Rehashed, rewarmed criticism of our 50 State Study still doesn’t change the fact Minnesota’s business property tax rankings are deserved.
Minnesota’s traditionally high business property tax rankings – and the role of the state general tax in contributing to those high rankings – have long been a political obstacle for policy advocates seeking to maintain or increase the property taxes businesses pay. As a result, over the last 20 years advocacy groups have delved deep into the methodology we employ in the 50 State Property Tax Comparison Study we co-publish with the Lincoln Institute of Land Policy -- the nation’s premier land policy research organization -- to raise questions and cast doubt about the accuracy and legitimacy of our Minnesota business property tax findings.
The latest such effort was included in report commissioned this year on property taxes and E-12 finance by the Minnesota Rural Education Association (MREA). In its review of state property tax rankings, the MREA report argues that the findings included in the 50 State Study do not capture the diversity and reality of Minnesota business property tax burdens cautioning, “in regard to business property tax rankings, the best approach may be to acknowledge what we do not know, rather than pretend we know more than we do.” What’s clear to us from a review of the MREA report is that criticisms of our study are based on things the authors do not seem to know – or choose to ignore – about property tax systems across the nation.
For over two decades criticism of the 50 State Study findings has centered on the same two issues. The first is that the choice of Minnesota cities used for “urban” and “rural” comparison purposes (Minneapolis and Glencoe[1] respectively) are not representative of business property taxation in the state. Researchers point out the tax rates for both these communities are high relative to their urban and rural “peers” in Minnesota. The problem with this argument is that it combines a misrepresentation of the study’s comparison intent with either a willful omission or gross misunderstanding of key issues affecting property tax rankings.
Since its inception, the 50 State Study has been designed to enable national comparisons among the largest cities in each state – not an urban center relative to its own municipal neighbors. The criticism that Minneapolis’ tax rate is high relative to its own suburbs is irrelevant.
The more interesting aspect of this criticism concerns rural rankings. That’s because the choice of a specific city from among an eligible pool might appear to have potentially profound implications on national rankings. Indeed, the MREA report indicates – correctly – that Glencoe’s net tax capacity (NTC) tax rate is on the high side compared to all the other Minnesota cities that meet the criteria for potential inclusion in the study. (Although at 15% higher than the average we would question whether this demonstrates the sort of outlier status that the MREA report suggests.)
So how does our choice of Glencoe instead of any other potential Minnesota rural city candidates[2] affect the study findings? The accompanying table provides the answer for tax year 2016, which was the basis of the MREA report. As the right-most column in the table shows, 11 of these 25 cities would rank second nationally in that edition of the 50 State Study – by far the most common result. The city with the median tax burden – Pipestone – would rank 3rd if used instead of Glencoe. 18 of the cities – nearly 75% – would rank in the top 5, and 22 of the 25 – nearly 90% – would rank in the top 7. In short, while minor adjustments to state rankings might ensue from a change in rural cities, the primary findings and conclusions would not, unless we actually did use an outlier.
So what explains these results and what is missing from the MREA’s analysis?
Assessment quality has a direct impact on local property tax rates because rates are calculated by dividing the total tax levy by the total property value being taxed.Underassessment of property shrinks the tax base and requires a higher tax rate to yield the same property tax levy.The converse is also true: overassessment of property will yield a lower property tax rate, all other things being equal.It is once again surprising that the MREA report would somehow overlook this feature of the property tax system, especially since many of the state’s education finance formulas use property values that have been adjusted for assessment quality to ensure that all districts are treated equally.
Here We Go Again, Part 2
The second chronic criticism discussed in great detail in the MREA report is even more technical: a claim that the study’s treatment of business personal property[4] understates the property tax advantage Minnesota’s exemption of personal property conveys to businesses, thus preventing meaningful or useful interstate comparisons. Specifically, critics note the tremendous diversity in personal property’s share of total property value across the myriad of different commercial property types and assert that the single 83% real/17% personal split on which our commercial rankings are constructed is both an oversimplification and differs from with the Department of Revenue’s estimate of a 70%/30% split for commercial property statewide. It follows, goes the argument, that using assumptions with higher proportions of personal property would show Minnesota in a better light, since more property would be untaxed vis-à-vis other states. As with the issue of city selection, this criticism combines a misrepresentation of our study with a gross misunderstanding of the tax treatment of personal property nationwide.
Contrary to how it is represented in the MREA report, the 50-State Study does not purport to analyze an “average” commercial property. In fact, the text explicitly states that the “analysis looks specifically at taxes on office buildings and other commercial properties without inventory on site”.[5] Our study purposely uses office property to represent commercial rankings for two reasons. First, this type of property is the predominant form of commercial property in Minnesota. According to estimates we prepared for a 2018 white paper prepared for our Lincoln Institute partners, we identified seven NAICS sectors and one NAICS subsector representing businesses where typical office activities take place.[6] Our modeling indicates that this group encompasses about 55% of total commercial sector property value (both real and personal property).
Second, we also use this subset of property to represent commercial rankings because the concept of “interstate tax competitiveness” applies most readily to this property type. Most other types of commercial businesses – notably retail, construction, restaurants, hospitals and care facilities, and entertainment/recreation facilities – are tied to population centers and the services they demand. New office space generally entails new jobs, which in turn drives economic growth – making tax competitiveness especially important for this large section of the commercial property tax base.
