed under federal law? This has the attraction of being a one-time, temporary tax. Comment about possible GOP response: Although the GOP legislature’s TCJA 2018 conformity bill taxed the income, it used its temporary revenues for a permanent rate cut; that does not show an appetite to use it as a revenue raiser for spending.
• Impose corporate tax on pass-through entities – this has been proposed as a way to circumvent TJCA’s $10k limit on the SALT itemized deduction (IRS has indicated it will issue regs allowing) – in a twist, DFL could turn it into a revenue raiser by setting a higher rate or not fully exempting the income on the individual income side (suboptimal approach because it would reduce federal deductibility of the tax paid)
• Temporary surtax – I do not think this has been done since the 1950s.

Individual income tax possibilities

• Temporary or permanent rate increase on high-income filers – seems like that well has been tapped already with the 2013 rate increase, but that is where DFL rhetoric typically points and other states still have higher top rates.
• Temporary increase of some sort (surtax as was done in the early 1980s). I doubt that they will go there, since GOP will not agree, and they would be bludgeoned with it in the 2022 campaign as taxing everybody, even though almost 50% of the population does not pay income tax.
• Repeal 2019 rate cut championed by the GOP – they might not want to go there because it would be a middle-class tax increase, since the rate cuts were on the lower brackets. Same arguments as made for the surtax apply here but it would not be temporary, so even worse politically.
• Base increase – e.g., limit deductions (mortgage interest, property taxes, or similar), repeal more recently enacted tax expenditures championed by GOP (529 plan breaks, reciprocity breaks for those working in Wisconsin, student loan credit, long term care credit, etc.) – since I’m no longer talking with members, I don’t have a good feel for the politics of any of this. Typically, they are considered a heavy political lift (concentrated opposition from the interest groups that support them) relative to the modest revenue they raise. I am sure that they will not go after the social security deduction that was enacted in 2017 and expanded in 2019, given its political popularity and senior citizens’ electoral power.

Sales tax possibilities

• Expand base by extending tax to services or repealing some exemptions – this was a classic move in the old days (late 1980s and early 1990s); no one seems to talk about it anymore, but I would not be surprised to see some limited options reappear.
• Expand local taxing authority – this could be done in the metro area for transit, allowing reduced general fund payments for transit operations or general authority could be provided for cities and counties to impose and use for general purposes. Most existing local taxes are restricted to specific capital type projects. State savings could be realized by offsetting or reducing aid paid to the local units that are granted new authority (LGA for cities or CPA for counties). This passes the formal political responsibility for actually imposing the tax increase to local units, slightly reducing the political risk to legislators. GOP response: This might have some slightly greater potential for inclusion in a final “deal” for that reason. Similar approach was taken in 1992 with counties imposing sale tax rate and offsetting state aid when Arne Carlson was governor and the DFL controlled the legislature. The current, strong version of GOP tax aversion seems unlikely to go for such a fig leaf, though.
• Temporary rate increase – seems unlikely because Minnesota’s rate is already very high and it’s regressive, which does not appeal to DFL legislators.

