CHICAGO – Minnesota Gov. Mark Dayton unveiled Tuesday a proposed $37.9 billion two-year budget for fiscal 2014-2015 that overhauls the state’s tax code, lowering but broadening the sales tax and raising income tax rates on top earners.

The net revenue increase expected from the tax overhaul would help close a $1.1 billion deficit, pay for property tax relief, and provide an additional $640 million for early childhood, primary, secondary, and higher education. The budget provides an additional $240 million for local and county government aid.

Under the proposed budget, the state’s tobacco tax would increase by 94 cents and the sales tax cut would be cut to 5.5% from 6.875% while expanding it to cover clothing items over $100, services, and online purchases.

The income tax rate would rise to 9.85% from 7.8% for individuals who earn taxable income of more than $150,000, have head of household status with $200,000 income, and couples earning more than $250,000. Corporations would see income tax and property tax relief but would lose some tax loopholes.

The income tax changes would generate $1.1 billion in new revenue and the sales tax changes another $2.1 billion. The tobacco tax increase would raise $370 million.  Property tax owners would see relief in the form of a $500 rebate at a cost of $1.4 billion. The overall tax changes would result in $2.14 billion in additional revenue, according to budget documents.

Dayton portrayed the budget plan as one that provides major investments in education and the state’s economy through a fairer tax system.

“If the investments in my budget proposal are made, they will yield returns in new jobs, private investments, vibrant communities and additional state and local tax revenues; and they will help keep our economy moving forward,” Dayton said in a statement.

The budget is also balanced with $225 million in spending cuts. It does not provide funds to repay $1.1 billion in aid withheld from schools to balance the current budget. Those funds are not repaid until fiscal 2015 and 2016.

“Some will say we spend too much in this budget, and some will say we don’t spend enough,” Dayton said. “To those who claim this spending is too high, I challenge you to say exactly where more cuts should be made. And to those who say we need to spend more, I challenge you to say exactly where the money should come from.”

Dayton also sought to portray the budget as one that is balanced without accounting gimmicks and payment delays relied on in the past to erase red ink. Dayton, a Democrat-Farmer-Labor Party member, sought to help eliminate a $5 billion deficit two years ago with an income tax increase on top earners but Republicans who then controlled the Legislature refused.

Dayton eventually agreed to go along with a Republican proposal for further school payment delays and a tobacco bond sale that generated $640 million in budget relief to end a partial state government shutdown.

The use of one-time revenues to erase red ink drove negative credit action. Standard & Poor’s rates Minnesota AA-plus and Moody’s Investors Service rates the credit an equivalent Aa1 with a negative outlook. Fitch Ratings rates the state’s $6 billion of GOs to AA-plus.

The November election handed majority control of the Legislature over to the DFL Party so Dayton’s proposals face a friendly audience this year. While Republicans will oppose most tax increases, Dayton could still face challenges within his party because he opposes their proposal to raise the gas tax for road and bridge construction.

Lawmakers will use revenue projections released in early March to craft a final budget. The annual November forecast projected a $1.3 billion balance in the current budget but warned of the $1.1 billion deficit looming in the next. All of the balance will go to repay some of what the state owes schools.

The state typically passes a capital budget known as the bonding bill in the year following adoption of an operating budget. The state also typically borrows its new money in early to mid-summer.

In addition to new money later this year, assistant MMB commissioner for treasury Kristin Hanson said last week her office was keeping its eye on refunding opportunities. The state also this year will be in the market with up to $498 million of appropriation-backed borrowing to help fund a new Minnesota Vikings stadium in downtown Minneapolis.

The budget also includes a proposal to further extend the state’s ability to use negotiated sales for its GO issues. The last two budgets have included that provision. “We would like to make it permanent,” Hanson said.

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