Comparing the 2001 and 2013 Tax Acts: Which was Better?
Over the last thirty years, the tax acts of 2001 and 2013 stand out in terms of providing homeowner property tax relief. The largest single year reduction in homeowner property taxes over the last three decades occurred in 2002 as a result of the 2001 tax act, with the 2014 tax reductions resulting from the 2013 tax act coming in second place.* While the 2001 tax act produced the largest single-year homeowner tax reductions, the long-term impact of the 2001 act on Minnesota homeowner property taxes was decidedly negative.
According to a 2002 simulation from the Research Department of the Minnesota House of Representatives, homestead property taxes fell by 12.8 percent from 2001 to 2002. This large decline was driven by several features of the 2001 tax act, most notably a massive 68 percent reduction in school property taxes resulting from full state funding of general education and the elimination of the general education property tax levy, combined with a significant reduction in school referendum levies.
By reducing business “class rates” (i.e., the rate used to determine the portion of business value that is locally taxable), the 2001 tax act increased the share of local property taxes borne by homeowners. However, the shift of local taxes on to homeowners in 2002 was more than offset by the school property tax reduction noted above, a reduction in other local levies resulting from increased state funding for transit, and by a new “homestead market value credit.”
The 12.8 percent reduction in homeowner property taxes from 2001 to 2002 reported in the 2002 House Research Department simulation arguably understates the magnitude of homestead property tax relief in 2002 because it does not include the homeowner property tax refund (PTR) increase that was part of the 2001 tax act. If we include the effects of the PTR increase and focus only on existing properties (a better basis for year to year comparisons of homeowner taxes because it focuses only on properties that underwent no new construction from 2001 to 2002), total homestead property taxes actually fell by a whopping 16 percent.
So in 2002, the 2001 tax act looked like a great deal for Minnesota homeowners. However, tucked within the 561 pages of this act were other provisions—some obvious and some subtle—that, when combined with the serpentine complexity of Minnesota’s property tax system, contributed to a series of large annual homeowner property tax increases in 2003 and subsequent years. Like little time bombs, these provisions began producing homestead property tax increases beginning in 2003 that ultimately obliterated the 2002 tax reductions. It is difficult to understand these arcane intricacies, much less explain them in a cogent fashion, but here goes nothing.
The first—and perhaps most technical—of the homeowner time bombs in the 2001 tax act is the result of an interaction between (1) the business class rate reductions in the 2001 act and (2) tax base sharing programs in the seven-county metropolitan area and taconite relief area, referred to as the metro and taconite “fiscal disparity” programs. As a result of the year lag in value data used to make fiscal disparity calculations, the full amount of business property tax relief resulting from the 2002 class rate reductions and the full tax shift on to homeowners did not materialize until the following year, resulting in significant new business tax relief and sizable homeowner property tax increases in 2003.
Second, the 2001 tax act began phasing out the “limited market value” (LMV) program beginning in 2003. The LMV program capped the rate of taxable value growth for selected classes of property, including homesteads, in order to keep a lid on value-driven property tax growth. Beginning in 2003 and for several years thereafter, the LMV phase-out returned homestead value which had been excluded from taxation to the tax rolls, resulting in a steady increase in homestead taxable value on top of already escalating value growth occurring prior to the collapse of the housing bubble in 2008. The acceleration of homestead taxable value growth resulting from the LMV phase-out contributed to significant homeowner property tax increases in 2003 through 2005, with a diminishing impact after that.†
Third, a curious feature of the homestead market value credit (HMVC) created in the 2001 tax act was that credit payments would shrink as homestead value increased, as described in a June 2013 Minnesota 2020 article. Thus, as market forces and the LMV phase-out pushed homestead taxable value upward, HMVC payments declined. From 2002 to 2008, per homestead property tax relief received through the HMVC declined by 24 percent (even before factoring in inflation and cuts made to the HMVC in response to state budget deficits), thereby contributing to steady growth in homestead property taxes.
While other provisions of the 2001 tax act played a role, the three features described above were the most significant in terms of driving homestead property tax increases after 2002. From 2002 to 2003, the tax on the average value homestead in Minnesota increased by approximately 15.5 percent, wiping out nearly all of homeowner property tax reductions occurring from 2001 to 2002. By 2004, the average tax had surpassed the 2001 level and by 2006 it was higher than the 2001 level even after adjusting for inflation.
Homestead tax growth began to level off in 2009, with the bursting of the housing bubble. By that time, the homestead time bombs in the 2001 tax act had already exploded or been rendered inert due to crashing home values, but the damage had already been done. From 2002 to 2008, the average Minnesota homestead tax grew 30 percent faster than the rate of inflation, despite the fact that total local government revenue had grown less rapidly than inflation over this period and the homestead share of statewide estimated market value had declined.
The 2001 tax act was not the only cause of rapid growth in homeowner property taxes beginning in 2003; large cuts in state aid to local governments also played a role. However, a 2002 analysis completed for the City of Saint Paul determined that the provisions of the 2001 tax act would cause taxes on the average value home in that city to increase by 23 percent from 2002 to 2008, even if there were no reductions in state aid, no increase in local levies or spending, and no change in estimated market values.
While the 2001 tax act provided massive homeowner property tax relief in 2002, other provisions in that act caused that relief to quickly dissipate and contributed to escalating homestead taxes down the road. Not so with the 2013 tax act. While the 2013 tax act provided less initial tax relief than the 2001 tax act, the 2013 act will provide more predictable and stable homeowner tax relief over the long haul. In fact, the 2013 tax act is likely the best deal for homeowners to come out of the state legislature in over thirty years. More on this in part 2 of this series.
*Determining the annual change in final statewide homestead tax levels (i.e., after the subtraction of the property tax refund) going back thirty years is no simple tax, since gross tax and refund amounts for each year are not routinely compiled in a single source. However, based on information gleaned from various Revenue Department and legislative documents, it appears as if the largest reduction in final homestead property taxes over the last three decades occurred from 2001 to 2002, followed by the reduction that occurred from 2013 to 2014.
†The LMV program was flawed public policy insofar as it resulted in similarly valued properties within the same class and located within the same local jurisdictions being taxed at the significantly different levels. The legislature could have begun phasing-out the LMV program effective for taxes payable in 2002, but opted not to, presumably because they did not want to erode the double-digit homeowner property tax relief going into the fall 2002 election. Rather, the legislature deferred the LMV phase-out until 2003, there producing a large increase in homeowner taxes in 2003 on the heels of the large decline that occurred in 2002. The LMV phase-out continued to cause homestead property tax increases for the next several years, but by approximately 2006 the level of statewide homestead value still excluded from taxation due to the LMV program was small and the LMV phase-out was no longer contributing to annual homeowner property tax increases.