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November 2, 2012 Association of Metropolitan School Districts November 2, 2012 Association of Metropolitan School Districts

Minnesota is a Great State

Governor Daytons Governor Daytons Priorities Getting Minnesota Working Again 3 Create jobs and improve Minnesotas competitiveness Improve how state government works to deliver the best services at the best price Sustainable, balanced budget and tax reform EDUCATION & TAX REFORM Governors Priority #1 Governors Priority #2 Governors Priority #3

Creating Momentum for Tax Reform 47 Cities 134 Meetings 76 Legislators 6,171 People 1 Advisory Group Updated 10.31

Minnesota is a Great State WHY NOW? Minnesotas Tax Code is: Out of date Out of balance Not fair Too complex Picking winners & losers Not doing enough to provide for a great education system

Minnesota is a Great State MINNESOTA IS CHANGING Is our tax code?

Taxes tell part of the story 7

Minnesota collected tax revenues at or above the national average for 45 years through 2002 but below the national average seven of the last eight years. 2010 MN U.S. Average 8 Above U.S. Average Below U.S. Average

But taxes dont tell the whole story 9

10 2011

Source: U.S. Bureau of Economic Analysis 11

Estimated lost revenue from untaxed consumer e-commerce sales Millions of dollars Losses grew by 800% in just 11 years! 12 2011 total loss = $400 m E-commerce$149 m Catalogs$ 55 m Remote seller$190 m Outdated tax code hurts Minnesota's Main Street retailers

Myron 28 years from now Demographic change is coming 13 Myron 28 years ago ? Myron Today Source: Minnesota State Demographer Photo Credit for David Beckham Photo: publicdomainpictures.net

Demographics impact income tax revenue Tax revenue declines 40-50% after retirement. 14

Growing income disparity Top 10% now has 50% share of income (U.S.) 15

Note: Adults are assigned to income categories based on their size-adjusted household income in the calendar year prior to the survey year (e.g., 2010 income is from the 2011 survey). Middle Income for Family of Four is $46K-$137K Source: Pew Research Center Aug. 22, 2012 report The Lost Decade of the Middle Class http://www.pewsocialtrends.org/files/2012/08/pew-social-trends-lost-decade-of-the-middle-class.pdf Percentage distribution of adults by income category, 1971-2011 The middle class is shrinking 16

Minnesota is a Great State OUT OF BALANCE Over time, the mix of Minnesotas taxes has become unbalanced.

The three legged stool Income Tax 33% Sales Tax 33% Property Tax 33% Income Tax 33% Sales Tax 27% Property Tax 40% 2010Balanced 18

Property Tax: Longest Leg of the Stool 19

Sales Tax: Shortest Leg of the Stool and yet our rate is highest in five state area Minnesota has the highest sales tax rate in the five state area Of the five states, Minnesota taxes the least amount of goods Minnesota also has a very narrow sales tax base for services 5% 6% 6.875% 4% MINNESOTA NORTH DAKOTA SOUTH DAKOTA IOWA WISCONSIN

Minnesota is a Great State WHO PAYS? When Income, Sales, Property and other taxes are added up, Minnesotans pay different amounts of their income in state and local taxes.

22 Percent of Income Paid to Taxes The income tax is based on your ability to pay Sources: Minnesota Tax Incidence Study 2011 (Tax Year 2008), MN Dept. of Revenue. (Annual income amounts rounded.) 22 MN income tax Annual Household Income ($ Thousands)

23 Percent of Income Paid to Taxes 23 Property taxes after the PTR Property taxes are not based on your ability to pay Sources: Minnesota Tax Incidence Study 2011 (Tax Year 2008), MN Dept. of Revenue. (Annual income amounts rounded.) Annual Household Income ($ Thousands)

24 Percent of Income Paid to Taxes 24 State & local sales taxes Annual Household Income ($ Thousands) The sales tax is based on what you buy Sources: Minnesota Tax Incidence Study 2011 (Tax Year 2008), MN Dept. of Revenue. (Annual income amounts rounded.)

