Personal Income Tax

Issue

Are further personal income tax reductions needed to make Minnesota more attractive to operate a business? Should the state create a new income tax bracket for high wage-earners?

Policy

The personal income tax is not only a tax on employee compensation, but it's also a tax on small business income. Small businesses organized as S-corporations, limited liability companies (LLC), partnerships or sole proprietors flow their business income through their personal income tax return. As such, the structure of the personal income tax – rates and tax base – is an important component of Minnesota's business climate.

The personal income tax cuts of 1999 and 2000 reduced state revenues by more than $1 billion per year; however, the tax is still a competitive problem for Minnesota. In 2008, Minnesota had the sixth highest personal income taxes per $1,000 of income. Of our surrounding states, only Wisconsin (9th highest) was in the top 10 states nationally. To the extent that further personal income tax cuts are made, they should focus on the following:

• "Pass-through" income. Minnesota should enact a 20-percent exemption for active business income for "pass through" entities – S-corporations, partnerships and limited liability companies. Doing so would drop the marginal tax rate on business earnings, allowing more capital to be reinvested in the business.
• Capital gains. Minnesota should reduce taxes on individual capital gains by either taxing them at a rate lower than ordinary income or enacting a capital gains exclusion. (The average and median top capital gains tax rate in the 40 states plus the District of Columbia that tax capital gains is about 6 percent. Ten states do not tax capital gains.)
• Rates. Minnesota should continue to reduce personal income tax rates across the board.

Moreover, the Chamber opposes the creation of a new fourth income tax bracket for high wage-earners. A new fourth bracket would disproportionately and adversely affect Minnesota employers who flow their business income through their personal income tax returns. Ninety-two percent of Minnesota business owners flow their business income through their personal income tax returns.

Business Impact

Enacting an exemption for active pass-through income would effectively drop Minnesota's highest marginal rate on active business income from 7.85 percent to 6.28 percent. This would put Minnesota in the middle of the states that tax personal income. Since research indicates that high marginal tax rates discourage investment and hiring by entrepreneurs, a reduction in marginal rates should spur investment and hiring in the state. It also would move Minnesota's personal income tax more toward a tax on wages rather than both a tax on wages and business income.