As COVID cases dwindled, Minnesota found itself a huge state budget surplus. It was a remarkable situation but raised perennial questions about what to do. Taxes can be reduced or expenses can be increased. Paying off debt was another option, though more complicated than people realized.
After a long, contentious session, the legislature struck a tentative deal combining some tax cuts with some spending increases.
There are several options on what, and how, taxes should be deducted. Eliminating the application of Minnesota’s personal income tax for certain Social Security benefits is a perennial proposition. This strikes most citizens as a good idea. But what is the economics of actually doing this? Is this really as good a move as the public’s off-the-cuff reactions might indicate?
We are fortunate to have public policy research institutes to explain such issues. Two – one deemed politically “conservative” and the other considered “progressive”, analyzed such and released excellent reports. Both systematically explore issues that many people never thought of.
In evaluating any policy issue, economists begin with two criteria. One is “efficiency”. How will the tax change incentives on gains for savings and investment, or any other factor that determines how many needs and wants of people we meet with a given set of resources, change?
Then there’s the incentive of “equity,” or fairness. Who benefits and who loses? How are high-income people affected compared to low-income people? Will our society be more just – or less?
The excellent report from the Minnesota Center for Fiscal Excellence gets to this point in its key paragraph, describing Social Security’s complete exclusion from taxation as “much more surprising and justifiably curious.” It then notes that it is the largest tax-cut ever in a measure package, amounting to more than $500 million per year, and that it will “primarily benefit upper-middle and high-income retirees.” doing is a tax break.” Hooray for insight and common sense!
The Center is not alone. The Minnesota Budget Project, an initiative of the Minnesota Council of Nonprofits, also released an excellent, but somewhat concise, report. It is titled: “Tax Deductions from Full Social Security Exemption Skewed for High-Income Minnesotans.”
The center, originally organized as the Minnesota Taxpayers Association, generally favors lower taxation and is seen as “conservative” in orientation. The “progressive” budget project focuses more on effective spending to reduce poverty and improve social justice. Yet both agree on the efficiency and equity of this major tax change.
So what is going on?
The answer is that both are aware of a fundamental principle of economics: “opportunity cost.” What should we sacrifice if we adopt this remedy?
For the Centre, this means skipping other possible tax cuts that it sees as greater efficiency and greater fairness. For the project, this means giving up extra spending on social needs that it sees as pressure. Yet both agree that taking all Social Security benefits out of taxation is a bad idea. Why?
Let’s start with some history, which gets the most attention in the center’s lengthy report.
Why are Social Security benefits taxed at all? Because in the tax-cutting Reagan years of the 1980s, the federal government began running large budget deficits. Taxing Social Security benefits was one way to bridge the gap without increasing tax rates. It was “widening the base”.
But objectivity and political considerations partly resulted. Only a portion of the profits will be taxed and then only for those with total income above a certain limit. The typical retiree earning less than his monthly Social Security check won’t have to pay anything.
Minnesota has long been criticized for the complexity of the state income tax. In the days before the turbo tax, filing state returns required hours of hard work. So the legislature proceeded to make our state tax as “consistent” with federal provisions as possible. Whether or not you agree with some of the specific details of the federal tax, we’ll just keep things simple by following along.
Why give it up now? Because many other states have done so. And states compete for revenue. The logic is that keeping it here provides incentives for high-income people to move to those other states. His departure will take his total expenses with him, hurting the general level of economic activity here, making the situation worse for the rest of us.
Why would a “complete boycott” primarily benefit the rich? Because Social Security benefits themselves are skewed. For 2022, the maximum monthly amount one can meet is $3,345. The average for retirement benefits is about $1,600. But the average, the amount that is the exact midpoint, is even less. Most recipients do not pay taxes on their benefits under current law. In Minnesota, most of the taxes actually paid come from high-income people who are already in the highest tax rate brackets and also receive the highest Social Security benefits. So a complete boycott would mainly benefit them.
Isn’t the current taxation turning away such people? No, this is a myth. A brief paragraph in the Centre’s report explains it well. These people have multiple sources of income that are already exposed to Minnesota taxes. Profit is a small fraction of their total income. If higher taxes are going to drive them away, then full exemption of benefits won’t make much difference.
There are more details. Both reports are well written and concise, only a few pages, including graphs, tables, and citations. And glad we have both institutions.
St. Paul economist and author Edward Lauterman can be contacted at [email protected]