Other taxes or revenue possibilities

• Increase gas tax and back out some general fund money used for highways (e.g. dedication of sales tax on vehicle repair parts or vehicle leases) – Governor proposed gas tax in 2019 and seems likely to do so again; this could be used as a backdoor way to help general fund by reducing general fund subsidies for highways. Likely GOP response is strong opposition: Senator Gazelka’s public statements and their campaign positions probably lock that in.
• Increase cigarette excise tax – this was done in 2013 to such an extent that there is little room for additional increases, but the 2017 tax bill repealed indexing of the tax rate. One possibility would be to restore that or to increase the rate by the amount that indexing would have yielded absent its repeal. Sin taxes (same goes for alcohol excise taxes which are a less popular option) are among the most regressive taxes, which causes DFLers generally to disfavor them, but the revenue and government costs of the vices often overcome their equity concerns. Legislators representing districts on the state borders generally strongly oppose increases because they cause leakage of sales to retailers in neighboring states.
• Increase alcohol excise tax – this has been proposed in the past to fund chemical dependency treatment; excise tax rate was last increased over 30 years ago and is not indexed for inflation; tax is much lower than the government’s cost of dealing with alcohol abuse.
• Legalize marijuana and impose an excise tax on it. Voters in four states (AZ, MT, NJ, and SD) authorized legalization and taxation in the 2020 election, but I doubt that will sway legislative opponents’ minds. The short run revenue potential is limited because it will take time to institute a regulatory and tax system for a newly legalized product; with its narrower majority in the House I wonder if the DFL has the votes to pass, although one or two libertarian GOPers could crossover and vote for it, I suppose.
• Repeal some of the GOP-led reductions in the state general tax (C/I property tax) – I doubt that they would propose to eliminate the exemption, but could see DFLers proposing to increase the levy, set the tax as a rate rather a levy, or restore indexing of the levy.
• Increase estate taxes, e.g., by reducing the exemption amount or making rate changes (e.g., going to a flat rate of 16%, the current top rate, or going even higher as in Washington state) – DFLers favor progressive taxes and estate taxes are an easy way to do that; the small potential revenue yield makes it largely symbolic, but it’s a big symbol to both parties; the ferocity of the debate is surprising given the small revenue stakes and number of taxpayers involved (like Henry Kissinger’s description of academic politics – “they’re so vicious because the stakes are so small”)
• Others may be proposed (carbon tax?)
• Compliance initiatives were a staple of Pawlenty administration to raise revenues without increasing taxes. In a stalemate environment, they could reappear. One option a few other states have started to look at are liquidated/defunct partnerships and S corporations with negative capital accounts from booking losses in excess of income. The IRS allegedly has not been attempting to collect the recapture taxes that would be owed as a result and that expanded data availability may allow auditing for that and collecting from the partners or S shareholders. This would be extraordinarily complex for a state (probably why the IRS has not pursued – in addition to the reality that it might encourage zombie partnerships and S corps to avoid paying) and the revenue yield is likely to be long run, rather than a quick fix. That reduces the ability to book money for budget purposes. GOP response: This seems like a live possibility because it is not a tax increase per se. But its viability will depend upon whether DOR staff think it is feasible option – I have no insight on that since I have not been in contact with them.

Prospects for a deal that includes some type of tax increase or other changes?

Based on the 2011 experience, it seems unlikely that the GOP Senate will agree to any meaningful tax increase. The election results, which they will regard as a rejection both nationally and in Minnesota of a liberal or big government agenda, will likely stiffen their resolve in that regard. However, I would not totally write off some limited and temporary tax changes (e.g., on corporations or excise taxes) that raise a modest amount of revenue BUT ONLY IF the deficit/gap is very large (e.g., $3 or $4 billion more than the current estimate).

As I suggested at the beginning, making predictions about what the legislature will do it foolhardy. But here goes (disclosure: I would not put any money on my predictions):

• One thing that is safe to predict is that there will be a budget deal. It may take an extended special session and a government shutdown (as in 2011).  But Minnesota, unlike some states (e.g., Wisconsin and Illinois), does not have a permanent spending authority allowing the state to operate on autopilot in a deadlock. On the surface that is good, because it makes running up a de facto deficit as Illinois has done more difficult. It makes government shutdowns more likely of course.
• The deal will include a large helping of shifts – closer to the maximum tolerable amount than a minimal amount like $1 billion. That is so because it is something both the DFL and GOP can agree on; it’s the politically easiest solution. Opposition to forcing schools to borrow, which is what the school shift does, was a drum beat of DFL legislative campaigns in 2012 election and may have affected the GOP’s loss of their majorities. But it’s unclear how much that was a factor, given the myriad of factors involved in any election campaign. For example, the 2011 legislative Republicans also were responsible for repealing the market value credit, resulting in homeowner property tax increases (especially in rural areas of the state, their strongholds). One GOP legislative staffer privately told me that they felt the decisive factor in 2012 election was putting the two constitutional amendments on the ballot (Voter ID and Same Sex Marriage ban), which drove the DFL base to turnout in mass. So, it is not clear to me how much they will consider a big increase in the school shift to be a political liability based on the 2012 experience. I think will view the shift as preferrable to tax increases or larger spending cuts in reaching a deal with the DFL. But that’s just a guess by a nonpolitical guy.
• There will be some amount of spending reductions, many of which will likely be shared or primarily borne by cities and counties through reductions in state aid. Failing to fully fund the current services level of health and human services programs seems likely because there is so much money in those budgets and the GOP typically proposes it.  (Whether you consider that to be a spending reduction typically depends upon whether you are a Democrat – yes – or a Republican – no.)
• Whether there will be any or significant tax increases is the big unknown. If the deficit remains modest – e.g., because Congress comes through with aid and/or the economy continues to recover – will be a key factor. If the budget gap is less than $4 to $5 billion, I would guess there will be no tax increases or very small ones wearing disguises (fee increases, cuts in tax expenditures, etc.). As the size of the gap rises, the possibility of some type of tax increase rises. But …
• I would be remiss if I did not point out that the 2011 budget deal uncovered the legal ability of the state to use “appropriation bonds” or non-tax revenue securitization (such as tobacco bonds) as a de facto deficit financing mechanism. I would not be surprised to see that option reemerge if the gap to be closed is exceptionally large ($6+ billion). The tobacco settlement payments are no longer an option.  But there are other nontax state revenues that could be securitized. I would guess the Senate GOP will hold out for that before agreeing to material tax increases. This approach is problematic (more so than deferrals or shifts) because payback must start in the next biennium, deepening the hole the state will be in then. That was not a big problem in 2013-14 because DFL control resulted in enactment of a large tax increase augmented by a modestly robust economic recovery. It would be very problematic with continued divided government and a stagnant economy in the 2023-24 biennium.

