2015 POLICIES

PERSONAL INCOME TAX DRAFT

ISSUE
Are further personal income tax changes needed to make Minnesota more attractive to operate a
business and to best position Minnesota for strong economic growth?
POLICY
The structure of the personal income tax rates and tax base is an important component of Minnesotas
business climate and competitiveness. 92% of Minnesotas businesses are pass-through entities,
including its smallest and newest (sole proprietors, limited liability companies, partnerships and Scorporations). These businesses pass through business income to the owners personal income tax
return, making the personal income tax just as important to Minnesotas business climate as the
corporate income tax. The personal income tax is not only a tax on employee compensation, but its also
a tax on the vast majority of businesses.
In todays world of global competition and increased mobility, tax burdens and costs do matter. It is
important for Minnesotas tax burdens to be competitive with those of other states and nations in order
to have a strong and growing economy. Economic growth ultimately comes from production,
innovation and risk-taking. Studies have found that high marginal rates detrimentally impact business
investment decisions, entrepreneurial activities, and recruitment of talent the very items needed for
economic growth. In the 2013 session, a new forth tier was added to Minnesotas income tax,
increasing the top rate from 7.95% to 9.85% for married filing joint filers at $250,000 of federal taxable
income and $150,000 for single filers. The 2013 tax increases raised individual income taxes by $1.1
billion, impacted over 21,000 business filers and the majority of pass-through business income. The
income tax is a critical component of Minnesotas competitiveness as follows:

The individual income tax impacts the vast majority of business entities as 92 % of businesses are
pass-through entities. Businesses both small and large are organized as S-corporations, limited
liability companies (LLC), partnerships or sole proprietors and flow their business income through to
the owners personal income tax return.i

Minnesotas top rate is now second highest at some incomes and fourth highest overall behind
California, Hawaii and Oregon (Oregon does not have a sales tax). Minnesotas top rate is now
much higher than our bordering states.ii

High tax rates mean less money available for investment in the business and its employees. Passthrough income is taxed even if it is not distributed to the owners/shareholders. This phantom

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income is recognized for income tax purposes even if the income is retained within the business for
reinvestment.

Study after study by non-partisan economists have determined that the taxes most harmful to
economic growth are corporate income tax and high personal income taxes because capital is very
mobile and the most sensitive to high rates of tax. iii Business entrepreneurship is one area that is
most negatively impacted by higher marginal tax rates as the investment decisions of sole
proprietors are quite sensitive to tax rates.iv

Studies have also found that high marginal income tax rates negatively impact the ability to recruit
talent.v High rates can also influence outmigration. There is growing concern that Minnesotas
high income tax rate combined with the estate tax that kicks in at $2 million, a lower level than
most states and the new gift tax has created a great disincentive for wealthy individuals and
retirees to remain in Minnesota. (See the Minnesota Chamber of Commerces Estate and Gift Tax
Policy.)

72% of businesses in the 2013 Business Barometer survey say the new fourth tier in personal
income taxes will significantly impact their operations with 55% stating it will reduce their ability to
add jobs in Minnesota.vi

The recent federal tax increases combined with the states new tax increase will result in large tax
increases for many businesses reducing their abilities to invest in their businesses. Many businesses
will have top marginal rates among the highest in the nation, with marginal rates exceeding
nearing 50% when the federal top rate of 39.6% plus 3.2% Affordable Care Act investment tax is
combined with state top rate of 9.85%. vii These businesses are also facing other fixed cost
increases such as the increase in minimum fee, the new business to business sales taxes, health
care cost increases, energy costs due to new mandates, etc.

