Fiscal Fairness Moving Forward: Business Property Tax
The following article is another installment in our ongoing series Fiscal Fairness Moving Forward.
Over the last six years, Minnesota 2020 has generally argued for property tax relief. After all, the property tax is regressive, falling most heavily on those with the least ability to pay. That having been said, it may come as a surprise to readers that there is one form of property tax relief that we do not support: the elimination, phase-out, or freezing of the state business property tax.
Prior to 2002, property taxes in Minnesota were exclusively the domain of local governments—counties, cities, towns, school districts, and special taxing districts. In 2002, the state began levying its own property tax that was applied exclusively to business and seasonal recreational properties. The state tax on these two types of properties was imposed in exchange for massive reduction in the local property tax imposed on these properties. The state property tax on businesses was separated from the tax on seasonal recreational property beginning in 2006. Since its inception, growth in the state property tax has been linked to the rate of inflation.
Taxpayers—including most business owners—tend to favor taxes that are stable, predictable, and slow growing. By these criteria, the state business property tax is a good tax.
The state business property tax is relatively slow growing because—by definition—it cannot grow faster than the rate of inflation. In fact, during the early years of the state property tax (2002-2005), the state tax on businesses grew less rapidly than the rate of inflation because the more rapid growth in seasonal recreational value caused a shift of taxes on to this class of property and away from business property.
Because the state business property tax is linked to the rate of inflation, it is insulated from the effects that cuts in state aid, the elimination of the homestead credit, and population growth have had on other property taxes in Minnesota. While local property taxes have climbed as counties, cities, and school district respond to aid cuts and population growth, the state business property tax remains blissfully immune from these upward pressures. As a result, while the state business property tax has declined in real (i.e., inflation-adjusted) dollars from 2002 to 2013,* local property taxes on business have increased by 14%; total business property taxes—including both the state and local portions—have increased by 9%.
However, business owners are still lucky in comparison to other property taxpayers. In real dollars, the percentage growth in total non-business property taxes since 2002 in Minnesota has been four times more rapid than the growth in total business property taxes. The slower rate of growth in total business property taxes is due in part to the fact that a significant portion of business property taxes—specifically, the portion paid to the state—has declined in real dollars.
The state business property tax also has the advantage that it is much more stable than many other forms of business taxes. For example, corporate income tax revenue can fluctuate dramatically over time as the economy cycles between recessions and recoveries. Radical fluctuation in taxes is not only an issue for taxpayers, but for state government as well. It is prudent policy to balance the state’s dependence on volatile revenue sources—such as the corporate income tax—with more stable sources—such as the property tax.
Finally, the state business property tax has the advantage of predictability. Businesses like to be able to determine what changes in costs—including taxes—will be over time. Projections of the measure of inflation used to determine growth in the state business property tax are currently available through the year 2020, thereby giving businesses a basis for anticipating the change in the state property tax well into the future. No other form of business taxation has this level of predictability.
The graph below illustrates the advantages of the state business property tax relative to other business taxes. Since its inception in 2002, the state business property tax has been far more stable than the corporate income tax and slower growing than local business property taxes. The annual rate of change of the state business property tax has also been more predictable than that of the other two business taxes. The dashed line indicating the rate of inflation is also shown for comparison purposes.
Yet another advantage of the state business property tax is that it helps to reduce variation in business property tax rates between communities. Businesses in some parts of the state—such as parts of rural Minnesota—are at a competitive disadvantage relative to businesses in more prosperous regions because they are subject to higher property tax rates. By basing a significant portion of business property taxes at a uniform statewide rate through the state business property tax, the variation in business tax rates between communities is reduced, thereby helping to level the playing field between businesses around the state.
This is not to say that we should turn a deaf ear to calls for business property tax relief. After all, property taxes are the single largest tax paid by Minnesota businesses. However, there are better ways of achieving business property tax relief than through reductions to the state business property tax.
One way would be to increase state aid dollars to local communities. Over the last decade, real cuts to school aid, city local government aid, and county program aid have resulted not only in cuts to local government budgets, but in property tax increases that have affected all taxpayers, including businesses. Restoring a portion of these aid cuts would not only reduce property taxes for businesses, but for all other categories of Minnesota property taxpayers as well.
Another thing that could be done would be to eliminate the homestead market value exclusion. Enacted during the 2011 special session, this exclusion sought to reduce homestead property tax increases resulting from the elimination of the homestead credit by exempting a portion of homestead value from taxation. This reduction in the taxable value of homesteads resulted in a shift of taxes on to other classes of property, including business. Holding all other factors constant, the new exclusion resulted in a three percent statewide business property tax increase. These business property tax increases could be reversed simply by eliminating the convoluted homestead value exclusion and enacting a reformed homestead credit to protect homeowners. One such approach was described in a recent Minnesota 2020 article.
Like all property taxpayers, Minnesota business can make a legitimate case for property tax relief, but elimination of the state business property tax is not how this relief should be achieved. The state business property tax is stable, predictable, and slowing growing and helps to equalize business property taxes around the state. There are other ways of achieving business tax relief without messing with a tax that is helping to achieve such worthwhile policy objectives.
* All inflation adjustments in this analysis are based on the implicit price deflator for state and local governments, which is the appropriate measure of inflation for state and local government pruchases. The inflation adjustment to the state business property tax is also based on the same implicit price deflator.