Why Local Aids Are Never a Magic Bullet for Controlling Property Taxes

Levies are rising once again, and pressure to increase local aids to stem this tide is likely coming in 2015. State aids may be very important to local governments and community welfare, but they are not and never will be a cure for rising property tax levies.

The Department of Revenue recently reported that preliminary property taxes for 2015 are 4.2% higher than the payable 2014 levels. Local governments will establish their final levies at the end of December and they often adjust them slightly downward. Nevertheless, a 4% increase or more on a statewide basis is likely.

No one should be particularly surprised by this. The cost of government generally goes up over time. Population growth creates more demands on services. Infrastructure wears out. And government is certainly not immune from inflationary pressures. The good news is that the expanded accessibility and generosity of the state’s income-tested refund program will protect even more taxpayers from feeling the full effects of any increases.

Any surprise taxpayers feel is likely rooted in the belief that 1) the local aid increases the state provided in 2013 should have had more “staying power”; and 2) even more local aid would have done a much better job of keeping levies in check this year. The problem is that the relationship between property taxes, aids, and local spending is a lot more complicated than this. To put it simply, a dollar of aid provided does not turn into a dollar of property tax not levied.

Here’s an excellent example of this point, which demonstrates why taxpayers should remain eternally skeptical about what state aids and other property tax buydowns can actually accomplish regarding levy restraint. This particular example – which deals with city finances – comes from another buydown effort: Governor Ventura’s “Big Plan.” Among other things, the “Big Plan” wiped out the mandatory $1.3 billion general education levy, which lowered property tax bills across the state. The table below shows city property tax levies and the amount cities received from two aid programs (LGA and HACA) for the years leading up to the adoption of the “Big Plan” and the year immediately afterward.

So what happened? The first thing to notice is the relationship between LGA and city levies in the years leading up to the Big Plan. Despite reasonable annual growth in LGA (ranging from 2.5% to 4.3% from 1996-2001), levy increases during these economic boom years still increased at a very healthy average annual clip of 5.8%. This alone should cast some doubt on the notion that local aids restrain levy growth and indirectly provide property tax relief. In the language of public finance scholars, it’s strong circumstantial evidence of the “flypaper effect” – money sticks where it lands.

Even more telling are cities’ levy decisions following the adoption of the Big Plan. As part of the reform, the state eliminated a big pool of local aid (HACA). The state partially offset the $200 million cities lost in HACA aid with a $157 million increase in LGA (explaining the 38.4% jump in 2002). The net result was that cities needed to backfill a net loss of $43 million in state aid, which undoubtedly influenced city levy decisions for 2002.

Was the big 17.4 % increase in city levies in 2002 justified by the aid cuts alone? Nope. As the right-most column in the table shows, the change in levy-plus-aid between 2001 and 2002 – a measure of the change in city revenue base – was 7.6%. That’s 78% higher than the average of the six previous years.

Was inflation running amok requiring bigger levies to keep up? Hardly. Cities’ levy-plus-aid growth during this period far exceeded inflation (measured by either the Consumer Price Index or the specialized government inflation measure called the IPD). From 1995-2001 cumulative levy-plus-aid grew 39% faster than the IPD and 75% faster than the CPI.

So what explains this big jump in city levies? Evidence strongly suggests that – even after several years of strong levy growth in a modest inflation environment – cities simply took advantage of the new “spare capacity” on business and homeowner property tax bills created by the elimination of the general education levy to support higher spending.

The moral of the tale is this: state aids are very important to local governments and community health, but they are not and never will be a magic bullet for restraining levies. It may put a temporary dent in a longstanding trend but local governments still spend that money. The result: higher levels of spending and higher government cost structures for which the property tax will always remain the “go to” source of support in the future. And once government programs and cost structures are in place, they can be extremely difficult to unwind.

What options are available for controlling levy growth? There are two. The first is what many other states have resorted to: impose some form of permanent property tax limitation. These clumsy, heavy-handed efforts undercut the basic idea of local control, incentivize highly “creative” financing of government programs and services that damages accountability and transparency, and are often so riddled with exemptions they can be more ornamental than functional.

The alternative is quaint and old fashioned – but reflects the basic responsibilities of a self-governing society: citizen vigilance, participation, and engagement in the levy setting process. This starts at the ground floor with understanding why your own property tax bill looks like it does and knowing why it is changing. With respect to controlling levy growth, this alternative may lack the political drama of efforts to pump millions more into property tax aids every legislative session, but over the long run it will be a lot more effective.