Minnesotans could face significant state tax hike next year in wake of federal changes

The federal tax overhaul passed late last year could mean a hefty state tax increase for Minnesotans.

If the Legislature simply conforms the state tax code to its federal counterpart — which has been standard practice in recent years — then state government would collect an additional $813 million in taxes next fiscal year, and $1.49 billion during the two years after that, due to major changes in federal tax law approved late last year by the Republican Congress and President Donald Trump.

That's according to an estimate released this week by the state Department of Revenue. But Sen. Roger Chamberlain, R-Lino Lakes, said Minnesotans shouldn't worry.

"One thing is for sure: We are not going to increase taxes in the state of Minnesota," Chamberlain said Wednesday.

But Minnesota lawmakers, who convene on Feb. 20 for their annual session, have work to do if they want to prevent a tax increase.

That's because Minnesota is one of a few states that base state taxes on an income figure plucked from the federal filing called "federal taxable income," which then becomes the starting point for determining Minnesotans' taxable income.

The loss of personal and dependent exemptions in the new federal law would increase federal taxable income for many Minnesotans, and, thus increase their taxes if the state adopts the federal changes, the new estimates show.

If the state tax code diverges significantly from federal law, "Minnesotans are going to have to hire tax accountants," Chamberlain warned.

State lawmakers and the administration of Gov. Mark Dayton face what the Minnesota Center for Fiscal Excellence is calling a "once-a-generation challenge" to balance demands of tax fairness, sufficient revenue and simplicity of tax administration and filing.

Chamberlain said Minnesota should also consider competitiveness: "All the other states around us are going to be taking advantage of this, improving their state's economy. If Minnesota does nothing, we will suffer economically," he said.

Tax policy has already been a major source of conflict between DFLer Dayton and the Republican-controlled Legislature. Last year, a dispute over the tax bill grew so heated that Dayton and GOP legislative leaders ended up fighting it out in the state Supreme Court.

Also coloring the debate is the upcoming election, with an open governor's office and control of the state House on the line. A number of sitting lawmakers are candidates for governor and are likely to be looking for way to score points in the tax debate.

According to the estimates for 2019, corporations would pay slightly more than half of the increase, with individual income tax filers paying the rest. In the second year of the major increases, however, individuals would pay an extra $407 million, while corporations would pay an extra $217 million.

In just one example of the complex policy questions facing the Legislature, lawmakers will have to consider family size. In the old system, parents with kids got to claim the children as dependent exemptions and themselves under personal exemptions, reducing their taxable income and thus their taxes significantly. The new federal law eliminates the dependent and personal exemptions, which means if Minnesota wants to adapt its tax code to the federal law, the Legislature would also need to create a new system if it wants to protect large families from a tax hike.

Among the surprising trickle down effects of the federal law, these same Minnesotans could lose some of their property tax rebates. Without the federal personal and dependent exemptions, big families would see their taxable income rise and lose state property tax rebates as a result, costing them a collective $84 million in each of fiscal year 2020 and 2021, according to the state's estimates.

"I don't think reductions in property tax refunds is a reasonable response to the federal tax bill," said Nan Madden, director of the liberal-leaning Minnesota Budget Project.

Asked whether the distribution of the tax burden would remain the same under a Republican tax plan, Chamberlain did not answer directly but said, "Our goal is to give relief to as many Minnesotans as possible."

"Being fully informed on the policy impact is the smart way for Minnesota policymakers to go," she said.

The state's current two-year budget is about $46 billion, so a $1.5 billion surplus would represent about 3 percent of the budget.