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6 March 2000

Northern City Journal
(ISSN 1528-9575)
Vol. 1, No. 8

Minneapolis, Minnesota

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Using State Surplus for Tax Cuts Would Benefit the Most People

by Jerome F. Winzig

This year, for the eighth consecutive year, the state of Minnesota is forecasting a significant budget surplus. By June 1, the state is expected to have $1.8 billion more than is needed to maintain the current high levels of state spending. In response, some state legislators think we should increase state spending to use up the excess revenue. Other legislators suggest keeping the surplus in the state treasury as a "rainy day" fund. The governor is proposing another sales tax rebate similar to the one that passed in the last session, but for only one-fourth of the surplus.

All three of these options imply that excess tax revenues do not belong to the taxpayers but to the government, which is entitled to decide how to dispose of them. When the government spends everything that happens to come into its coffers rather than what is truly necessary for the common good, then it is likely to waste the people's resources. When the government hoards tax revenues it does not need, it prevents that money from being invested in productive economic activity that will benefit everyone.

Furthermore, when the government hands out rebate checks, there is a hidden agenda that justifies the expense of administering a rebate, just as there is when the private sector does it. When auto companies offer rebates on cars, or computer manufacturers offer rebates on laser printers, there are reasons why they do not simply reduce the price in the first place.

First, not everyone qualifies for the rebate. In the last sales tax rebate, 500,000 people who pay sales tax did not qualify for a rebate, including young people who were claimed as dependents on their parents' tax returns. Second, rebates make the company -- or the government -- handing out the rebate look good. Third, rebates allow companies to maintain existing pricing structures and governments to maintain existing tax rates even when they are too high to be justified. The rebates get the attention and distract the consumer or the taxpayer from the price or tax rate that is too high.

Cutting taxes is a more sensible solution, even though governments avoid it because they are reluctant to give up the cash cow of tax surpluses. A key advantage of cutting taxes is that it keeps the money in the hands of the people. In addition, can be implemented quickly because it does not require any distribution mechanism.

In the case of the state of Minnesota, there are three simple possibilities for reducing taxes:

The first option is to reduce the individual income tax. Since individual income taxes brings in about $10.8 billion every two years, the $1.8 billion surplus would allow a 10% reduction in individual income taxes without exhausting the surplus until September, 2003. By then, the positive economic results of such a cut would most likely boost revenues even further.

However, the politics of this alternative are quite tricky. If everyone's income tax were reduced by 10% across-the-board, wealthy Minnesotans would receive a large chunk of the dollar reduction because they pay a large chunk of Minnesota's income taxes. Democrats would raise an incredible fuss about this, as they did in the last session when a smaller income tax cut was passed. But if the income tax reduction is not an across-the-board reduction but instead is weighted in favor of low and middle-income Minnesotans, then Republicans would object. They would correctly point out that this is unfair since it would amount to a tax increase for higher-income Minnesotans, who would then be paying an even higher portion of the state's taxes.

The second option is to reduce the sales tax. Since sales taxes bring in about $7 billion a year, applying the $1.8 billion surplus would allow a 15% reduction in the sales tax rate without exhausting the surplus until December, 2003. This would enable the state to reduce its sales tax rate by a full percentage point, from 6.5% to 5.5%. It would have the added benefit of making Minnesota more competitive in comparison to neighboring states and the boost to the state's economy should offset the decreased rate in future years.

This option would be quite simple to implement and would apply to everyone. But it seems to have little support from Democrats, Republicans, or the governor, perhaps because it takes away future surpluses and thereby reduces their power.

The third option -- the most politically incorrect option -- is to reduce the corporate income tax. Since corporate income taxes bring in about $1.4 billion a year, applying the $1.8 billion surplus here would allow the state to eliminate the state corporate income tax entirely, without exhausting the surplus until June, 2003. This would, of course, provoke outrage from Democrats, who would charge that this would benefit the wealthy. And the prospect of such a charge would prevent Republicans from supporting this option.

However, the accusation that this would benefit mostly the wealthy would be wrong. It is not acceptable to say so, but eliminating the corporate income tax would benefit everyone. That's because corporations do not really pay taxes; they just pass them on. They can only increase prices (consumers pay), decrease wages (workers pay), or decrease profits (stockholders pay). We are all consumers and workers, and increasingly, we are all stockholders, so we pay that tax.

Pension funds now own over 30% of the outstanding stock in public companies in the United States. Institutional investors, which include mutual funds as well as pension funds, own over 60% of U.S. corporations. In addition, the percentage of individual Americans who own stock is now around 40%.

Thus, as astonishing as it seems at first glance, the elimination of corporate income taxes would benefit all of us, in the form of lower prices, increased wages, and/or increased returns on pension funds, mutual funds, and individual stock portfolios. It would also remove the incentive for corporations to incur certain expenses because they can deduct them from their taxes. For example, the effect on prices and profits of such highly-criticized expenses as high executive salaries and stock options would no longer be cushioned by tax deductions, making them more fully subject to market pressure. In addition, some of the tax reduction would be recovered in the form of higher income taxes paid by individuals and mutual fund investors receiving higher dividends.

Eliminating corporate income taxes in the state of Minnesota would also give this high-tax state a powerful competitive advantage in attracting and retaining businesses. This in turn would help to boost tax revenues in the future. Economists have long known that tax cuts, when applied sensibly across the board, can actually increase tax revenues in the future by making it possible for the private sector to flourish.

These tax cut options deserve serious consideration in the current session of the state legislature. Each alternative -- cutting individual income taxes by 10%, reducing the sales tax by 15%, or eliminating the corporate income tax entirely -- could benefit the people of Minnesota in important ways. However, the alternative that could benefit all the people the most -- eliminating the corporate income tax -- may not even be considered. It is drastic, controversial, and politically incorrect. But it ought to be discussed. We need to encourage further economic development because it is the most effective and lasting way to help those who have not yet benefited from the current economic boom.

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