Both Republicans and DFLers are proposing to change how Social Security is taxed in Minnesota. That’s where the similarities end.

11 May 2022

Finding areas of agreement between Senate Republicans and House DFLers on taxes this session hasn’t been easy.

REUTERS/Eric Miller
Gov. Tim Walz

With a record-setting surplus, both parties and Gov. Tim Walz want to spend some of it to reduce what the state collects. But they take vastly different approaches: Republicans favor tax-rate reductions that would benefit everyone who pays personal income taxes, while the DFL has proposed a series of targeted tax credits for families with children, child care and student loans.

But at least in the big type there is one sliver of commonality: Both the House and Senate propose changes to how Minnesota taxes Social Security income that would have retired residents pay less.

But in case anyone thought even that was going to be easy, each side gets to that result in different ways — and with different price tags.

What’s being proposed

The Senate GOP tax bill would end all state income tax collections on Social Security benefits, a change that would reduce tax collections by $550 million a year and would take effect with the current tax year.

“There is something that I think just about everyone on this tax committee has proposed at one time or another, and that is removing the double taxation on Social Security benefits,” Senate Taxes Committee Chair Carla Nelson told her committee last month.

“Our state is one of a handful that will tax those benefits,” said the Rochester Republican.

State Sen. Carla Nelson

Whether Social Security taxation is double taxation is subject to debate and interpretation. Proponents of eliminating the tax make that assertion frequently — along with the undisputed fact that only 13 states collect any taxes on Social Security, though many of those, like Minnesota, do exempt taxpayers at lower income levels. Social Security benefits also remain subject to federal income taxes, depending on the overall income of the taxpayer.

The House DFL would not eliminate all taxation on Social Security benefits but would increase the income thresholds for who pays those taxes. It would cost the treasury $114 million a year, growing to $135 million by 2025.

The fight over flight

The contrast in plans displays the philosophical — and partisan — differences between the parties. Republicans maintain that seniors have paid into Social Security for years and deserve its benefits without being taxed for them.

That is a popular position among senior residents — and senior voters. And some lawmakers argue that the taxation of those benefits contributes to retiree flight to states like Arizona, which doesn’t tax those benefits, or Florida, which has no state income taxes at all.

“I’m extremely confident that dropping the income tax on Social Security would result in more seniors staying and living comfortably in Minnesota, paying property taxes, paying sales taxes,” said Rep. Dave Lislegard, DFL-Aurora.

“It’s not the only reason people leave the state when they retire, but why give them any reason?” said Rep. Tony Jurgens, R-Cottage Grove.

MinnPost photo by Peter Callaghan
Mark Haveman

Yet Mark Haveman, the executive director of the Minnesota Center for Fiscal Excellence, doubts the change alone would affect where retirees live. That’s because higher-income seniors would still face state taxes on the bulk of their income which comes from sources other than Social Security. “Your retention bang for the buck would be minimal if it would exist at all,” Haveman said.

Room for compromise?

DFLers, including Gov. Tim Walz, think any tax benefits should go toward helping middle- and lower-income seniors and not include wealthier retirees whose income includes much more than Social Security. Currently, 55 percent of the 400,000 Social Security recipients in Minnesota pay no taxes on those benefits. The bulk of the GOP-proposed tax elimination would benefit taxpayers who are receiving $100,000 or more in total income, according to a Senate fiscal analysis.

Under the GOP plan, those with incomes between $50,000 and $75,000 a year would save an average of $733 a year while those with incomes over $500,000 would save $2,397. The other part of the Senate GOP tax cut — a reduction of the first-tier tax rate from 5.35% to 2.8% — is less regressive, with half of the benefit falling to taxpayers earning $100,000 or less.

State Rep. Paul Marquart

The House’s treatment of Social Security taxes continues a trend of gradually increasing income thresholds for when taxes are due to the state. An analysis of key segments of House Taxes Committee Chair Paul Marquart’s plan notes that about 282,000 tax returns would see an average savings of $397 under the DFL plan. Nearly all of those savings would be seen by households with incomes less than $100,000, and none would fall to filers earning $150,000 or more.

Walz said he supports increasing the income levels where taxes are eliminated or greatly reduced, but he doesn’t favor total cancellation of the tax because of the way that would advantage wealthier retirees.

Still, after another closed-door session with legislative leaders and budget staff Monday, Walz said he thinks there is room for compromise. “We need to keep lifting that to make sure that those in the middle are not seeing an increase,” Walz said.

But on Tuesday Senate Majority Leader Jeremy Miller disagreed with Walz’s assertion that wealthy retirees benefited the most from the Senate’s elimination of the tax. “We’re hearing from senior citizens every single day on how detrimental this tax is and how meaningful it would be to provide them this much-deserved tax relief,” the Winona Republican said. 

A brief history of Social Security benefits taxation

The complexity around Social Security taxation dates back to changes Congress made in 1983, moves that attempted to treat Social Security income the same as retirement income from other sources, such as pensions and 401ks. Before that year, Social Security was exempt from taxation. That was changed in part to shore up the Social Security trust fund itself.

Retirement income is either taxed at the front end or the back end — that is, when people pay into funds while working or take income from them after retirement. And Congress wanted to treat Social Security like other retirement income but also to avoid double taxation — taxing it when people paid in and when they got the benefit.

Tax Foundation
State tax treatment of Social Security benefits, 2021

Initially, half of the benefits were exempt from taxation. Then, in 1993, Congress lowed the exemption to the first 15 percent of Social Security benefits, an amount considered equal to the percentage that an average recipient paid into the system during their working years, according to an analysis prepared by the House Research Department

The federal government also excludes an additional amount depending on a taxpayer’s income. And since Minnesota’s income tax depends on the federal calculations of adjusted gross income (technically a slightly different calculation dubbed “provisional income”), those exclusions pass through to state tax forms.

But Minnesota is more generous in how it taxes Social Security income than the federal government, since the state allows taxpayers to subtract some of their Social Security from their taxable income. In 2017 — the most recent year for which data is available — about 290,000 taxpayers saved a total of $58.3 million, or an average of $201, under the subtraction, according to the House Research staff. A 2019 tax bill compromise increased the thresholds to benefit more residents.

The tax treatment of Social Security means that “modest-income Minnesotans are less likely to get any tax cut from expanding the state Social Security exemption, and any tax cut they would receive would be small as well,” wrote the Minnesota Budget Project, a progressive advocacy organization affiliated with the Minnesota Council of Nonprofits.

Haveman, of the Center for Fiscal Excellence, sees political motivation as well, given the high voter turnout of seniors. ‘Targeted’ has been a theme in both parties’ tax relief messages,” he wrote. “And in 2022 seniors and their Social Security income are the bull’s-eye.”

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