Report misrepresentation aside, the criticism of our treatment of personal property also suggests ignorance – or purposeful neglect – with regards to how other property tax systems across the nation treat personal property. These oversights neuter the criticism on several fronts:
Some of the commercial business types the MREA report identifies has having the highest proportions of personal property include Rental/leasing services; (91.1%), Water Transportation (80.5%), Truck (77.0%), Air Transportation (67.5%), and Construction (59.0%).Given that much of their personal property are motor vehicles, watercraft, and aircraft that are subject to these alternate forms of taxation, it’s disingenuous to suggest that Minnesota’s personal property tax exemption somehow advantages these types of businesses on these types of property.(One important side note: when we eliminate these types of property from our modeling, we find that office space has, in total, 82.5% of total property value in land and buildings and 17.5% personal property – very close to the study assumptions of 83.3%/16.7%.)
What critics of the 50 State Study fail to understand is the importance “freeport exemptions” have for the property taxes owners of wholesale trade businesses pay. Generally, freeport exemptions apply to goods or merchandise held for short periods of time (the period varies but is generally no more than a year) that are to be shipped to an out-of-state destination. In this way, much if not all of a warehouse’s inventory that might otherwise be subject to property taxes is exempt. Our own modeling indicates that inventories are roughly 75% of a warehouse’s total personal property. Research done for our 2018 white paper shows that for the 53 urban cities in our payable 2016 report, only businesses in Anchorage and Atlanta were unable to take advantage of a complete freeport exemption. This (again) goes a long way toward negating the advantage Minnesota’s blanket personal property exemption provides. As the findings in our white paper show, Minneapolis’ ranking for a warehouse with $1 million of real property for payable 2016 would be 19th highest – down 10 spots from the office space ranking because of the relatively high proportions of other types of personal property besides inventories. But once again Minnesota’s personal property exemption does not deliver nearly the level of competitive advantage that critics imply for a commercial property type which constitutes only 15% of the total commercial value office space represents.
As our accompanying article on the payable 18 study results finds, Minnesota’s business property tax competitiveness/affordability rankings have actually improved this year – influenced by the state general tax levy freeze and $100,000 valuation exclusion enacted in 2017. Ironically, as we note in our accompanying property tax article, policy architects intended the state general tax to serve as a relief valve should business property tax competitiveness or affordability issues become a concern.
This policy consideration is understandably a non-issue for spending interests. Building an argument for more tax dollars is the objective, which is entirely appropriate for them to do. Misrepresenting and questioning the validity of research which may inconveniently present a potential obstacle to that objective is not.
It would be welcome if at least some advocacy research money and energy would be redirected internally for a change to examine ways in which the E-12 system could be reformed to secure a financially healthier and more sustainable trajectory. One suggestion would be to examine more closely the issues and relationships highlighted in our 2015 education finance report, “How Much is Enough?” One critical question raised in our investigation: how does the single salary schedule – a compensation system design first introduced in De Moines in 1921 and essentially unchanged since its inception – affect the sustainability of Minnesota education finance 100 years later?
We are not holding our breath. In future years, we expect a continuing reprise and rehash of these same two decade-old arguments no matter how many times we refute them. So until this changes – and in response to the MREA report’s exhortation to “acknowledge what we do not know, rather than pretend we know more than we do” – our own recommendation is simple: look in the mirror.
[1] It is also important to recognize that continuity over time for a national investigation is an important consideration in selecting a representative city. Our choice of Glencoe was done in consultation with the Department of Revenue many years ago in identifying an “average” rural city and as our analysis in this article shows, nothing has evolved over time to warrant reconsideration of this choice.
[2] Note that the MREA report asserts that 27 cities in Minnesota could qualify as the state’s rural representative in our 50-State Study. We dispute that finding; based on our methodology the number is 25. As our 50 State Study indicates, cities must be located in a county that scores a “6” or “7” on the U.S. Department of Agriculture’s Rural Urban Continuum Codes classification scheme (https://www.ers.usda.gov/data-products/rural-urban-continuum-codes/.aspx). The most recent such codes, from 2013, show 34 Minnesota counties classified with a “6” or “7”. 25 of the 34 county seats meet our population criteria (between 2,500 and 10,000) and therefore constitute the eligible population. It is unclear to us how the MREA report arrives at 27 cities; nor does the report list what those cities might be.
[3] The Department’s 2015 Sales Ratio Study, which applies to the valuations used to determine payable 2016 property taxes, only reports class-specific sales ratio data for a city or county if there were six or more sales of that type of property. Some of these 25 counties did not meet the six-sale threshold for commercial property, and no sales ratio was reported for 2016. For these counties, we used the average sales ratio for 2014-2018. In four counties, no commercial sales ratios were reported for any of the five years between 2014 and 2018. In those cases, we assume the sales ratio is the average for all other counties.
[4] Broadly speaking, “personal property” is any property outside of land and buildings. Major categories include machinery and equipment, inventories, office equipment and furniture, and motor vehicles.
[5] 50-State Property Tax Comparison Study for Taxes Paid in 2018, p 19.
[6] These are NAICS sectors 51 (Information), 52 (Finance and Insurance), 53 (Real Estate Rental and Leasing), 54 (Professional, Scientific, and Technical Services), 55 (Management of Companies and Enterprises), 61 (Educational Services), and 81 (Other Services); and NAICS subsector 561 (Administrative and Support Services).