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Minnesota lawmakers agree to pursue conformity with federal tax rules, but disagree on how to get there

The word "taxes" is seen on the facade of the Internal Revenue Service (IRS) headquarters in Washington. Bloomberg photo by Andrew Harrer

ST. PAUL — If Minnesota lawmakers can overcome their differences, it should be easier to file your state taxes next year.

You might even get a tax cut. Or pay more.

With a month left to go in their legislative session, tax policy is front and center again at the Capitol. The Legislature has more work to do on the topic than usual this year because they were unable to agree on a bill in 2018.

The biggest thing they want to do is take advantage of changes in the federal Tax Cuts and Jobs Act of 2017. That requires either “conforming” to federal tax policy or coming up with Minnesota-specific tax provisions.

Republicans and Democrats agree that passing a conformity bill is important. Without one, state taxes will remain dramatically different from the federal code.

The agreement pretty much ends there.

Democratic-Farmer-Labor Party members see federal tax conformity as a chance to raise new revenues to fund priorities like education, health care and what they like to call “community prosperity.” They’ve proposed more than $1 billion in new revenues largely from raising taxes on businesses and the wealthy.

DFLers also want to increase gas taxes and fees on car sales and registrations to pay for transportation needs. And they don’t want to let a 2% tax on health care providers sunset in 2020 as planned.

Describing House Democrats’ plan, tax committee chair Rep. Paul Marquart, of Dilworth, said: “It finds those resources and sets the foundation for a DFL budget that invests in people and invests in making this state better.”

Republicans don’t like any of Democrats’ big ideas. They say higher taxes won’t make Minnesota better.

Instead, they’ve offered a tax bill that raises some new revenue, but the new money goes toward tax cuts for the middle class and businesses. They’ve characterized their plan as “protecting the taxpayer,” arguing that letting residents keep more of their money is best for the economy.

“The best thing we can do for Minnesota, the best social program for Minnesota is a job and opportunity,” said Sen. Roger Chamberlain, R-Lino Lakes, who leads the Senate tax committee.

Why tax conformity?

The federal tax changes passed by the Republican-controlled Congress and signed by President Donald Trump in 2017 dramatically remade the country’s tax code. Rates for individuals and corporations were lowered, but in exchange, a lot of popular credits and deductions were curtailed or eliminated.

Since Minnesota uses federal tax policy as a starting point for the state’s code, not aligning with the 2017 changes means computing state taxes is now more difficult. Officials at the Department of Revenue spent months last year tweaking forms and computer code to keep the process relatively seamless for most Minnesotans.

State leaders say a lack of matching the changes in the federal bill doesn’t necessarily mean Minnesotans are paying more in state taxes. They just might not be getting all the benefits of the federal changes.

Changes for individuals

One of the biggest benefits for individual filers under the federal bill is a near doubling of the standard deduction. At $24,000 for couples and $12,000 for individuals, this is the amount you can lop off your income that is subject to tax.

Families also saw an increase in the child tax credit.

However, to pay for the bigger standard deduction, a lot of credits and other deductions shrank or went away entirely. Taxpayers can no longer deduct as much mortgage interest, property taxes or charitable donations as they did before the legislation.

Another caveat of these changes is many of the benefits for individuals, such as the lower rates and larger standard deduction, go away. But most of the things individuals gave up for them don’t come back.

Minnesota lawmakers largely want to mimic things in the federal bill that make it easier to file taxes. They’re proposing a larger standard deduction in exchange for fewer itemized write-offs.

Both parties use part of the new revenue that’s raised in their bills to give individuals and families tax cuts.

Republicans want to cut the second tax bracket from 7.05% to 6.65% by 2022. That impacts earnings between $26,521 to $87,110 for singles and $38,771 to $154,020 for married couples.

Democrats want to aim their tax cuts at lower-income families. They’ve proposed increasing the “working-family tax credit” and giving a new break to those same taxpayers to help offset the cost of a proposed gas tax hike.

Both parties also want to modify how much Social Security income is subject to tax to help seniors.

Changes for businesses

The federal changes cut business taxes from 35% to 21%. It also allows businesses to bring money stashed overseas in tax shelters back to the U.S. at a lower tax rate.

Small-business owners who file for their company with individual returns also saw lower tax rates. Corporations also are now able to write off equipment purchases and other expenses more quickly.

State lawmakers are sort of picking and choosing which of these provisions they want to adopt and which ones they don’t. The most consequential is what they do with foreign income.

Democrats want businesses with money held overseas to pay state taxes on it if they bring it back to the U.S. They hope to raise about $1 billion in new income from taxing foreign profits.

Republicans, worrying taxing that money may bring legal trouble, have declined to do that.

Transportation and other taxes

Outside of tax conformity, Democrats have other tax proposals that will raise more than $1 billion a year for transportation projects and maintain $700 million a year for state-run health care programs.

Gov. Tim Walz campaigned on raising the state’s gas tax 20 cents per gallon. He’s suggested phasing in that hike over two years and then tying the tax to inflation.

He also wants to increase vehicle registration fees and sales taxes on autos, and borrow money for road projects.

All of that new revenue would pay for a 10-year plan to repair aging infrastructure, build new roads and bridges and fund mass transit. Multiple studies have shown Minnesota’s roads are deteriorating and need new investment.

Republicans also want to fix roads and bridges, but they don’t want to raise taxes to do it. They’re less concerned with funding mass transit.

As for funding, GOP leaders say they want to continue to have money from the state’s general fund supplement dollars from existing taxes that are already dedicated to transit projects. Democrats have criticized that approach, saying it’s doing too little.

Finally, Walz and DFLers seek to maintain a 2% tax on health care providers that provides about $700 million a year for the health care access fund. The fund helps pay for MinnesotaCare, insurance for the working poor and other programs that improve health care access and affordability.

Without the provider tax, Democrats say health care programs for the poor would be put at risk. They worry federal funds that also support these programs will eventually go away.

Republicans say it’s a “sick tax” that increases the cost of health care. They want to fund programs for the poor with money already in the budget.

What's next?

The Republican-led Senate and Democrat-controlled House plan to pass all their budget bills, including tax plans, by May 1. But that will be just the first step in rewriting the state’s tax code.

Then party leaders will sit down with Walz to negotiate. The hope is the three sides will find common ground before the session ends May 20.

Without agreement, the challenges of having a state tax code divergent from the federal rules will continue.