Committee for a Responsible Federal Budget

Spotlight on the States: Minnesota

Mar 25, 2011 | Taxes

In this installment of our Spotlight on the States blog series, focused on Minnesota, we take a slightly different look at the state's fiscal situation. In the past this series has given brief looks at states' fiscal problems and the different ways they've gone about solving them--mostly through examining their respective budgets and new budget proposals. We thought that this recent development in Minnesota, however, deserved its own unique blog in our series.

Last month, Minnesota's Department of Revenue released a comprehensive analysis of the state’s tax expenditures. The report, titled Tax Expenditure Review Report: Bringing Tax Expenditures into the Budget Process, was done in compliance with state legislation enacted in 2010 to suggest a process for reviewing tax expenditures and improving their oversight. The report makes several recommendations to the state legislature and offers interesting insight into the purpose, benefit, and efficiency of tax expenditures.

While reading about a tax expenditure review process doesn't sound like fun, the issue is so important for responsible budgeting and Minnesota has provided a great model--so bear with us! The evaluation followed three guiding principles of tax policy: efficiency, equality, and simplicity. The information used to evaluate each tax expenditure was its purpose (many do not have a stated purpose or do not effectively meet their purpose), its impact (direct, indirect, and on the budget), and consideration of alternatives (whether another method could achieve similar results more efficiently). The report recommends an eight-year cycle of evaluations in which the highest priority tax expenditures are evaluated first. Some of the tax expenditures recommended for early review were:

  • The mortgage interest deduction
  • Charitable deductions
  • Child and dependent care (credit and exclusion)
  • Sales tax expenditures for clothing, food, and drugs and medical expenses
  • All property tax expenditures
  • All but one of the nine corporate tax expenditures that cost more than $10 million

Factors in designating a tax expenditure as high-priority included if it's difficult to administer, if it has a large annual revenue impact, if it could be easily replaced with a direct expenditure, and if it's been the subject of recent legislative proposals for modification or repeal. The report also stated that while Minnesota has a better budgeting process for tax expenditures than most states, their overall assessment of them “remains weak” and that:

"A tax system based on these three principles [efficiency, equality, and simplicity] would have far fewer tax expenditures than currently exist. Efficiency and equal treatment of equals both favor broad tax bases with low rates. Justified tax expenditures would include only tax provisions that offset a market failure or externality or that decrease the cost of tax administration by enough to offset lost efficiency or equity."

This report provides an excellent framework for evaluating tax expenditures, something that absolutely needs to be done and that we've recommended, along with many others. A recently published GAO report recommended implementing regular review of all federal tax expenditures, and the final report of the President's Fiscal Commission recommended reforming tax expenditures as well. And the Peterson-Pew Commission on Budget Reform recommended a new focus on tax expenditures in the federal budget in Getting Back in the Black.

Minnesota's fiscal responsibility in conducting this comprehensive review of tax expenditures--which cost the federal government over $1 trillion each year--should serve as a model to other states, as well as Washington. Effective tax reform that results in a fairer, more efficient, and simpler tax code is possible, and it starts with becoming as informed as possible. By examing all aspects of tax expenditures--their purpose, effectiveness, social and budgetary impacts, administrative and compliance burdens, etc--Minnesota has taken a great first step. Hopefully the federal government can show the same leadership and diligence before it's too late.