Minn. governor calls for income tax hike

ST. PAUL, Minn. (AP) -- Haircuts, car repairs, downloaded novels, lawyer bills and pricey clothes are just a few of the purchases that Gov. Mark Dayton said Tuesday should be newly subject to Minnesota's sales tax as part of a plan to boost state tax revenue by $2.1 billion.

The sales tax rate overall would fall, part of a proposed retooling of Minnesota's tax system that Dayton argues would make it fairer. The Democratic governor's $38 billion budget would eliminate a deficit and increase spending on public schools, higher education and job-creation programs. Dayton proposes paying for it with more money from sales taxes, an income tax hike on the state's wealthiest residents and higher cigarette taxes.

"I'm not out to raise anybody's taxes," Dayton said, adding that most middle-class Minnesotans wouldn't wind up with a greater overall tax burden. "I'm out to raise enough revenue to do what's right for Minnesota."

Dayton's template includes property tax relief for all homeowners and farmers in the form of a $500 yearly rebate. He also pitched a reduction in corporate tax rates to 8.4 percent from the current 9.8 percent, while closing some tax loopholes that benefit businesses.

Dayton campaigned for governor in 2010 on a vow to raise income taxes on the wealthy, but Republican legislative majorities thwarted that goal in the first two years of his term. Democrats now control the state House and Senate, improving the chances that much in his budget will be enacted. But parts of it may still be a tough sell as lawmakers start a months-long process of review, and while DFL leaders offered strong general support for Dayton's budget, they didn't predict what would survive.

Republican legislative leaders, stuck in the minority, were left to issue warnings. "Get prepared. Everything is going to get more expensive," said Senate Minority Leader David Hann, R-Eden Prairie.

Dayton said lawmakers who think he spends too much should propose specific cuts, but none were immediately forthcoming from GOP leaders.

More items would be subject to the state sales tax under Dayton's plan, but the current rate of 6.875 percent would be cut to 5.5 percent. The Dayton administration said that would take Minnesota from 7th highest sales tax rate to 27th among the states.

Minnesota would lose its longtime distinction as one of the few states that doesn't tax clothing, but Dayton would apply it only to items priced at $100 and up — meaning $120 pair of pants would be taxed, but two $60 pairs would not. The entire $120 would be taxed.

The sales tax would be added to many services not currently taxed, including the services of lawyers and accountants, business support services, specialized design, car repairs and hair salons, and purchases made over the Internet.

Mike Hickey, state director of the National Federation of Independent Business, warned that the expanded sales tax would be most onerous to businesses, which would have to pay a range of taxes they don't now. Some could decide to forego hiring public relations firms, computer consultants or accountants, he said. But Hickey predicted the added costs would mostly trickle down to customers.

"They'll certainly try to pass it on through a higher cost on a good or service," Hickey said.

House Minority Leader Kurt Daudt, R-Crown, suggested that applying sales tax to services would make businesses head for neighboring states, calling it "a budget for a better Wisconsin."

On cue, GOP Wisconsin Gov. Scott Walker said he might "put a little bit more of a push" to lure Minnesota companies across the border.

On income taxes, Dayton proposed a new, fourth tax rate of 9.85 percent on income above $150,000 for single filers and $250,000 for joint filers. Currently, the top state income tax rate is 7.85 percent.

Dayton said he was most reluctant to raise cigarette taxes, knowing it would fall harder on people of limited means.

"That is one I have not felt favorable toward for some time. I had to be talked into it this time," Dayton said. But he said he was convinced it was worthwhile because it's projected to reduce the number of smokers.

Minnesota currently taxes cigarettes $1.58 per pack. Dayton said increasing that by 94 cents would make Minnesota's per-pack tax equal to that of Wisconsin.

Dayton has seized an ambitious goal in seeking to remake the state's tax structure, particularly in pitching changes that will be noticed at cash registers and on service bills all over the state. But he said he hoped people would ultimately get behind what he called a trade-off in favor of investments that reflect shared priorities.

"Everybody would like to lower taxes and do the things that make Minnesota a great state, that have made us successful in the past," Dayton said. "We may not have the lowest taxes, but we have the best value for taxes — for individuals, for businesses, quality of life, quality of medical services, environmental protection, clean air and clean water."

Almost two-thirds, or about $640 million, of Dayton's proposed $1 billion in new spending would go to K-12 and higher education. New money would spread to many different programs: $125 million to improve special education, $44 million for early childhood education scholarships and $40 million to provide about 46,000 children with access to all-day kindergarten.

The governor's budget also adds $118 million for general school funding, boosting per-student funding to districts by $52 and headed toward an average funding increase of $339 per student by 2015, according to the state's Department of Education.

"This is the best state budget we've seen for education in decades," said House Speaker Paul Thissen, DFL-Minneapolis. Despite that, Dayton's proposal moves slowly in settling the state treasury's debts to school districts stemming from delayed aid payments of recent years; those shifts would not be fully repaid until 2016.

Dayton also proposed an $86.5 million spending boost on job-creation programs.

Dayton and his Democratic allies touted his proposal as an honest reflection of the cost of Minnesota priorities, after more than a decade in which budget deficits were eliminated with one-time sources of money, delays in aid payments, borrowing, and cuts to popular programs.

"The budget I am proposing today will end those games and gimmicks, and replace them with honest accounting and responsible financial management," Dayton said.

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Associated Press writers Brian Bakst and Scott Bauer contributed to this report.