Eliminating Tax Breaks: A Path to Budget Compromise?

By: - March 24, 2011 12:00 am

From the moment it became clear who the state’s new governor and legislative leaders would be, Minnesota seemed to be heading for political stalemate. Mark Dayton, the newly elected Democratic governor, campaigned on a promise to raise taxes on the wealthy as a way of closing a massive budget deficit. The new Republican majorities in the House of Representatives and Senate were elected promising not to raise any taxes on anybody for any reason.

Between those perspectives, there didn’t appear to be any room for common ground — until Julianne Ortman said something surprising last month. Ortman, the Republican chair of the Senate’s Taxes Committee, declared that she didn’t think tax subsidies — the exemptions, deductions and credits built into the tax code — are really tax reductions at all. Instead, they’re government programs in disguise, the sorts of things a good fiscal conservative should be happy to consider cutting. “We should be viewing each of these expenditures as a spending program,” she said, according to the Associated Press , “and we came here to review every single aspect of state spending.”

With those remarks, Ortman was hinting at a way to simultaneously meet the demands of the governor and of the Republican majorities in closing a $5 billion shortfall in the state’s $39 billion biennial general fund budget . The state could collect more revenue by eliminating an exemption, without the higher tax rates that Republicans oppose. That revenue could be used to blunt cuts in the budgets of schools, Medicaid and other social services, the programs Dayton is trying to protect. 

The possibilities in this area are huge. If Minnesota were to get rid of all of its tax expenditures — an unlikely proposition, to be sure — it could eliminate the budget gap and still have billions of dollars left over.

Even a partial cutback in tax expenditures may not work out. For now, Republican lawmakers continue to pursue a budget that relies exclusively on spending cuts, while Dayton continues to promote higher income taxes and higher property taxes for the rich. But it’s not clear where else a deal could come from, unless Dayton or the legislature simply gives in. In Minnesota, as in several other states, top elected officials have begun to wonder whether eliminating tax expenditures is the least unpleasant of the painful budget options they face.

Lack of scrutiny

If there’s one person who’s ready to embrace this approach in Minnesota, it’s Ann Lenczewski.  She’s the ranking Democratic member of the House Taxes Committee and the legislature’s leading foe of tax expenditures. Her case is similar to the one like-minded legislators make in other states. She thinks tax expenditures are often poorly targeted and give some taxpayers unfair preferences over others. What she dislikes most, though, is the lack of scrutiny they receive.

Regular government programs are reviewed every time a new budget is written. If those programs take the form of an exemption or credit written into the tax code, however, lawmakers don’t have to do anything to keep them going. “What’s the most insidious part of tax expenditures is that they go below the radar,” Lenczewski says. “They don’t get reviewed until someone says, ‘We’ve been doing this since 1942, why the heck are we doing this?’ ”

Lenczewski argues that many tax expenditures wouldn’t survive if they were regular appropriations. Minnesota has 296 tax expenditures in all, according to a recent report . Among the most costly are income tax deductions for home mortgage interest, charitable contributions and the state’s version of the earned income tax credit, and sales tax exemptions for food, clothing, drugs and many services.

Eliminating many of these would be difficult or even politically impossible. Still, Lenczewski cites several tax expenditures that she thinks are ripe for elimination to help balance the budget. The state offers a $100 credit every time someone buys long-term health care insurance, even though that’s likely far too little to influence many people to make the purchase. The state offers a variety of credits to businesses that locate outside of the Twin Cities area, credits which Lenczewski says aren’t shown by research to be worth the cost. Minnesotans even get a tax credit for testing their cows for tuberculosis.

Governors in several other states are thinking the same way. In California, Jerry Brown’s budget would eliminate tax credits for businesses that locate in distressed areas. Michigan’s Rick Snyder is going after those same credits, and also targeting subsidies for film production and historic preservation. Snyder and Hawaii’s Neil Abercrombie both want to end tax exemptions on pension income. Connecticut Governor Dan Malloy wants to end sales tax exemptions on everything from clothing to pet grooming to cosmetic surgery. In Rhode Island, Lincoln Chafee wants to broaden his state’s sales tax to include a variety of currently exempt goods and services, from over-the-counter drugs to concert tickets.


Diehard opposition

The efforts to eliminate exemptions are proving controversial. For Snyder, Abercrombie, Brown, Malloy and Chafee, these proposals have turned out to be among the most inflammatory aspects of their budgets. Nor did Ortman’s remarks suddenly make solving Minnesota’s budget shortfall easy.

One reason is that not everyone agrees tax expenditures are really spending in disguise. If, say, Minnesota were to get rid of the sales tax exemption on clothing, it would feel like a boost in taxes to a lot of people. Greg Davids, Ortman’s counterpart on the Minnesota House Taxes Committee, has declared that getting rid of a tax expenditure is no different than imposing a tax increase.

Soon after Ortman spoke up, every Minnesota Senate Republican, including Ortman, signed a letter reiterating their opposition to tax increases. Tax expenditures weren’t mentioned. House Republican budget plans introduced this week include deep cuts to health care and a 15 percent reduction in the state workforce by 2015. Likewise, the Senate is pursuing budget bills that don’t add more revenue from tax increases or the elimination of tax expenditures. “I am also working on a separate bill that will include federal conformities and tax expenditures in a revenue-neutral plan,” Ortman told Stateline, “to prioritize tax relief in our tax code and provide for annual review and consideration of tax expenditures.”

A revenue-neutral approach to tax expenditures, of course, wouldn’t reduce the budget gap. That seems to put the governor and legislature back on a collision course much like the one Minnesota experienced in 2005. Then, the roles were reversed: The Democratic legislature was insisting on tax increases, while Tim Pawlenty, the Republican governor, wouldn’t accept them. Minnesota went through a 10-day partial government shutdown.

But however the two sides may be digging in now, the picture could look different in a couple of months. Nan Madden, the director of the Minnesota Budget Project, notes a reason for optimism. She points out that the legislature is passing its budget much earlier than usual. She takes that as a sign that leaders understand they need time to negotiate. “The governor’s budget is not going to pass as he presented it,” Madden says. “Their budget isn’t going to pass as (the legislature) presented it.”

In fact, the options are relatively limited. Both sides have already agreed to a major fiscal gimmick, pushing off an education payment into the next budget period. There’s some talk of expanding gambling to raise revenue, though that’s controversial too. But those wouldn’t be enough to solve the problem. It’s at that point that dealing with tax expenditures comes up as a possible solution.

Lenczewski’s idea is that the elimination of tax expenditures could be used to close the budget gap this year; then, as a concession to Republicans, used to lower tax rates for future years. Whether the governor or the legislative majorities will go for it remains to be seen. “If there is going to be some area of negotiation or compromise,” says Mark Haveman, executive director of the Minnesota Taxpayers Association, “it’s going to be in this area.” 

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Josh Goodman

Josh Goodman helps lead research on fiscal management and place-based economic development programs as part of Pew’s state fiscal health project. Goodman has served as a primary author for Pew studies that examine how states should evaluate tax incentives and maintain budget discipline when implementing those incentives.