The Landscape for 2023 Property Tax Policymaking

As November approaches, local governments are preparing their final budgets and preparing for Truth in Taxation hearings.  Proposed property tax levies and the impact on tax bills will be in the spotlight, and taxpayer reaction to them will capture the attention of legislators next year.  We take a look at some research findings offering insights on two issues — homeowner impacts and tax competitiveness — that always have an outsized role in influencing state property tax policy.

Homeowner Frustration

Perhaps the most under acknowledged and underappreciated research report the state publishes is the Department of Revenue’s one-of-a-kind “Residential Property Tax Burden Report,” also known as the “Voss Report.”  By linking a homestead’s net property taxes (which includes the state property tax refund) with the homeowner’s income, the Voss report generates a unique measure of “property tax burden,” providing perspective on homestead property tax effort, affordability, and trends.  The report presents median results for 10 Twin Cities Metro regions and 10 Greater Minnesota regions.  The most recent release from early this year is for taxes payable in 2020 since data cleaning requires some time and effort.  Payable 2021 results are expected around the start of the 2023 session.

Results from 2020 show that property taxes continue to make a greater relative claim on homeowner income in the metro area than in greater Minnesota.  The median property tax burden is 2.9% in the ten metro regions versus 2.3% in the outstate regions.  Perhaps surprisingly, the median burden in most areas of the state is still lower than when the first Voss Report was published for 2007 taxes year payable.  In fifteen of the twenty state regions the median burden is still at or – in most cases – below the reported 2007 median burden meaning the property tax’s claim on household income for the majority of homeowners in these regions is no greater than it was over a decade ago.  The five regional exceptions have median burdens 0.1% - 0.3% higher but still have some of the lowest property tax burdens in the state.

These regional median results would suggest property tax burdens are largely in line with past burdens.  However, when regional results are broken down further by income level, a couple of interesting findings emerge:

• In the highest income cohort in all 10 metro regions (incomes above $125,000) and all 10 Greater Minnesota regions (incomes above $90,000), the 2020 median property tax claim on homeowner income is the highest it has ever been since the study began.  Notably, homeowners in these two segments represent just under half of all home ownership in the state.
• The report also documents the frequency of burdens that exceed 5% of household income – an after-refund level of property taxation which could be considered an indicator of tax stress.  The accompanying table shows that the percentage of homesteads with burdens exceeding 5% are at an all-time report high across all regions of the state and across every income cohort. 

If the forthcoming 2021 results show these trends have continued, it suggests a ripe environment for conveying property tax frustration to lawmakers.

Some consolation might be found in the recent release of our 50 State Property Tax Comparison Report for Taxes Payable 2021, a joint venture of the MCFE and the Lincoln Institute of Land Policy.  From a pure property tax perspective, there are certainly worse places to own a home than Minnesota.  Minnesota median value homestead property taxes are in the middle of the pack nationally (24th urban and 20th rural).  Compared to the largest cities in each state, Minneapolis’ 1.235% effective tax rate on the median valued home is again below average -- for the 12th time in the last 15 years.  That shouldn’t be too surprising given homeowner protection from the state’s commercial-homestead classification ratio (still 18th highest in the nation), the homestead valuation exclusion, and the state’s relatively strong education finance responsibilities compared to other states.  If a Voss-like national property tax burden rank was able to be constructed, Minnesota’s national homeowner rank would be even lower since our 50 State Comparison results do not include the effect of our income-tested and special refund programs which are among the most, if not the most, generous and accessible in the nation.  Such findings are a useful reminder that state reliance on taxes differ and tax burden is always best evaluated from a whole system perspective.

Tax Competitiveness

The property tax competitiveness discussion centers primarily on the state general tax.  As a non-dedicated state levy paid only by certain types of property (business and seasonal recreational) there is nothing like it anywhere in the country.  Ironically, “interstate tax competitiveness” was one of the policy rationales in the creation of the tax in the first place in conjunction with the state takeover of the general education levy.  The idea was to make future policy discussions on interstate business property tax competitiveness a state policy (and budget) issue rather than a local government issue.  If business property tax levels and competitiveness became a concern, the governor and legislators could use the state general tax as a “relief valve” and dial down the levy accordingly. 

