Budget Includes Revenue Increases

Four major tax changes that would impact cities are included in the Governor's 2014-2015 biennial budget.
(Published Jan 23, 2013)

Below is a list of the major tax changes included in the governor's 2014-2015 biennial budget. Please note that the new homeowner property tax rebate and the reduction in the state business property tax are booked as a tax reduction in the budget documents but will be described in a separate article on property tax initiatives.

Sales Tax
For cities, the most significant tax reforms relate to the sales tax due to the fact that purchases by cities as well as counties are subject to the sales tax.

The budget recommends significant changes to the state's sales tax system by broadening the sales tax base and reducing the overall sales and use tax rate to 5.5 percent from the current general state sales tax rate of 6.875 percent. Within the overall rate change, the state's general fund share would drop to 5.266 percent from the current 6.5 percent while the constitutionally dedicated Legacy fund rate would drop to 0.234 percent from the current 0.375 percent rate, holding the Legacy fund harmless. The budget recommends that the sales tax changes are effective Jan. 1, 2014.

The base broadening changes that allow the sales tax rate to be reduced are extensive. The governor recommends that the state extend the sales tax to business services, including legal, accounting, architectural, specialized design, computer, management consulting, advertising, employment, and business support services. In addition, the budget recommends applying the sales tax to clothing items over $100, admissions, memberships, over-the-counter drugs, personal care services, personal legal and accounting services, and automobile and other repair services.

In addition, the budget recommends extending the sales tax to a broader array of digital goods and would also require some non-Minnesota vendors to collect the Minnesota sales tax if they have an affiliate relationship to a Minnesota-based individual or business.

The extension of the sales tax base would increase state revenues by an estimated $4.22 billion but the rate reduction would decrease state revenues by $2.14 billion, resulting in a net increase in state general fund revenues of $2.08 billion.

As a result of these changes, the benefit to cities of the overall sales tax rate reduction will be offset by the application of the sales tax to new purchases, most notably the professional service such as legal and accounting. If your city analyzes the impact of the rate change and the base expansion, please share your analysis with the League staff.

Individual Income Tax
The governor is recommending a new fourth tier income tax bracket for upper income tax filers with a marginal income tax rate of 9.85 percent. The new marginal rate will apply only to taxable income above $250,000 for married joint filers, $125,000 for married separate filers, $150,000 for single filers, and $200,000 for head of household filers. The fourth tier would be implemented for tax year 2013 and is estimated to increase state revenues for the biennium by $1.099 billion.

Corporate Franchise Tax (Income)
The governor recommends reducing the corporate franchise tax rate from 9.8 percent to 8.4 percent effective Jan. 1, 2013. He also recommends several base-broadening changes to the corporate franchise tax such as repealing the current law subtraction for foreign royalties and provisions for foreign operating corporations (FOCs), amending statutes to require that all sales to this state of a unitary business be included in the sales factor for this state, and adopting statutory language requiring business transactions to meet an economic substance test to be allowed in determining Minnesota taxable income. The base broadening changes will increase state revenues over the biennium by $323 million while the rate reduction will reduce state revenues by $319 million.

Cigarette and Tobacco Products Excise Tax
The governor recommends increasing the cigarette excise tax from 48 cents per pack to $1.42 per pack, while he is proposing no change in the dedicated 75-cent cigarette health impact fee. This will increase the total cigarette excise tax and fee to $2.17 from the current $1.23 per pack. The tobacco products excise tax of 35 percent will increase 20 percentage points to a total of 55 percent of the wholesale price. The tobacco products health impact fee of 35 percent of the wholesale price would not be changed. The total tax and fee on tobacco products will increase from 70 percent to 90 percent of the wholesale price. These changes would increase overall state general fund revenues by roughly $370 million over the biennium.

The budget includes several other smaller increases in taxes such as an income tax extension for partial year residents, an up-front capital equipment sales tax exemption for businesses beginning in fiscal year 2016 and a 2.85 percent increase in the motor vehicle rental tax rate, which will set the overall rate at 9.05 percent. All told, the governor is recommending a net increase in state tax revenues of $2.139 billion over the biennium.

Questions? Contact Gary N. Carlson at (651) 281-1255 or gcarlson@lmc.org

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