Minnesotans need a break, but not Social Security
With a distraction or two in the news and no legal requirement to do much in the state capitol this session, the Minnesota Legislature is getting little attention so far in 2022. That could be a mistake, as a tireless watchdog — the always-excellent Minnesota Center for Fiscal Excellence — has come out with a telling update.
Not in more than 20 years, the center reports, “have legislators not been … tempted to embark on a similar leniency on both tax relief and new spending.”
With state coffers swollen by a record $7.8 billion budget surplus, as well as various sources of federal pandemic relief funds, state leaders are busy planning what they apparently assume will be. years of such abundance.
Gov. Tim Walz’s “supplementary budget proposal,” according to the center, “consumes…98% of the current surplus” and “93% of the currently projected structural balance…” for the next biennium in 2024-25.
This all happens, the center notes, “nine months before we elect legislators to determine what the fiscal year 24-25 budget needs and priorities should be.”
And “meanwhile, Senate Republicans have yet to release the specifics of their tax relief plan…”.
That’s enough to inspire a celebration of Minnesota’s usual, currently unusual, and still maligned divided government and the stalemate it often results in. “A divided legislature,” the center observes, “ensures that neither party’s visions of a fundamental transformation of the state’s budget and fiscal structure will be adopted.”
It would be nice to think that the forced compromises to come could ensure that only the best ideas survive – the most useful and necessary spending programs, the fairest and most economically energizing tax breaks. That would be nice, but also naive.
“The only sure thing,” the center predicts, “is a bill to exclude all Social Security income from [state] taxation. Seven such bills have been introduced, including one co-authored by the House Tax Committee’s DFL co-chair.
You could call this misguided political idea the kind of tax cut for the (mostly) rich that even liberals can warm up to — or the kind of unproductive wealth redistribution that conservatives embrace. Either way, it’s a “targeted tax cut” which, like most targeted tax cuts, is to pick government favorites primarily to inspire their political gratitude. This would cost about half a billion dollars in reduced revenue per year.
The center observes that what is called “horizontal equity” is a central principle of tax fairness. It is the idea that people with the same income should pay the same tax. As part of its illuminating webpage detailing the state’s tax treatment of Social Security benefits, the staff of Minnesota House Research provides an interactive calculator that shows just how much this type of deductible Social Security equity d deviates.
Under current law, a couple over 65 earning $100,000 in ordinary annual income and not yet collecting Social Security would pay $4,365 in Minnesota income tax. If this couple retired and started receiving a total of $50,000 in annual Social Security benefits while dipping into pensions and savings for an additional $50,000 — keeping their total income at $100,000 — their taxes would be pay in Minnesota would drop to $2,809.
This tax relief exists because the federal tax code already excludes a portion of Social Security benefits from taxable income, while Minnesota has already enacted additional subtractions for state income tax purposes.
What if total exemption becomes law?
In this case, our couple, still living on $100,000 a year, would only owe $1,209 in state taxes, barely a quarter of what they pay on the same pre-retirement income.
Things would become even less fair if our couple had earned total Social Security benefits of $75,000 a year and had only drawn $25,000 from other sources to make up their total income of $100,000. His state tax in this case, under current law, would only be $754.
And in case of total exemption, his income tax would become – 0 $.
Meanwhile, less well-off retirees are barely forced to eat their cats by Minnesota’s Social Security tax. Under current law, a couple receiving a total of $40,000 in Social Security benefits could add $25,427 of other income before owing a single dollar in Minnesota income tax.
Social Security is different, we are told; workers have paid into the system for many years. Yes, and that’s why federal law excludes some of the benefits from tax. But the contributions generally represent only a fraction of the benefits to which one is entitled during a long retirement. The bulk of his social security benefits are, in effect, a previously untaxed return on his contributions. In short, there is no double taxation of Social Security.
It’s also doubtful that lowering Social Security taxes will do much to grow the economy — to incentivize work, investment, or innovation. On the contrary, they would seem to slightly encourage early retirement and lower paid work during retirement.
What about the worries that wealthy seniors are leaving high-taxed Minnesota, taking with them their tax payments, their charitable donations, their talents and volunteer energies? This deserves reflection. The center’s idea is that if well-to-do seniors evade taxes in Minnesota, surely it’s the state’s entire tax system that concerns them, not whether the state exempts “which is often a relatively small fraction of their income”.
All of this may indicate the true appeal of this proposal. Surely Minnesota needs tax relief, in fairer and more economically productive forms – primarily broader relief. But less “targeted” reductions could be more difficult to implement politically. Every politician can see some wisdom in pleasing the elderly.
It is this “political wisdom,” the center speculates, that inspires most states to completely exempt Social Security benefits from taxation as “a way for lawmakers to curry favor with one of the most vulnerable demographic groups.” more politically engaged, who also happens to be one of the wealthiest.”
Tax-free Social Security might not be the most pointless thing politicians are doing in St. Paul this year, but that might not mean much.
DJ Tice is at [email protected]