Corporate tax: A stinker that pays

When Marvin Windows was weighing where to expand in 1997, honchos at the Warroad, Minn., plant looked around their home state and settled on ... Grafton in North Dakota.

What did tiny Grafton have that Minnesota did not?

Lower corporate taxes, lower income taxes, access to the workforce of Grand Forks and a state government willing to stand on its head to make a deal. Included was an annual $1,000-per-employee "labor subsidy."

Gov. Tim Pawlenty says it's examples like Marvin Windows that illustrate the need for a daring -- some say foolhardy -- pro-business gesture from Minnesota, even as the state grapples with a $5 billion budget deficit.

Pawlenty wants to slice in half a corporate tax rate that is the second-highest in the country.

Without such a reduction, which would be phased in over six years, Minnesota might find itself increasingly unattractive to businesses that are looking for even the smallest advantages in the struggle to survive, Pawlenty says.

But would the corporate tax cut stimulate the economy in the way Pawlenty predicts? Or would it simply drain away revenues that already are shrinking?

Economists and business leaders are mixed on whether lowered business taxes would prove a jump-starter. But they are virtually unanimous in their assessment that the corporate income tax is, to put it bluntly, a stinker.

Pawlenty may have some surprising allies in this fight, in some respects. Several prominent DFLers steeped in tax policy say the corporate income tax has long been a bad fit -- unstable, hard to collect, unattractive to business and a limiting factor that winds up hitting workers and consumers harder than stockholders.

Sen. Ann Rest, DFL-New Hope, follows tax policy closely and said she would opt to jettison the tax altogether if she could. "It's one of the most volatile taxes we have and the hardest to audit," she said. "We should be looking for better ways for the business world to contribute their share, but this isn't it."

But Rest said she is unconvinced that a lower corporate rate would boost the state's job creation. Merely dialing the tax down over years could make the reduction too gradual to serve as a meaningful draw, she said, while steadily eroding the revenue stream it generates.

And make no mistake about it, for all its problems, the corporate business tax has been a boon to state coffers. The tax yielded only $588 million five years ago and now hauls in $1.02 billion a year.

"Given our economic situation, if we're going to get rid of that, we have to think of what replaces it," said Senate Taxes Committee Chairman Tom Bakk, DFL-Cook. "Given where this state is right now, we can't afford to turn our backs on a billion dollars of revenue unless it's offset somewhere else."

That would mean raising $1 billion in taxes somewhere else in the system -- a move Pawlenty has sworn not to make.

Birthed in the Depression

Minnesota's corporate tax was born in the midst of another severe economic downturn -- the Great Depression. Enacted at a mere 1 percent in 1933, it quickly leapt to 7 percent in 1937, a year in which the downturn deepened again.

The tax peaked in 1971 at 12 percent and stayed there for a decade. In 1990 it settled in at 9.8 percent and has been there ever since.

A 2009 ranking of states by the nonpartisan Tax Foundation showed that Minnesota now has the second-highest flat rate in the country, exceeded only by Pennsylvania, at 9.99 percent. Neighboring Iowa has a graduated rate that ranges from 6 percent for its smallest corporations to 12 percent at the top.

Meanwhile, most industrialized nations, including most in Europe, have been lowering their corporate tax rates to lure companies. Much of the European Union now taxes corporations at 23 to 26 percent, far lower than the U.S. federal rate of 35 percent.

Pawlenty has said that having one of the highest federal corporate tax rates in the world and one of the highest state corporate tax rates has been a double whammy that Minnesota's crippled economy can no longer afford.

But in Minnesota, higher corporate taxes have also helped fund the public services and amenities -- good schools, lush parks, well-stocked lakes -- that can provide as strong a draw as low taxes. Critics of tax cuts say the state can ill afford a race to the bottom on taxes.

What kinds of taxes?

Tom Tiller, former CEO of Medina-based Polaris Industries, a leading manufacturer of snowmobiles, motorcycles and ATVs, said that when Polaris decided to expand in 2002, it was wooed across the country.

"We had states in the South that were willing to build our facility for free and just give it to us," said Tiller, who stepped down last year to pursue other interests. But Polaris was looking for more than just tax giveaways. "We wanted a great workforce, good education system, strong infrastructure and a nearby university," Tiller said. "Taxes are a factor, but they're not the only factor."

Wisconsin came close, but in the end, Wyoming, Minn., got the nod. The dealmaker came in the form of tax deferments that tipped the balance in Minnesota's favor. Without that, Tiller said, "it wouldn't even have been close."

Minnesota lost the taxes Polaris would have paid had it not gotten the deferments, but it gained 250 high-paying engineering and technical jobs and a 700-acre, cutting-edge research and development facility on the site of an old sewage treatment plant.

"Was it the lowest cost to us? No," Tiller said. "But it was reasonable. Like most things in life, it's a balance. Would it have been enough to bring us here if we'd been based in Tennessee? Probably not."

Economist Art Rolnick, vice president at the Federal Reserve Bank of Minneapolis, said that whether times are good or bad, "business taxes are always bad." Studies have shown they are borne largely by consumers, through higher prices, or workers, who wind up with lower wages or fewer positions.

Rolnick and others say that business rate reductions may not provide much of an immediate jump-start, particularly when businesses are struggling just to stay afloat, but would prove a worthwhile, long-term strategy.

However, Rolnick said, not replacing those revenues could also be a recipe for diminished appeal.

"All the research says that lower business taxes should lead to a stronger economy," Rolnick said. "But the money for all those amenities, the good schools, the clean water, that has to come from somewhere."

The most sensible choice for Minnesota, Rolnick said, is also one of the least palatable -- extending the state's sales tax to food and clothing.

"It's less regressive, it's simpler and if I'm going to buy a $1,000 suit at Nordstrom's, there's no good reason I shouldn't pay tax on it," he said.

The question, he said, is not whether Minnesota's taxes are out of line.

"Taxes have provided a great quality of life in this state," he said. "Do we have the right kinds? That's the question."

Patricia Lopez • 651-222-1288