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Tax cut consensus is building at state Capitol — what kind, how much, who gets one and how big all still issues

ST. PAUL — With a large chunk of extra cash sitting in the state treasury, Minnesota legislative leaders say they want to cut taxes in 2016, an appealing option to politicians in an election year.

On Thursday, state finance officials will make an early prediction about how much money lawmakers and Gov. Mark Dayton will have available to give back to taxpayers, spend on additional services or stash away in a rainy-day fund.

That’s when the Minnesota Management and Budget agency will issue its next budget and economic forecast. It will serve as the basis for Dayton’s tax and spending recommendations to the Legislature next session.

Many Capitol observers expect the forecast to show a surplus of more than $1 billion.

The bulk of that surplus would be the $865 million that lawmakers left unspent in June, when they passed a two-year, $42 billion budget.

Since then, the state has collected $140 million more in taxes than forecast for July through September. In addition, the U.S. economy continues to perform well, which usually means more state tax revenue.

Dayton and lawmakers failed to reach agreement on tax cuts last session, despite all parties calling it a top priority. They also left unfinished putting additional money into transportation projects, even though all sides agreed the state will need to spend about $7 billion more on roads, bridges and transit infrastructure over the next decade.

Those two pieces of business, plus borrowing money for public works construction projects, will be at the top of their to-do list next year. Dayton wants to add more preschool funding to that list.

“This was the year that we spent money on education and nursing homes. Next year, I think we’re going to see tax relief for our over-burdened Minnesota taxpayers,” said House Tax Committee Chair Greg Davids, R-Preston.

The Senate Tax Committee vice chair, DFLer Ann Rest of New Hope, agreed tax cuts are likely. “I anticipate all the stars are going to align correctly,” she said.

High-tax reputation

Why cut taxes? One reason is “Minnesota has reestablished its reputation as a high-tax state,” the Minnesota Center for Fiscal Excellence reported in October.

Between 2005 and 2008, Minnesota’s ranking for state and local government taxes per $1,000 of personal income ranged from 19th- and 23rd-highest among the states. Since then, the state’s rank has slowly moved upward to ninth place, the most recent year for which tax data is available.

The state’s rank is likely to rise again when the 2014 tax numbers show the impact of the income tax increase on the top-earning 2 percent of state taxpayers enacted by Dayton and the Legislature two years ago.

Leaders in both parties contend certain tax cuts would make Minnesota more competitive with other states and ease tax burdens for middle-income families.

Narrowing differences

Tax bill writers at the Capitol will have a head start on negotiating a deal. A House-Senate tax conference committee appointed last spring remains open with 182 tax-cut proposals worth $2.7 billion on the table.

The two chambers passed vastly different tax bills. House Republicans proposed cutting taxes by more than $2 billion, while DFL senators offered less than $500 million in tax reductions.

But Davids said the two sides had narrowed their differences last spring. If Dayton and the top legislative leaders had given the negotiators a tax-cut target last spring, he believes that he, Senate Tax Committee Chair Rod Skoe and state Revenue Commissioner Cynthia Bauerly “could have gone in a room and cut a deal in 30 minutes. We were that close.”

He and Rest expect the tax conference committee to be reappointed after the Legislature returns to St. Paul on March 8.

The two tax committees are expected to conduct hearings and consider adding more proposals to the stack that’s before the negotiators. But the provisions they have already agreed to are the “basic structure for what we want to accomplish,” Davids said.

Lines drawn

Hammering out a compromise won’t be easy. Noting vast differences in the sizes and contents of the House and Senate proposals, House DFL Minority Leader Paul Thissen of Minneapolis said, “I’m not convinced there will be a tax bill.”

The fate of tax-cut proposals is tied to other contentious issues. Dayton said in September that he wouldn’t support reducing taxes unless lawmakers address his top priority of expanding preschool funding.

Then there’s the clash over how to pay for roads, bridges and transit. Many Democratic-Farmer-Labor legislators support raising the gas tax as part of the solution.

But a gas tax hike is “flat-out off the table” for Republicans, said GOP Sen. Paul Gazelka of Nisswa, a tax conference committee member.

House Republicans have proposed diverting taxes from auto parts, car rentals and motor vehicle leases from the general fund to an account dedicated to roads and bridges.

DFLers oppose the GOP plan because, when fully implemented, it would shift more than $300 million a year that could otherwise be spent on education, health care and other services they staunchly back. In addition, Rest said, “it would be an unreliable revenue source for transportation” because it would fluctuate with the economy.

