Time to Reassess the State Property Tax

When the State General Levy Tax– the statewide property tax levy on business and cabin properties – was created in 2001 it served both political and policy interests.   Politically, it generated revenue needed to grease the passage of tax reform (Governor Ventura’s “Big Plan”) while addressing the complaint that businesses were getting too sweet a deal from class rate compression which reduced business property subsidization of homeowners.   Policy-wise it shifted responsibility for addressing property tax competitiveness problems from local governments to the state while introducing a modicum of additional stability to the state revenue system.

But it also marked a departure from a traditional and long-held idea in public finance – that the property tax should “belong” to local governments.  Books have been written about how self-determination in raising revenue is the key to maintaining strong local governments, and how local governments’ exclusive rights to the use of property taxes contributes to its effectiveness as a local tax, greater accountability, and promoting local autonomy.   The existence of the state general tax means up to a third of business property taxpayers’ payments support state rather than local government operations making hyper-sensitive local levy decision-making more difficult and contentious.   

About a decade after its passage, some indications of buyer’s remorse became evident.   In 2010, the legislature established a Property Tax Working Group comprised of a bipartisan group of legislators and local government stakeholders to examine Minnesota's property tax system and develop recommendations on “how to make the system more simple, understandable, transparent, accountable, and efficient.”  The first “guiding principle” used by the working group to develop their 2012 recommendations argued for a return to the property tax’s historical roots: 

Defend the Purpose -- The purpose of the property tax is to provide a local revenue source to pay for local services (emphasis theirs). Although the state should define a uniform structure, the tax should be accountable to local people and the state’s involvements should be very limited. It should not be an arena for state legislators to serve constituent interests. The property tax is foremost a local revenue system, not a vehicle for state policies.

Eight years later the tax has been cut and tweaked in several ways, but it remains a three-quarters of a billion dollar vehicle for state policies per year.

An Outlier Among the States

Just how unusual is Minnesota’s claim on local tax bases?   At first glance, findings from the 2018 Census of Governments gives the impression it’s not that uncommon.  Thirty-six of fifty states report state property tax collections, although as a share of total state revenue, the majority of state collections are very modest.[1]   In 21 of the 36 states, property tax share is less than 4% of total state collections.  Minnesota reports 3.1% of state tax collections from property taxation.

On closer inspection, however, most of these states’ property tax collections are limited to state ad valorem taxation of tangible personal property, not real property.   Annual ad valorem taxation for vehicle registration/licensing/title purposes is by far the most common example of this.  Certain real estate transfer and related taxes in which the tax amount is determined by the value of the property is another state revenue source likely being classified as “state property tax revenue” by some states. 

As the accompanying table shows, only 16 states levy taxes on real property.   Within this smaller population Minnesota further distinguishes itself in three ways:

• Minnesota is one of only four states that use all or some portion of their real property tax collections for general fund appropriations.  Most states dedicate 100% of their real property tax revenues to specific spending purposes -- K-12 education and state debt service being by far the most common.     
• Minnesota is one of only two states that limit state property taxation to specific property types.   Most state real property tax collections apply to all property types.
• Minnesota appears to be one of a very small minority of states that levies to determine total state property tax collections.   Most states employ a “rate driven system” that applies an established statewide mil rate to taxable property value.

Put it all together and it is quite reasonable to conclude there is nothing like the state general tax anywhere else in the country.

Table 1: State Taxation of Real Property for State Expenditure Purposes [2]

_{Sources:  List of statewide property taxes was obtained from “How States Can Tax Wealth” Citizens for Budget and Policy Priorities Issue Brief, October 1, 2019.   Some states CBPP identified as having limited statewide real property taxes are excluded from this analysis based on our review and subsequent discussions with state officials (see for example, footnote 2).  Revenue totals obtained from most recent state Consolidated Annual Financial Reports and related materials.  Revenue disposition information obtained from state CAFRs, state Departments of Revenue, Finance, or Treasurer’s offices and contact with state officials.}

The Dedication Question

When lawmakers created the state general tax, there was a push to have this money dedicated to K-12 finance.  That effort was rebuffed, but schools would have by far the strongest claim on any such dedication since the Minnesota Constitution makes it clear that providing for “a thorough and efficient system of public schools” is a state responsibility.   The Legislature’s 2012 Property Tax Working Group recommended restoring the property tax to being a true local tax and eliminating the use of property tax for state funding.  However, the report also concluded, “if the state property tax continues to be levied, the revenue should stay within the local system and be given directly to school districts and other local units of government.”  

As Table 1 shows the most common beneficiaries of state property tax revenues across the nation are state public school systems.  However, in many if not all these states, state property taxation arose out of education finance reform prompted by court-influenced equalization demands requiring the state to assume a larger role in education finance.  That is something Minnesota has been doing for 50 years since the Minnesota Miracle, albeit with traditional general fund revenue sources.

There is no evidence to support a claim that the failure to dedicate state general levy revenue to schools has diminished or undercut the state’s financial commitment to public education.   According the latest information from the National Center for Education Statistics, Minnesota provides $3.73 of state support for every dollar of local property tax support for K-12 education.   That ranks Minnesota 5^th highest in the nation (behind two states that are essentially state K-12 systems) and nearly three times the national average.   As Table 2 shows Minnesota’s state share of K-12 financing is actually greater than all the states with K-12 dedicated state property taxes with one exception (Table 2).[3]  Minnesota’s spending per pupil is also greater than most of these states.  Importantly, Minnesota business properties do not “escape” education finance responsibilities from not dedicating the state property tax.  All taxable commercial/industrial property pays every type of local school levy, whether based on net tax capacity or referendum market value.  

Table 2: Division of Education Finance Responsibilities Between State and Local Governments: Minnesota vs. States Dedicating Statewide Property Tax Collections to K-12 Education

_{Sources: 2018 Digest of Educational Statistics, National Center for Education Statistics; Table 235.20;  How Does Minnesota Compare FY 2017, MCFE, December, 2019}

Even if there is agreement with the Working Group’s recommendation that if you can’t get rid of the tax, then give it to schools, there is a big implementation challenge making this idea problematic.  Distribution complexities aside, government revenues are fungible, and lawmakers would inevitably take the existence of this dedication into account as part of their broader education finance decision-making and the general fund appropriations process.    As we witnessed with the passage of the Legacy Amendment several years ago, efforts to circumvent the fungibility problem with “supplement not substitute” type language are chock full of complex interpretation issues, questions and determinations rendering such provisions largely unenforceable.[4]   Even if these revenues would be dedicated, there is reason to doubt K-12 education finance would be meaningfully changed.  

Love Thy Enemy

As annoying as property taxes are to citizens, they remain indispensable to local finance.  Last November, 88% of school operating levies and more than 70% of school bonding levies on Minnesota ballots passed – one of the highest success rates ever.   It’s impossible to imagine any kind of state tax increase that would have enabled this support for schools.   Minnesota ranks 14^th in the nation in K-12 spending per pupil.   Of the 13 states that spend more per pupil, 8 of them receive more money from local property taxation than they do from the state.

Protection and preservation of the local tax base is one of the best things the state could do to support not just education finance but all local governments.   The ongoing challenges and needs of local government will get a lot of air time in front of the legislature over the next couple months.  This will be accompanied by calls for different types of state action.     Restoring the property tax as a true local tax needs to be part of this discussion.  

Footnotes