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MN2020 - Frozen State Aid is Declining State Aid
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Frozen State Aid is Declining State Aid

April 22, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Despite the most far reaching revisions to the city Local Government Aid (LGA) formula in two decades, lawmakers left out one major piece when they signed the deal in 2013: an annual adjustment to make sure LGA keeps pace with inflation and population growth over time.

The 2013 reform included an $80 million increase in LGA funding beginning in 2014. This represents a 19 percent increase above the prior year level and was sufficient to replace just over half of the nominal cut in LGA since 2002 (but less than one-quarter of the inflation-adjusted cut). The increase in LGA funding along with the significant reforms in the LGA formula represented a renewed commitment from state policymakers to an important property tax relief program that had languished during the preceding decade of deficits and “no new state taxes.” The result was increased funding for city services—which had been slashed over the preceding decade—and a reduction in real (i.e., inflation-adjusted) city property taxes.

Unfortunately, with the exception of two small LGA increases in 2015 and 2016—less than one-sixth of what is needed to keep pace with inflation and population growth—the LGA appropriation is frozen in future years. With frozen LGA, the entire impact of inflation and population growth on city budgets must be borne by property taxes

Of course, the impact of frozen LGA is not the same for all cities. The larger a city’s “aid gap” (defined as a city’s need for state aid as measured by the new formula minus the amount of aid it actually received in the preceding year), the more the city will be hurt by the failure to adjust the LGA appropriation for inflation and population growth.

The following analysis demonstrates this relationship by examining five groups of cities.* The group entitled “Non-LGA cities” consists of cities that receive no LGA because their local tax base is sufficient to meet their entire expenditure need. The remaining cities are placed into four groups of equal size, with cities with the smallest aid gap as a percentage of tax base comprising the first quartile and cities with the largest aid gap comprising the fourth quartile. Tax rates shown below are based on actual data for 2014, and a combination of legislative simulations and projected data for 2016 to 2020.† Rates shown are unweighted averages.

The graph below shows what happens to the average city tax rate within each of these groups under assumptions described above when the LGA appropriation grows only minimally in 2015 and 2016 (per current law) and is frozen thereafter.

The group of cities with the largest tax rate increase—12.4 percent from 2014 to 2015—are cities with the largest aid gap. These cities start out with the highest tax rates in the state, which increase steadily over time both in an absolute sense and relative to other cities. This demonstrates that a frozen LGA appropriation is most detrimental to cities in greatest need of state assistance; these cities tend to be property-poor areas with relative high expenditure need relative to their ability to pay. In short, the cities that the new LGA formula was designed to help most are hurt most when LGA funding is frozen.

The next graph shows what happens when the LGA appropriation is increased to keep pace with inflation and population growth.

When the LGA appropriation is adjusted for inflation and population growth, we see the opposite. With an LGA appropriation adjustment, the cities with the highest tax rates and the greatest need for state assistance see the largest tax rate reductions.

The final graph contrasts the change in projected tax rates from 2014 to 2020 under the frozen LGA appropriation versus an appropriation that is allowed to increase with inflation and population growth.

Further analysis shows that when the LGA appropriation is frozen the gap between high tax rate and low tax rate cities grows.  On the other hand, when the appropriation increases to keep pace with inflation and population growth, the new formula successfully reduces tax rate disparities by directing assistance to communities with the greatest need.

Some legislators have argued that LGA will drain too many resources from the state general fund if it is allowed to increase along with inflation and population growth. This argument does not pass muster. General fund current resources are projected to grow faster than the rate of inflation and population growth for the foreseeable future, so the LGA appropriation can be adjusted and still shrink as a percentage of total general fund revenue. Even if general fund revenue does not increase as expected, the LGA appropriation can be capped so that growth does not exceed growth in general fund resources.

Governor Dayton and progressive legislators ran for office on a platform of restoring at least a portion the LGA cuts imposed during a decade of shortsighted “no new state tax” austerity. During the 2013 session, they followed through on this pledge. However, some state policymakers are now resisting a reasonable LGA appropriation adjustment in future years, preferring instead a frozen appropriation that will result in a return to property tax hikes that will be greatest in cities with the smallest tax bases and greatest need for state assistance.

Fortunately, there is still time for progressive state policymakers to do the right thing during the 2014 session. The House Omnibus Tax Bill will increase the LGA appropriation to keep pace with inflation and population growth. The Governor and Senate should accede to this position so that the purchasing power of LGA does not erode over time, resulting in property tax increases in the cities that can least afford it.

 

*Excluded from this analysis are 111 cities that are already receiving LGA in excess of their need for state assistance as measured by the new formula. Under current law, the aid for these cities will be gradually reduced over time until it equals their need for state assistance; the aid levels for these cities would not be affected by an LGA appropriation adjustment.

†Specifically, the 2015 LGA amounts used in this analysis are based on legislative simulations. LGA amounts for subsequent years were calculated based on the current formula, assuming that the tax base and revenue need of each city increases at the rate of inflation and that the population of each city increases at the projected statewide average. For each year from 2015 to 2020, city tax rates are calculated based on the assumption that the tax base and combined levy plus LGA of each city grows at the rate of inflation. Effectively, this analysis assumes that the revenue need, tax base, and population of each city relative to other cities does not change over time.

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