Minnesotas tax system should be structured to best position Minnesota for a strong, vibrant, changing
and growing economy. Income tax changes should be reviewed to ensure that they advance important
tax principles of competitiveness, stability, simplicity and minimization of economic distortions.
The Minnesota Chamber advocates for income tax changes that will improve economic growth and
competitiveness as follows:

Rates. The Minnesota Chamber supports lowering the top income tax rates to be more competitive
not only regionally but nationally in order to encourage greater economic growth and job creation

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and retention. Minnesota should reduce the personal income tax rate so Minnesotas top rates are
out of the top ten nationally and when resources allow enact across the board rate reductions.
Reducing reliance on the top tier would improve stability of state revenue system as the new fourth
tier is a more volatile source of revenue since a greater portion is from capital gains and business
income.

Pass-through income. Enactment of a 20-percent exemption for active business income for
pass-through entities S-corporations, partnerships and limited liability companies. Reduce tax
burdens for all pass-through entities by enacting a meaningful tax reduction for business income.
Doing so would drop the marginal tax rate on business earnings, allowing more capital to be
reinvested in the business and its employees

Capital gains. Reduce taxes on individual capital gains by either taxing them at a rate lower than
ordinary income or enacting capital gains exclusion. (The average and median top capital gains tax
rate in the 40 states plus the District of Columbia that tax capital gains is about 6 %. Ten states do
not tax capital gains.)

Federal conformity. Conform to federal tax law definition changes in order to lessen
administrative burden and complexity.

BUSINESS IMPACT
Reducing personal income tax rates will make the state more attractive for businesses to operate and
make it easier to recruit high-skilled workers. The vast majority of Minnesotas businesses, including its
smallest and newest (sole proprietors, limited liability companies, partnerships and S-corporations),
flow their business income through a personal rather than a corporate income tax return. Policy
makers should not forget that individual income tax rates are just as important to business activity as is
the corporate rate. Minnesotas new income top rate of 9.85% puts Minnesota second highest in the
nation for some incomes and fourth highest state rate in the nation overall. Minnesotas rate is much
higher than all neighboring states and many of those states have actually reduced their tax rates.
These high tax burdens place Minnesota businesses at a competitive disadvantage. High marginal rates
have been shown to be extremely detrimental to entrepreneurial investments and net-in migration of
individuals which will make it much harder to recruit talent to Minnesota. Return on investment is
affected by labor costs so personal income tax rates can influence location of plants and facilities as
employers have to adjust compensation to compensate for cost of higher taxes especially for higher
skilled occupations.
Enacting a 20 percent exemption for subtraction for pass-through income would target income tax
reductions to taxpayers with business income and effectively drop Minnesotas highest marginal rate

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on business income from among the highest rates in the nation. 9.85 percent to 7.88 percent (which is
still higher than it was before the 2013 tax increase). This would give Minnesota businesses a more
competitive ranking. It also would move Minnesotas personal income tax more toward a tax on wages
rather than both a tax on wages and business income. This was a recommendation of the Governors
21st Century Tax Reform Commission 2009 report as research indicates that higher marginal taxes on
pass-through businesses increase of cost of capital and discourage investment and hiring by
entrepreneurs. A key component of good tax policy is to make sure there is parity between business
types in order to minimize economic inefficiencies and to minimize the picking of business winners and
losers in the tax code.
One key component for economic growth is capital formation and studies have found investment
decisions are sensitive to high tax rates. Reducing individual capital gains taxes will help increase the
formation of venture capital so small firms are better able to acquire the financing needed to grow.
Capital generally flows to places where it can earn the greatest return. Reducing the taxation of capital
gains will increase that return, resulting in more capital flowing into Minnesota.

Taxation and Small Business in Minnesota, January 2011, Minnesota House Research
Federation of Tax Administrators
iii
Tax Foundation, What is Evidence on Taxes and Growth, Dec. 2012.
iv
So What Actually Happens When You Tax the Wealthy? A Review of Literature, October 2010, Minnesota Center for Fiscal
Excellence
v
Minnesota Center for Fiscal Excellence
vi
2013 Minnesota Business Barometer Survey, Oct. 2, 2013 press release Minnesota Chamber and Himmler Rapp Company
vii
Tax Foundation Fiscal Fact No. 394
ii