25 Percent of Income Paid to Taxes 25 Other taxes Annual Household Income ($ Thousands) Most of the other taxes include: Corporate tax Motor fuels tax Motor vehicle registration tax Cigarette & tobacco taxes (incl. HIF) MinnesotaCare provider & drug taxes Insurance premiums taxes Other taxes are regressive as well Sources: Minnesota Tax Incidence Study 2011 (Tax Year 2008), MN Dept. of Revenue. (Annual income amounts rounded.)

Percent of Income Paid to Taxes Our S&L effective tax rate includes regressive taxes and the progressive income tax 12.3% 9.7% Sources: Minnesota Tax Incidence Study 2011 (Tax Year 2008), MN Dept. of Revenue. (Annual income amounts rounded.) 26 MN income tax Property taxesState & local sales taxes Other taxes Annual Household Income ($ Thousands) 10.3%

The tax burden is being shifted to those with the least ability to pay 27

Tale of two taxpayers Joe Smith Typical Middle Income Minnesotan Pays 12.7% of his income in MN state & local taxes Sara Jones Top 2% Income Earner 28 Pays 9.8% of her income in MN state & local taxes Higher from 1990 Lower from 1990 Sara pays 23% less in state & local taxes as a % of income than Joe

29 As a percent of income, the top 10 percent pay less than the rest of Minnesotans (and increasingly so!)

Minnesota is a Great State COMPLEXITY CREEP Over time, Minnesotas tax code has become more complex.

2010 Income Tax Calculation Start with:Federal taxable income Add:Itemized deduction for state income taxes Non-Minnesota state and municipal bond interest 80% of bonus depreciation taken federally 80% of increased federal Section 179 expensing taken federally Federal deduction for domestic production activities Additional federal standard deduction for real estate taxes or motor vehicle sales tax Expenses deducted federally on income not taxed by Minnesota Federally-exempt subsidy to employers with prescription drug coverage for their retirees Fines, fees, and penalties deducted federally as a trade or business expense Federally-exempt suspended losses generated by bonus depreciation Federally-exempt discharge of indebtedness Capital gain portion of a lump-sum distribution Net operating loss carryover adjustment for 2010 Subtract:State income tax refund (if itemized in 2009) U.S. bond interest Dependent K-12 education expenses 50% of charitable contributions over $500 for non-itemizers 20% of 2004-2009 addition for bonus depreciation 20% of 2006-2009 addition for 179 expensing Income of the elderly or disabled (limited) Railroad retirement income For American Indians, income earned on a reservation while living on the reservation Federal active duty military pay taxed federally (nonresidents) Federal active duty military pay taxed federally (residents) National Guard pay for service in Minnesota Organ donor expenses Income taxes paid to a subnational level of a foreign country other than Canada JOBZ business and investment income Gain from the sale of farm property by an insolvent farmer Post-service education award from AmeriCorps Net operating loss carryover adjustment from 2008 and 2009 Prior add-back of reacquisition of business indebtedness Equals:Minnesota taxable income Subtract:Non-refundable tax credits Marriage credit Credit for income taxes paid to another state Credit for long-term care insurance premiums Credit for past military service Credit for nonresident partners on taxes paid to home state Employer transit pass credit Credit for new participants in a Section 125 employer health insurance plan Alternative minimum tax credit SEED capital investment credit Refundable Tax Credits Child and dependent care credit Minnesota working family credit K-12 education credit Research credit Angel investment credit Historic rehabilitation