Possibility of other tax changes. Even if the final deal does not involve tax increases, I would assume that would not foreclose making changes that shift the tax burdens around without raising revenues. That might allow passing a conformity bill that addresses some of the federal changes made in the CARES Act, among others. Conforming to the NOL and loss changes is highly unlikely because of the large revenue reduction that would result, but there may be ways to mitigate the complexity caused by linking Minnesota law to an earlier version of the IRC.  Working around TCJA’s limits on SALT deductibility for pass-through entities (referenced above as a revenue raiser) is sure to be seriously considered and has a good possibility of being adopted because it is a relative cheap way (feds bear the cost) to bestow a benefit on an important constituency. Addressing extenders will come up in 2022.

In any case, a session that must respond to a (hopefully) once-in-a-century pandemic and close a very large budget gap is sure to hold many surprises and unexpected results. It is also safe to predict that enacting a budget will require a special session that will not conclude before June, if then.

Yesterday’s WaPo has a story, David J. Lynch, “Mounting commercial real estate losses threaten banks, recovery” (11/11/2020), about the growing problems in commercial real estate as a result of the pandemic. The main thrust of the story is the pressure that this may/will put on banks and other real estate lenders. Two paragraphs on the details of the Burnsville Center bankruptcy caught my eye. I’m sure they weren’t news to locals (unlike me) who are involved in real estate and who pay attention to such matters, but they appear sobering. Here are the two paragraphs (the whole article is worth reading):

In July, CBL & Associates, a real estate investment trust, was due to pay off its $63 million mortgage on the Burnsville Center, anchored by tenants such as J.C. Penney and Macy’s. Instead, after pandemic-related “store closures and rent reductions” cut into mall income, CBL surrendered to its lender half of the mall, which it had pledged as collateral.

That 525,000-square-foot parcel was worth $137 million in 2010. But last month when the unpaid note was auctioned off, it sold for less than $20 million, according to Trepp. That 85 percent decline will mean losses for investors holding the riskiest slices of a securitized loan pool packaged by Goldman Sachs’s structured finance unit.

David J. Lynch, “Mounting commercial real estate losses threaten banks, recovery” Washington Post, 11/11/2020

That is a spectacular drop (recall 2010 was not a good real estate market), if I’m reading it correctly and the numbers are close to actual market values. Distressed sales, of course, don’t often reflect fair market values and assessors reject them as comparable sales, of course. But if this is a partial glimpse of the new retail reality, the property tax effects on other properties (think homes and apartments in taxing districts with malls, especially the less healthy ones) will be felt as the assessors’ values recognize the market reality (more displacement of bricks-and-mortar retail sales by Amazon and other online sellers). That will probably take two or three years to show up, which is just when local governments are likely to start raising their levies again and putting a pause on levy increases to give taxpayers some pandemic relief.

The bonding bill that Governor Walz signed on Wednesday (October 20) is also a tax conformity bill of sorts. It ends a decade-plus run in which Minnesota failed to conform to the § 179 rules allowing some businesses to deduct purchases of capital equipment in the year made, instead requiring 6-year amortization. This House Research publication explains the old Minnesota rules, which are now largely obsolete starting for purchases made in 2020 or for qualifying like-kind exchange property purchased in 2019. Earlier versions of the publication (which I coauthored) detailed the history of federal changes in the § 179 rules that Minnesota did not conform to, but the one-page format no long can accommodate that long list. I do not believe the old editions are available on the Internet.

What’s the single subject?

