Yes, Minnesota, Our Commercial Property Taxes Are High Relative to Most Other States

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.

Here We Go Again

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?

• Referendum tax rates.  Stunningly, especially for a study that spotlights E-12 education finances commissioned by an education advocacy group, the MREA report completely leaves out any mention of referendum tax rates.  Had the analysis included this information, readers of the MREA report would have learned that Glencoe had a relatively low referendum tax rate for payable 2016 – ranking 18^th of the 25 eligible cities, or 17% below the average.  Glencoe’s lower referendum tax rates work to offset the relatively high NTC tax rates the MREA report only mentions.
• Assessment quality.  Even more significantly, the MREA report also fails to account for assessment quality – unlike our 50 State Study.  The Department of Revenue measures assessment quality annually through the use of sales ratio studies[3], which according to the Department “compares real estate sales prices to market values calculated by assessors to measure the overall accuracy of their appraisals. 

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.

• A failure to understand that property tax structural features, rather than local levy decisions, have the predominant influence on interstate tax rankings.  Business properties in these 25 cities (and for that matter in every city in Minnesota) are all exposed to different local levy amounts.  But they all participate together in Minnesota’s property tax classification system, are all exposed to the state general levy, are all affected by local government access to state aid programs, are all affected by Minnesota’s decisions about how to divide up responsibilities between state and local governments, and all share in the same general limitations the state imposes on alternative local revenue raising authority.  No less importantly, all of Minnesota’s cities also share in the absence of structural features other states may have in place like assessment limitations and levy limits.  In short, MREA’s report focuses on one piece of the puzzle but does not understand – or chooses to ignore – that with respect to interstate tax rankings, both urban and rural, it is these shared characteristics that have the greatest influence.

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:

• Inclusion of personal property that is already subject to a registration tax.  Embedded in the MREA critique is the faulty assumption that all personal property is, or ought to be, subject in all instances to the property tax.  That is highly problematic for commercial business types whose very large personal property shares are already subject to taxation in some other form.  A primary difference between our modeling and the modeling done by Revenue is that we remove personal property that is typically subject to a tax in lieu of property taxes including aircraft, watercraft, and motor vehicles. 

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%.)

• Drastically overstating the importance of Minnesota’s personal property tax exemption when it comes to commercial inventories.  The MREA report implies Minnesota’s exemption of commercial inventories conveys a major tax benefit that goes unrecognized in the study.  What the authors of the MREA report do not seem to understand is that 39 states and the District of Columbia categorically exempt business inventories from property taxation.  In four other states, local governments may tax business inventories on an optional basis.  Only seven states – Arkansas, Kentucky, Louisiana, Mississippi, Oklahoma, Texas, and West Virginia – mandate property taxation of business inventories.  As in our “city choice” findings, modeling a facility with substantial retail inventory has little effect on commercial property tax rankings.  When we modeled the property taxes on a $1 million commercial retail establishment for payable 2016 in our white paper, the property taxes for Minneapolis ranked 11^th overall – down slightly from the 9^th highest ranking for office space, but nowhere near the reduction that critics assert through the misrepresentation of the taxation of inventories nationwide.
• Unfamiliarity with state freeport exemptions.  As commercial enterprises which, according to the DOR estimates cited in the MREA report, have 66% of their total value in personal property, wholesale trade businesses are featured prominently in the MREA report as “properties which derive a large advantage from Minnesota’s personal property exemption.”  That might be true if 96% of the urban cities in our study across the nation did not offer similar advantages to wholesalers. 

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 19^th 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.

And It Will Happen Again in the Future

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.