credit JOBZ jobs credit Credit for tuberculosis testing in cattle Enterprise zone credit Credit for military service in a combat zone (administered off-form) 2010 Income Tax Calculation Start with:Federal taxable income Add:Itemized deduction for state income taxes Non-Minnesota state and municipal bond interest 80% of bonus depreciation taken federally 80% of increased federal Section 179 expensing taken federally Federal deduction for domestic production activities Additional federal standard deduction for real estate taxes or motor vehicle sales tax Expenses deducted federally on income not taxed by Minnesota Federally-exempt subsidy to employers with prescription drug coverage for their retirees Fines, fees, and penalties deducted federally as a trade or business expense Federally-exempt suspended losses generated by bonus depreciation Federally-exempt discharge of indebtedness Capital gain portion of a lump-sum distribution Net operating loss carryover adjustment for 2010 Subtract:State income tax refund (if itemized in 2009) U.S. bond interest Dependent K-12 education expenses 50% of charitable contributions over $500 for non-itemizers 20% of 2004-2009 addition for bonus depreciation 20% of 2006-2009 addition for 179 expensing Income of the elderly or disabled (limited) Railroad retirement income For American Indians, income earned on a reservation while living on the reservation Federal active duty military pay taxed federally (nonresidents) Federal active duty military pay taxed federally (residents) National Guard pay for service in Minnesota Organ donor expenses Income taxes paid to a subnational level of a foreign country other than Canada JOBZ business and investment income Gain from the sale of farm property by an insolvent farmer Post-service education award from AmeriCorps Net operating loss carryover adjustment from 2008 and 2009 Prior add-back of reacquisition of business indebtedness Equals:Minnesota taxable income Subtract:Non-refundable tax credits Marriage credit Credit for income taxes paid to another state Credit for long-term care insurance premiums Credit for past military service Credit for nonresident partners on taxes paid to home state Employer transit pass credit Credit for new participants in a Section 125 employer health insurance plan Alternative minimum tax credit SEED capital investment credit Refundable Tax Credits Child and dependent care credit Minnesota working family credit K-12 education credit Research credit Angel investment credit Historic rehabilitation credit JOBZ jobs credit Credit for tuberculosis testing in cattle Enterprise zone credit Credit for military service in a combat zone (administered off-form) 1987 Income Tax Calculation Start with:Federal taxable income Add:Itemized deduction for state income taxes State and municipal bond interest Capital gain portion of lump-sum distribution Subtract: State income tax refund U.S. Bond interest Dependent K-12 education expenses Equals:Minnesota taxable income Subtract:Non-refundable tax credits Credit for income taxes paid to another state Credit for the elderly or disabled Refundable tax credits Child and dependent care credit 1987 Income Tax Calculation Start with:Federal taxable income Add:Itemized deduction for state income taxes State and municipal bond interest Capital gain portion of lump-sum distribution Subtract: State income tax refund U.S. Bond interest Dependent K-12 education expenses Equals:Minnesota taxable income Subtract:Non-refundable tax credits Credit for income taxes paid to another state Credit for the elderly or disabled Refundable tax credits Child and dependent care credit For the Individual Income Tax, the number of adjustments and credits has risen from 9 to 50! 31