Tax cuts, if enacted, are likely to be “part of a potential grand bargain” that also addresses transportation and education funding, said Mark Haveman, executive director of the Center for Fiscal Excellence.

Where to begin

Which taxes should be cut? There appears to be bipartisan agreement that the statewide property tax levy on businesses is too high. Cutting it is the top priority for the state’s two largest business organizations, the Minnesota Chamber of Commerce and the Minnesota Business Partnership.

Businesses in rural Minnesota pay the second-highest commercial property taxes in the nation, while taxes on metro area business properties are sixth highest, according to a recent Center for Fiscal Excellence study. Only businesses and cabins are required to pay state property tax levy in addition to local property taxes.

Lowering the state levy would reduce the cost of doing business and make Minnesota firms more competitive, said Beth Kadoun, the Minnesota Chamber’s vice president for tax and fiscal policy.

Cutting that tax is also Davids’ top goal. The House bill would phase out the state business property tax over six years, eventually providing more than $500 million a year in tax relief.

At a minimum, he said, he’d like to exempt the first $500,000 of a business’ property value from the tax. “That would really help the small guy a lot,” he said.

Although the Senate bill would only provide a small reduction in the state business property levy, Rest said, “the Senate stands ready to make some huge improvements in that area. … It’s crying to be revised.”

Middle-class focus

Dayton’s top tax priority is “focusing on middle-class families,” said Revenue Commissioner Bauerly, the governor’s representative at the bargaining table.

Earlier this year, Dayton proposed expanding the state’s “working family tax credit” to include more people and provide larger refunds.

The working family credit, like the federal earned income tax credit, provides refunds to low- to moderate-income individuals and couples, especially those with children, even if they don’t pay income taxes.

“There are a lot of working families who, even at $40,000, depending on the number of kids they have, really do need help getting into the middle class and staying there,” Bauerly said.

The working family credit encourages people to work, makes the tax system fairer and helps kids stay healthier, do better in school, go to college and earn more as adults, said Nan Madden, director of the Minnesota Budget Project, an initiative of the Minnesota Council of Nonprofits.

To further aid middle-class taxpayers, Bauerly said, the governor proposed making more families eligible for tax credits for child and elderly dependent care. Davids said that’s one issue where he agrees with Dayton.

Legislative options

The Senate called for increasing tax credits for K-12 education expenses. While senators didn’t include working family tax credits in their bill, “I think we should,” Rest said.

She also expects Senate negotiators to advocate “some economic development incentives,” such as investment tax credits, particularly for the medical device industry.

The House and Senate bills both would increase the state research and development tax credits. That’s second on the tax wish list for the Chamber of Commerce and the Business Partnership.

Minnesota was the first state to offer an R&D credit in 1981, but since then other states have provided more generous tax breaks.

“That credit really is an important incentive to create high-paying R&D jobs here,” said Jill Larson, the Business Partnership’s deputy executive director.

Other options on the negotiators’ table include tax breaks for Social Security income and military pensions, credits for student loan payments, property tax relief for farmers and more.

Stronger safety net

If the state has a budget surplus, lawmakers can’t give all of it back in tax cuts.

A 2014 law requires that one-third of a state surplus must be transferred into a budget reserve account to protect against future revenue shortfalls. The state currently has $994 million socked away in reserve, but the management and budget office recommends setting aside $2 billion to be safe.

“I think this is a time for policymakers to be prudent,” said the Budget Project’s Madden. “We’ve just turned the corner after a decade or more of deficits almost every year. … Any tax cuts should be reasonably sized.”

Tax cut priorities

Here are some of the high-priority tax cuts that Gov. Mark Dayton, the Republican-controlled Minnesota House and the DFL-controlled state Senate proposed earlier this year. (Dollar figures are for the 2016-17 fiscal years.)

Dayton:

  • Expand child and dependent care income tax credits, $105 million.
  • Enlarge working family tax credit for low-income earners, $83 million.
  • Increase income tax credits for K-12 education expenses, $11 million.

House:

  • Exempt more business and cabin property value from the state property tax levy, $555 million.
  • Create a new personal or dependent income tax exemption, $539 million.
  • Start phasing out state taxes on Social Security income, $237 million.

Senate:

  • Reduce state levy on business property, $51 million.
  • Increase income tax credits for K-12 education expenses, $15 million.
  • Offer tax credits to employers who hire veterans, $5 million.
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