It is somewhat unusual (to put it mildly) that the provision passed as part of what is predominantly a capital investment or bonding bill.  Moreover, it’s not the only tax provisions in the bill; article 8 contains a collection of minor tax provisions, mostly changing property tax rules (eliminating the need to pay tax before demolishing damaged property in some cases – think Lake Street – classification of Airbnb rented cabins, etc.). The bill also contains supplemental appropriations. Including tax provisions in a bonding bill may very well violate the constitutional requirement (article IV, section 17) that a bill embrace a single subject, although I guess one could argue its single subject is public and private “investments” so to speak. (The bill’s title, which is one touchstone of the constitutional provision, does not do that but characterizes it as “relating to public finance[.]”) Any single subject concern is likely a technical one, since I doubt anyone with legal standing to challenge the conformity provision would want to bring a lawsuit. Minnesota’s taxpayer standing is limited to challenging illegal spending, not unconstitutional tax reductions and the provision does not raise anyone’s tax, conferring standing in that way. That would not be true of the property tax provisions – any owner of taxable property in a jurisdiction affected by the changes would likely have legal standing to sue, since the property tax is levied-based (i.e., any change in the tax base changes the rate and shifts the burden). But no one likely will do so. Thus, musing about single subject violations would be an academic exercise.

Revisionist history

The Strib story on Senate passage of the bill quoted Majority Leader Gazelka on the conformity provision (my emphasis in bold):

Senate Majority Leader Paul Gazelka, R-East Gull Lake, praised a provision to align state and federal tax law to allow businesses to deduct large equipment purchases. Gazelka said the change, which Republicans have pushed for years, will allow farmers and business owners “to invest in their operations and keep growing their business in these challenging times.”

Torey Van Oot, “Minnesota Senate approves record $1.9 billion infrastructure package,” Star Tribune (October 16,2020).

Their ”pushing” of § 179 conformity, by my lights, was pretty weak, since they:

• Did not bother to include section 179 conformity in the 2017 tax bill that they passed, when Republicans controlled both houses of the legislature. (That was the bill that Governor Dayton signed to avoid triggering an effective date in another bill making Department of Revenue funding contingent on tax bill becoming law.) Instead, they opted for:
  1. Tax deductions for social security recipients
  2. Deductions and credits for parents saving for college in 529 plans
  3. Tax credits to educate first-time farmers and to help them buy farmland
  4. A business property tax cut
  5. Tax credits for student loan payments
  6. Tax deductions for those saving to buy a home
  7. Tax credits for Minnesotans who work in Wisconsin and pay higher taxes because Wisconsin’s income tax is higher than Minnesota’s
• They did include it in their 2018 tax bill, but they knew that bill would be vetoed by Governor Dayton because it was wrapped up in a tax cut unacceptable to him. Coming up with a conformity bill that could be enacted into law would have required negotiating with the governor and jettisoning some of the bill’s tax cuts (probably § 179 conformity if their actions in 2019 are the guide).
• They did include it in their initial 2019 tax bill (as did Governor Walz in his tax proposal and the House Democrats in their bill), but they did not insist on it in either the high level budget negotiations or in the tax conference committee negotiations because it was not included in the final 2019 bill. Instead they must have insisted on:
  • More tax deductions for social security recipients
  • An income tax rate cut
  • More business property tax cuts

All those tax cuts made it into law and were priority items for the GOP Senate by most accounts.

Thus, Senator Gazelka’s comment that “Republicans have pushed [§ 179 conformity] for years” really means it was on our list of tax cuts (a really long list I would add), but was a lower priority than handing goodies to seniors and business property owners. It was only when farmers and tax preparers started telling us the effects and making a stink that we got religion and, in the process, created a bigger budget hole for the governor and 2021 legislature to solve.

One counter is that Democrats were also responsible for the 2019 failure, since they proposed it as well. True enough but they’re not the party of business, the party defined by tax cuts, and they don’t claim (to my knowledge) that they have been pushing for the provision for “years” as the GOP Senate apparently now does. Moreover, one would think the party that regularly touts the importance of “job creators” would prioritize reductions for businesses buying new capital equipment over breaks for social security and similar.

One possible view is that the GOP Senate is really just a clever negotiator, since their strategy ended up yielding larger tax cuts, a plus for Republicans, than if they had responsibly insisted its inclusion in the 2019 tax bill. (I tend to think this was not an intentional 2019 strategy – I can’t imagine they’re planning chess moves that far ahead, but who knows.) The legislative process does reward what seems (to me anyway) bad faith behavior in negotiations all too frequently.

My point is not to diss Republicans rhetoric and their positions but that this episode reveals the tepid political appeal of federal conformity – particularly for business provisions – as I will describe in a forthcoming second post on conformity.