37 55 6 11 19 26 Expanding number of property classes and tiers

So you want agricultural homestead? 33

Does the sales tax apply to a Bob Dylan album bought from a neighborhood record store? YES Bob Dylan album downloaded from the internet? NO 34 Reason: State law does not tax digital downloads and products

Does the sales tax apply to a Milky Way Candy Bar? YES Twix Candy Bar? NO 35 Reason: Flour content rules in the Streamlined Sales and Use Tax Agreement

Minnesota is a Great State TAX BREAKS Minnesotas Hidden Spending

Swiss cheese tax policy? Smaller block, not as many holes Bigger block, lots of holes 37

Income Tax Federal Exclusions: Lodging - Housing Allowances for Ministers - Employer-Provided Dependent Care - Employee Awards - Employer Pension Plans - Contributions by Employers for Medical Insurance Premiums and Medical Care - Employer-Paid Accident and Disability Premiums - Employer-Paid Group Term - Life Insurance Premiums - Employer-Paid Transportation Benefits - Cafeteria Plans - Employer-Provided Adoption Assistance - Employer-Provided Education Assistance - Miscellaneous Employee Fringe Benefits - Income Earned Abroad by U.S. Citizens and Foreign Housing Costs - Certain Allowances for Federal Employees Abroad Benefits and Allowances to Armed Forces Personnel - Medical Care and Tricare Medical Insurance for Military Dependents and Retirees Veterans Benefits Military Disability Pensions - Workers Compensation Benefits - Special Benefits For Disabled Coal Miners - Social Security Benefits - Medicare Benefits - Foster Care Payments - Public Assistance - Scholarship and Fellowship Income - Education Savings Accounts - Qualified Tuition Plans - Certain Agricultural Cost-Sharing Payments - Discharge of Indebtedness Income for Certain Farmers Investment Income on Life Insurance and Annuity Contracts - Interest on Minnesota State and Local Government Bonds - Capital Gains on Home Sales - Capital Gains at Death - Capital Gains on Gifts - Exemptions from Imputed Interest Rules - Like-Kind Exchanges - Special Rules for Magazine, Paperback, and Record Returns - Energy Conservation Subsidies Provided by Public Utilities - Accelerated Depreciation - Expensing Depreciable Business Property - Excess of Percentage Over Cost Depletion - Five-Year Amortization of Business Organizational and Start-Up Costs - Expensing of Research and Development Costs Expensing of Magazine Circulation Expenditures - Expensing of Exploration and Development Costs - Cash Accounting and Expensing for Agriculture - Expensing of Multiperiod Timber Growing Costs Special Rules for Mining Reclamation Reserves - Cash Accounting Other than Agriculture - Installment Sales - Completed Contract Rules - Employee Stock Ownership Plans - Individual Retirement Accounts - Keogh Plans - Health Savings Accounts - Self-Employed Health Insurance - Interest on Student Loans - Per Diem Amounts Paid to State Legislators - Federal Personal Deductions 1.60 Additional Standard Deduction for the Elderly and Blind - Medical Expenses - Real Estate Taxes - Other Taxes - Home Mortgage Interest - Charitable Contributions and Theft Losses. Income Tax Minnesota Subtractions: K-12 Education Expenses - Charitable Contributions for Nonitemizers - Income of the Elderly or Disabled - Active Duty Military Service - National Guard and Reserve Pay - Expenses of Living Organ Donors - Job Opportunity Building Zone Income - Disposition of Farm Property - AmeriCorps National Service Education Awards - Preferential Computation - Five-Year Averaging of Lump Sum Distributions - Marriage Credit - Credit for Long-Term Care Insurance Premiums - Employer Transit Pass Credit - Credit for Past Military Service - Credit for New Participants in a Section 125 Employer Health Insurance Plan - Child and Dependent Care Credit - Working Family Credit - Credit for K-12 Education Expenses - Credit for Military Service in a Combat Zone - Job Opportunity Building Zone Jobs Credit - Enterprise Zone Employer Tax Credits - Credit for Bovine Tuberculosis Testing - Lower Income Motor Fuels - Exempt Organizations - Insurance Companies Corporate Tax Federal Exclusions: Permanent Exemptions from Imputed Interest Rules - Investment Income on Life Insurance and Annuity Contracts - Like-Kind Exchanges - Special Rules for Magazine, Paperback, and Record Returns Corporate Tax Federal Deductions: Accelerated Depreciation - Expensing Depreciable Business Property Excess of Percentage Over Cost Depletion (Mining Occupation Tax) - Amortization of Organizational and Start-Up Costs - Expensing of Research and Development Costs - Expensing of Magazine Circulation Expenditures - Expensing of Exploration and Development Costs - Cash Accounting and Expensing for Agriculture - Expensing of Multiperiod Timber Growing Costs - Special Rules for Mining Reclamation Reserves - Cash Accounting Other than Agriculture - Installment Sales - Completed Contract Rules - Charitable Contributions - Employee Stock Ownership Plans - Capital Construction Funds of Shipping Companies Apportionment - Weighted Apportionment - Throwback Sales - Single-Factor Apportionment for Mail Order Companies Corporate Tax Minnesota Subtractions: Dividend Received Deduction - Foreign Source Royalties - Foreign Operating Corporations - Job Opportunity Building Zone Income of Farm Property Credits - Research and Development Credit - Employer Transit Pass Credit - Job Opportunity Building Zone Jobs Credit Zone Employer Tax Credits - Credit for Bovine Tuberculosis Testing Estate Tax Exclusions: Life Insurance Proceeds Annuities - Social Security Benefits Estate Tax Deductions: Marital Deduction Gifts Sales and Use Tax Exemptions: Particular Food Products - Clothing and Wearing Apparel - Drugs and Medicines - Medical Devices - Prescription Eyeglasses - Baby Products - Feminine Hygiene Items - Caskets and Burial Vaults Publications - Textbooks Required for School Use - Personal Computers Required for School Use - De Minimis Use Tax Exemption for Individuals - Motor Fuels - Residential Heating Fuels - Residential Water Services - Sewer Services - Manufactured Homes - Selected Services - Capital Equipment - Accessory Tools Tooling - Telecommunications Equipment - Recovery Equipment - Used Motor Oil - Taconite Production Materials - Wind Energy Conversion Systems - Air Cooling Equipment - Solar Energy Systems - Airflight Equipment - Large Ships 1992 $100,000 $100,000 $100,000 $100,000 4.31 Repair and Replacement Parts for Ships and Vessels - Light Rail Transit Vehicles and Parts - Commuter Rail Vehicles and Parts - Petroleum Products Used by Transit Systems Petroleum Products Used in Passenger Snowmobiles - Ski Area Equipment - Logging Equipment - Farm Machinery - Repair and Replacement Parts for Farm Machinery Petroleum Products Used to Improve Agricultural Land - Farm Conservation Programs Horses - Prizes at Carnivals and Fairs Television - Advertising Materials - Court Reporter Documents - Patent, Trademark, and Copyright Drawings - Packing Materials - Property for Business Use Outside Minnesota - Automatic Fire-Safety Sprinkler Systems - Firefighter Personal Protective Equipment - Building Materials for Residences of Disabled Veterans - Chair Lifts, Ramps, and Elevators in Homesteads - Parts and Accessories to Make Motor Vehicles Handicapped Accessible - Maintenance of Cemetery Grounds - Trade-In Allowance Sales and Use Tax Exemptions - Sales to Particular Purchasers: Local Governments - Nonprofit Organizations - Hospitals and Outpatient Surgical Centers - Veterans Organizations - Construction Materials for Low-Income Housing - Public Safety Radio Systems - Biosolids Processing Equipment - Ambulances Leased to Private Ambulance Services - Certain Purchases by Private Ambulance Services - Job Opportunity Building Zones - Enterprise Zone Construction Materials Waste Recovery Facilities - Hydroelectric Generating Facility - Minnesota Twins Ballpark - University of Minnesota Football Stadium - Central Corridor Construction Materials Exemptions - Sales by Particular Sellers: Isolated or Occasional Sales - Institutional Meals - Fundraising Sales by Nonprofit - Organizations to Artistic Events - Admission to School-Sponsored Events - Admission to the Minnesota Zoo - Cross Country Ski Passes for Public Trails - YMCA, YWCA, and JCC Membership Dues - Minnesota Amateur Sports Commission Events - Admission to Charitable Golf Tournaments - Candy Sales by Certain Organizations - Sacramental Wine Sold by Religious Organizations - Reduced Sales Price New Manufactured Homes Local Property Tax Exemptions: Exempt Real Property - Opportunity Building Zone Property Preferential Valuations: Classification System - Green Acres Treatment of Agricultural Land - Open Space Property - Metropolitan Agricultural Preserves Land - Tax Increment Financing - Preferential Computation - Auxiliary Forest Tax Credits: Taconite Homestead Credit - Powerline Credit - Metropolitan Agricultural Preserves Credit - Conservation Tax Credit $27b =$16b -$11b Annual state tax revenue (2010) Tax breaks Total state tax revenue before preferences 38

