Third Time is Not a Charm

From our May-June 2013 edition of Fiscal Focus.  In 2013 Minnesota again embarked on another major attempt to buy down local property taxes.  A closer look at two previous attempts, the "Minnesota Miracle" and the "Big Plan", offers insights into the problems with these efforts and what happens next.

This session’s property tax provisions might be described as a low-cal version of the Minnesota Miracle. It lacks the transformative impacts on the state/local financial relationship its famous predecessor had, but with a price tag exceeding $400 million, the effort and impact is certainly not inconsequential.

Heading into the tax conference committee, the House and Senate positions were aligned on some important areas – including additional LGA and County Program Aid, an expansion of the renter’s refund program, and changes to the LGA distribution formula. However, there were also some important strategic and philosophical differences. Most notably, the House sought a significant expansion of the homeowner’s property tax refund program while the Senate prioritized a state takeover of a portion of school referendum levies. In the end, leaders negotiated a $400 million increase in aids and credits spending and allocated $130 million each to the House and Senate to spend on their chosen priorities.

As a result, legislators and Governor Dayton delivered on their promise of property tax relief but in the process also delivered on additional distortion of local tax prices and the prospect of further eroding accountability at the local government level. What implications might this session’s actions have going forward? A trip down memory lane of major state-funded property tax relief efforts offers some hints.

“Minnesota Miracle” In 1973, the year following the Miracle’s enactment, state taxpayers realized $11 per capita of property tax relief – made possible by $72 per capita in new state taxes. As the years progressed, state aid to cities increased three times faster than the national average and by 1986 total city spending had risen by 74% after adjusting for inflation. Concerns began to arise over the stimulative effect aids seemed to be having on local government spending, which led in part to a 1990 investigation by the Office of the Legislative Auditor (OLA) on local government spending.1 Among the report’s notable findings and statements:

• Cities used 82 percent of the additional aid to finance increased spending and 18 percent to reduce property taxes.

• By 1987, the fastest growing and largest expenditure category was not fire, or police, or parks, or streets, but the category labeled “Other.”

• “Property tax relief programs succeeded in keeping taxes low only as long as major new revenues were pumped into the system. They were not controlled by large but stable aid programs.” (emphasis ours)

• “We recommend the state not increase general purpose aid to cities or take on the job of preventing future city tax increases.”

The investigation led the OLA to conclude “responsibility for spending ought to be lined up to responsibility for raising revenue,” while recognizing that “since important state programs now compete for scarce dollars, it seems appropriate that state policymakers be assured that city services are what local residents really want and are willing to pay for.”

The “Big Plan” In 2001 the state engaged in another major buydown of local property taxes by taking over the general education levy which reduced school property taxes by over $1 billion or 55.4% in payable 2002. The accompanying table highlights city levy activity prior to and immediately following the takeover with accompanying aid changes as reference.

In the booming late 90’s, prior to the state takeover, LGA increased an average of 3.3% per year. But during this same period city levies grew at a robust 5% – 7% per year. Such juxtaposition raises major doubts about claims regarding the relationship between LGA and property tax restraint. Equally interesting is the levy behavior following the adoption of the Big Plan. As part of the reform, the state eliminated $200 million in HACA aid to cities which was partially offset by a $157 million increase in LGA (explaining the large percentage jump in 2002). The need to backfill a net loss of $43 million in state aid explains some of the 17.4% increase in city levies in 2002. Nevertheless, the year on year change in levy plus aid in 2002 – a measure of the change in city revenue base – was still 78% higher than the average of the six previous years (7.6% vs 4.25%).

  Certified City LeviesAnnual ChangePaid LGAAnnual ChangeCity HACAAnnual ChangeAnnual Change in Aid Plus Levy
 1998$769,189,9794.8%$365,814,6052.5%$195,829,633< 0.1%3.4%
 1999$807,671,8285.0%$378,061,3473.3%$195,709,227(< 0.1%)3.8%
 2001$912,030,6027.2%$408,086,7114.3%$199,739,369(< 0.1%)5.4%
Source: MN Department of Revenue Property Tax Research Unit

This strongly suggests that cities were both able and very willing to take advantage of the “spare capacity” on homeowner property tax bills created by the elimination of the general education levy – even after years of robust levy growth. Importantly, the sense of opportunism does not seem to be limited to city governments. In 2003, school levies rebounded by $200 million – 18.5% of the $1.3 billion the state bought down the year before. The imposition of a one-year levy limit on local governments in this year’s tax bill suggests these lessons from Minnesota’s long history of providing property tax relief are not totally lost on legislators.

The “Great Stool Balance of 2013” – as this year’s effort might be known by future students of Minnesota political history – lacks the scope and scale of its predecessors. It also operates in a different environment. Local governments would argue, undoubtedly with some merit, that the condition of operating budgets today after a tough decade of recessions and alleged state neglect is very different from the spending largesse captured in the 1990 OLA report. And the much more modest and diffuse state buyoff of local school referenda levies makes any attempt by other local governments to “fill the void” with their own new levies more challenging.

But the motivations, dynamics, and incentives inherent to any state buydown of property taxes are no less real in this year’s effort. There is more than enough to embark on another trip on the property tax buy down merry go round.

• $120 million of additional base general purpose aids to city and county governments (with small increases for cities through calendar year 2016) combined with $125 million in annual savings for cities and counties from a new sales tax exemption on their purchases creates a very rich environment for spending in-creases with little, if any, short term property tax repercussions.

• Public sector unions, keenly aware of the dramatically improving fortunes of local governments, will integrate these developments into their negotiating positions and look to make significant amends for what they consider to have been a very difficult period for their members. Local officials feel pressure to acquiesce since labor peace in the present has far greater currency for decision-makers than the impact of spending tails out in the indefinite future.

• Meanwhile, the most generous and broadly accessible property tax refund programs in the nation became even more generous and more accessible insulating more citizens from more of the cost of operating local governments.

• Finally, recovering real estate markets and ubiquitous taxpayer confusion about how property taxes work (primarily a belief that there’s a direct relationship between higher property values and higher property taxes) provides some temporary cover for whatever property tax increases do occur.

Each trip on the merry-go-round just rein-forces taxpayers’ expectations that local government services should be delivered at discount tax prices – the conditioning that led to the calls for property tax relief in the first place. The added irony is that any truly objective, apolitical analysis of the data would conclude that local property tax bur-dens are likely the least of our fiscal worries.

For anyone still truly interested in the quaint notion of local accountability, the history of riding this carousel offers one final invaluable lesson. Contrary to perception, times of economic difficulty and distress are not the times demanding greatest property taxpayer attention to local government finances. As our recent experiences through the Great Recession have demon-strated, local governments do an excellent job of restraining levy growth when taxpayers are on high alert. Rather, the time for maximum taxpayer vigilance is after the temporary relief has been provided, local taxpayers are placated, the economy is improving, and citizens are most oblivious to the cost structures and trends affecting local government services. That’s when the seeds of the next period of property tax outrage are sown. And that time is now here.

[From May-June 2013 edition of Fiscal Focus.]

  • 1 Local Government Spending, Office of the Legislative Auditor, Program Evaluation Division, March 1990.