From its beginning, however, the state general levy was treated primarily as a general fund revenue source adding a modicum of revenue stability to the General Fund, not as a regulatory mechanism for managing property tax competitiveness.  For several years the state general levy was on inflation-indexed autopilot.  Over the years efforts to restore the inflation adjustment and other bills to raise more revenue from the tax have been introduced but failed to pass.

In recent years, policy adjustments have headed in the other direction.  The levy has been chipped away at a couple of times with levy reductions enacted in 2017 and 2019 and another one left on the table in 2022.  A $100,000 market value exclusion was also enacted in 2017 providing additional relief to smaller businesses owning real property.

Have these efforts yielded competitiveness benefits?  Our 50 State Study Payable 2021 offers strong circumstantial evidence it has made an impact.  Since 2017, Minnesota’s $1 million urban commercial rank has fallen from 8^th to 15^th in the nation.¹  Effective tax rates have declined from 38.8% above the national average to 34.4% above the national average.  Looking specifically at the upper midwest region, as the table shows Minnesota is now below the regional average for $1 million urban commercial, although still at a noticeable disadvantage with states on the western border.  Similar results exist for industrial property (17^th to 19^th nationally), the difference influenced by Minnesota’s preexisting advantages in exempting industrial personal property.

The 50-state Study also offers some perspective on how the state’s classification system continues to influence business effective tax rates.  Four city factors have been shown to be statistically significant (p < 0.01) as correlates of cities’ effective tax rates: property tax reliance, median home value, local government spending, and the classification ratio.  The Lincoln Institute’s Fiscally Standardized City Database allows cross city comparisons to determine the influence of each of these factors on the effective tax rate relative to 74 other cities in this investigation.  Minnesota’s commercial homestead classification ratio has a 0.33 impact on the urban effective tax rate which is 11^th highest among the 74 cities.  This means if Minneapolis had the average classification ratio of the 74 cities but all other three characteristics of the city were unchanged (tax reliance, etc.) the city’s commercial effective tax rate would be 0.33 percentage points lower.  Notably, the tax rate impact of the other factors – property tax reliance, median home value, and local government spending – are all lower (0.00, - 0.14, and 0.12 respectively).  The moral is, despite considerable class rate compression over the years, Minnesota’s classified property tax system still has a material impact on effective tax rate differences among peer cities.

Looking Ahead to 2023

The Department of Revenue’s Preliminary Levy Report is not out yet, but if news reports of city decisions are representative of the state, it’s highly likely we will exceed this year’s 4.2% year-on-year total increase.  2023 also offers some potential wild card issues.  At the top of the list is the shifting of existing and new levy burden across property types due to some dramatic valuation changes exacerbated by state classification. 

While homestead values have skyrocketed in many areas of the state, the value of a lot of commercial property has likely been hit by COVID and its economic after effects.  For example, in a recent NBER Working Paper entitled "Work From Home and the Office Real Estate Apocalypse,” researchers documented large shifts in New York City office lease revenues, office occupancy, lease renewal rates, lease durations, and market rents as firms shifted to remote work in the wake of the Covid-19 pandemic.  The study found large effects on both current and expected future cash flows for office buildings.  Taking into account pandemic-induced cash flow and discount rate effects, researchers estimated a 45% decline in 2020 office values and projected a 39% decline in the longer-run totaling $453 billion of property value destruction just in New York city.  As the authors concluded in perhaps the most understated way imaginable, “these valuation changes have repercussions for local public finances.”  Effects like these are exacerbated in classified property tax systems as the multiple of lost tax capacity from classification results in rate increases with shares of tax burden sloshing over to homeowners and other property types.

In light of all this we can expect the full gamut of property tax relief ideas to be on the table in 2023.  That would include more income-tested refunds (and a reprise of the transformation of the renter’s credit in a refundable income tax credit), more general purpose aid for cities and counties, pushes for extensions of local sales tax authority, levy limits, and the usual potpourri of burden shifting strategies such as assessment limits, and targeted exemptions for favored property uses or types.  Income taxation may be the headline generator these days, but when all is said and done, Minnesota’s property tax system is guaranteed to have its moment in the sun.