The Budget Debate, Part 2

Forgive the length of this post.  I am trying to make some subtle points about tax policy, and I think the reading will pay off, in the end.

Our state legislature has less than a week to go before it must adjourn for the year.  In today's Star Tribune, Timothy Taylor writes an opinion piece on the central question of the budget debate:  should we raise taxes on "the rich"?

I don't think it is unfair to say that Mark Dayton made raising taxes on "the rich" the signature issue of his 2010 campaign for Governor.  (I am using scare quotes around "the rich" because the actual definition keeps fluctuating.)  In turn, Gov. Dayton rested his argument for higher tax rates on the Department of Revenue's Tax Incidence Study (the 2011 version is located here).  The study shows (Table 4-2) that--after combining state income taxes, property taxes, and sales taxes--the percentage of income paid in taxes falls as income rises.  Gov. Dayton finds this outrageous, that higher income taxpayers don't contribute their "fair share" as a percentage of their income.

His solution is to raise income taxes to the highest/nearly the highest levels in the country.  But a close look at Table 4-2 indicates that income taxes are not the source of the disparity.  Minnesota has a highly progressive income tax rate structure, and does not have lower rates for capital gains and dividend income, as is the case with the Federal income tax structure.

No, the disparity arises when you add in sales and property taxes.  Sales taxes are a flat percentage of the sales price, regardless of your income.  A low-income person buying a gallon of gasoline pays the same tax, in cents, that a rich person pays per gallon, even if the gasoline is going into the tank of a Bentley.  However, low income households spend a greater percentage of their total incomes, hence they pay a larger percentage of their incomes in sales tax.  Putting it another way, higher income households save more of their income and, thus, do not consume stuff at as high a proportion of their income as do lower-income households.

Property taxes, for the most part, vary with the value of the property taxed.  Higher priced homes will pay proportionately higher taxes.  However, as with the sales tax, higher income households do not consume housing in the same proportion as lower income households.  Thus, lower income households pay a greater percentage of their income in property taxes.  The rich simply do not have homes as big as their incomes could support.

In the end, what drives this "disparity" in effective tax rates is not that rates on "the rich" are too low, but that higher income households save too much.  If higher income households would buy larger homes and spend more money on stuff, then the disparity would disappear.

So, in the end, what Gov. Dayton hopes to accomplish is to punish the relative thriftiness of higher income households.  He wants to tax them more so that they can save and invest less.  How will this policy create more private sector jobs?