Minnesotans need a break, but not on Social Security

With a distraction or two in the news, and no legal requirement to do much of anything at the State Capitol this session, the Minnesota Legislature is so far attracting little attention in 2022. That might be a mistake, because one tireless watchdog — the always-excellent Minnesota Center for Fiscal Excellence — is out with an eye-opening update.

Not in more than 20 years, the center reports, "have lawmakers been ... tempted to embark on a similar indulgence of both tax relief and new spending."

With state coffers bulging from a record $7.8 billion projected budget surplus, plus various still-flowing gushers of federal pandemic relief funds, state leaders are busy planning for what they apparently assume will be years on end of such abundance.

Gov. Tim Walz's "supplemental budget proposal," the center says, "consumes ... 98% of the current surplus" and "93% of the currently forecasted ... structural balance" for the following biennium in 2024-25.

All this is happening, the center notes, "nine months before we elect lawmakers to determine what the FY 24-25 budget needs and priorities should be."

And "meanwhile, Senate Republicans have not yet unveiled the specific elements of their tax relief plan ... ."

It's enough to inspire a celebration of Minnesota's habitual, currently unusual and always maligned divided government and the stalemate it often brings. "A divided Legislature," the center observes, "guarantees neither side's visions of a fundamental transformation of the state's budget and fiscal structure will be enacted."

It would nice to think the forced compromises ahead might ensure that the only best ideas will survive — the most useful and needed spending programs, the most fair and economically energizing tax relief. It would be nice, but also naive.

"The one 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 DFL co-chair of the House Tax Committee.

You could call this misguided policy idea the kind of tax cut for the well-off (mostly) that even liberals can warm up to — or the kind of unproductive redistribution of wealth conservatives embrace. Either way, it's a "targeted tax cut" that, like most targeted tax cuts, is government picking favorites mainly to inspire their political gratitude. This one would cost about half a billion dollars in reduced revenue per year.

The center observes that what's called "horizontal equity" is a central principle of tax fairness. It's the idea that people with the same income should pay the same tax. As part of its illuminating web page detailing state tax treatment of Social Security benefits, the Minnesota House Research staff provides an interactive calculator that shows just how far from that kind of fairness tax-free Social Security strays.

Under current law, an over-65 couple earning $100,000 in ordinary annual income and not yet drawing Social Security would pay $4,365 in Minnesota income tax. If that couple retired, and began receiving a total of $50,000 in annual Social Security benefits while tapping pensions and savings for another $50,000 — keeping its total income at $100,000 — its Minnesota tax liability would fall to $2,809.

This tax break 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.

And if full exemption becomes law?

In that event our couple, still living on $100,000 a year, would owe just $1,209 in state tax — barely a quarter of what they pay on the same income before retirement.

Things would grow still less equitable if our couple had earned total Social Security benefits of $75,000 a year and drew just $25,000 from other sources to assemble its $100,000 total income. Its state tax in that case, under current law, would be just $754.

And under full exemption its state income tax would become — $0.

Meanwhile, less affluent retirees are hardly being forced to eat their cats by Minnesota's tax on Social Security. Under current law, a couple drawing $40,000 total in Social Security benefits could add $25,427 in other income before owing a single dollar of Minnesota income tax.

Social Security is different, we are told; workers paid into the system over many years. Yes, and that's why federal law excludes a portion of benefits from taxation. But contributions are typically a fraction of the benefits to which one is entitled during a long retirement. Most of one's Social Security benefit is, in effect, a previously untaxed return on one's contributions. There is, in short, no double taxation of Social Security.

It's also doubtful that lower taxes on Social Security do much to grow the economy — to incentivize work or investment or innovation. If anything, they would seem to slightly encourage earlier retirement and less paid work during retirement.

What about concerns that affluent elders are leaving high-tax Minnesota, taking with them their tax payments, their charitable donations, their volunteer talents and energies? It's worth some thought. The center's thought is that if well-off seniors are fleeing Minnesota taxation, it surely is the state's whole tax system that concerns them, not whether the state exempts "what is often a relatively small fraction of their income."

All this may point to the real appeal of this proposal. Minnesota surely needs tax relief, in fairer and more economically productive forms — mainly broader relief. But less "targeted" cuts might be more difficult to enact politically. Every politician can see some wisdom in pleasing senior citizens.

It's this "political wisdom," the center speculates, that inspires most states to fully exempt Social Security benefits from taxation as "a way for lawmakers to gain favor with one of the most politically engaged demographic groups, which also happens to be one of the wealthiest."

Tax-free Social Security may not be the most wasteful thing politicians do in St. Paul this year — but that may not be saying much.

D.J. Tice is at doug.tice@startribune.com.