For every dollar of state tax revenue without preferences 60 goes to education, health care and other public expenditures 40 goes to tax breaks 39

Minnesota is a Great State TAXES IMPACT K-12 EDUCATION

Inflation-adjusted state aid per student declined significantly between 2003 and 2013: Between 2003 and 2013, the general education formula allowance has increased by 13.5%, while inflation has been 26.4% as measured by the CPI or 42.9% as measured by the IPD. The unfunded cost of special education (special education cross subsidy) has increased from $397 million in FY 2003 to a projected $614 million in FY 2013. Total inflation-adjusted state aid per student will decline by 2.0% if inflation is measured using the CPI or by 13.3% if inflation is measured using the IPD. These declines are in addition to the loss of cash flow from the state aid payment and property tax shifts

Our public schools are serving a more diverse population with growing needs. Between 2003 and 2011: Students eligible for free or reduced price lunch increased from 27% to 37% of total enrollment Students in special education increased from 13% to 15% of total enrollment Students with limited English proficiency increased from 6% to 8% of enrollment Students of color increased from 19% to 26% of enrollment

With growing needs and declining state aids, school districts increased their reliance on property taxes to balance budgets between taxes payable in 2002 and 2012: Total school levies increased 120%, from $986 million to $2.167 billion. Growth in voter approved operating referendum levies accounted for the largest share of the increase: up 222%, from $226 million to $729 million Debt service levies also increased: up $294 million or 58% Funding shifts from state aids to the property tax (e.g., Operating Capital, $120 million, Equity $76 million) also contributed to levy increases, as did decline in state equalization aids, which caused the local share of equalized levies to increase.

Growing reliance on voter-approved property tax levies has increased disparities among school districts and created instability in school funding: The disparity between the 95 th percentile and the 5 th percentile of general revenue per student (excluding cost differential funding) increased from 19% in FY 2003 to 30% in FY 2012 Some districts have been unable to pass an operating referendum levy despite repeated efforts Due to the erosion of state equalization formulas, there is wide variation among school districts in property tax rates needed to raise a given level of referendum revenue per student State-wide, 12% of school district general education revenue is from voter approved referendums; 16% in the 7 county metro area

Minnesota is a Great State TAXES IMPACT HIGHER EDUCATION

46 Who needs a postsecondary education? More than 900,000 new jobs will be created in Minnesota between now and 2018. (150,000 new jobs and the rest the result of retirements) 620,000 for those with postsecondary degrees 227,000 for high school graduates 55,000 for high school dropouts Source: Georgetown University: Help Wanted: Projections of Jobs and Education Requirements Through 2018

47 Jobs of the Future 70% of all jobs in Minnesota (2.1 million jobs) will require some postsecondary training beyond high school in 2018

48 What does that mean? For Minnesota workers, the occupations classified as high-growth and high-wage in workforce projections overwhelmingly will require a postsecondary degree. DEED employment projections through 2019: The fastest job growth includes occupations that require: 16.1 percent for associate degrees 13.1 percent for masters degrees. 18.8 percent for doctoral degrees

49 Higher education and unemployment National unemployment figures: 12% overall 4% for those with some postsecondary completion According to DEED, the more educated a worker, the less likely they are to be unemployed

50 Barriers to postsecondary education Rising college tuition Tuition in Minnesota has increased at more than 3 times the rate of inflation and per capita personal income in the past decade Student debt has increased, both in terms of number of students with loans and the amount they borrow Challenging job market

51 State Grant, Public Institution Appropriations, and Total Loan Aid Borrowed per Undergraduate Enrollment (Inflation Adjusted to 2010 Dollars) Source: Minnesota Private College Research Foundation analysis of Grapevine compilation of state higher education tax appropriations and Minnesota Office of Higher Education enrollment data.

52 The total amount borrowed increased faster than tuition

53 MN students are more likely to have student loans and borrow more

56 Three key trends in Minnesota higher education: Accessibility and Cost Tuition in Minnesota has increased at more than 3 times the rate of inflation and per capita personal income in the past decade Student debt has increased, both in terms of number of students with loans and how much they borrow Total undergraduate price of attendance in Fiscal Year 2009 in Minnesota is estimated at about $6 billion Nearly $5 billion was paid for by students and their families Of the $5 billion, $1.7 billion is loans and $3.2 billion is current income

Fair Simple Supports Growth What do we value in a tax system? 57

We Must Act. Now.Its broken.

Governor Legislative Champions Committed Staff & Organizations YOU! What will it take to achieve tax reform in Minnesota? Minnesotans

What are your ideas for reform in education and taxes? Tell us! Myron Frans Commissioner of Revenue 651-556-6003 [email protected] http://bit.ly/TaxReformMN @MNRevenue #MNTaxReform Sign up for email updates