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Horner Tax Plan Still Shifting State Problem to Counties

October 21, 2010 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Part 2 of 2 (read part 1)

Due to a lack of specificity, it is not possible to determine precisely how IP gubernatorial candidate Tom Horner’s county option sales tax and program funding cut would affect Minnesota counties. However, after simulating a proposal that contains the basic features of the Horner plan, it seems likely that it would leave many counties in position similar to what they endured under Governor Pawlenty. Most counties would be compelled to increase taxes--either property taxes or the new county option sales tax--and/or make more cuts to services and infrastructure.

Horner’s plan differs from Pawlenty’s policies in a key way. Horner acknowledges counties will need to raise revenue to counteract aid cuts; thus, the Horner plan grants counties authority to impose a 0.5 percent sales tax, 20 percent of which must be shared with other counties. This would provide counties with a major revenue source other than just property taxes.

In this second of a two-part series, Minnesota 2020 considers Horner’s county optional 0.5 percent sales tax proposal under two scenarios. The first looks at the impact if all 87 Minnesota counties implemented the tax. In the second scenario, all counties except Hennepin adopt the local option sales tax.

The proposal analyzed below is consistent with the basic parameters of the plan outlined by Mr. Horner. The characteristics of this proposal include the following:

  • The state would eliminate several county aid and credit programs, including County Program Aid.*
  • Counties would be allowed to impose a 0.5 percent sales tax, to be levied against the expanded list of goods and services authorized under the Horner budget proposal, as described in part 1.
  • Each county would be required to share 20 percent of the revenue generated from their sales tax with counties in which 80 percent of the county sales tax revenue was not sufficient to replace the amount of lost state aids and credits.**

Scenario 1: All Counties Adopt the Optional Sales Tax
Click here for the 87-county table.

Only five of Minnesota’s 87 counties could fully replace their lost aid with the 80 percent of their sales tax revenue that they would be allowed to keep. The state’s largest county, Hennepin, would also be the largest net revenue gainer under this scenario. Hennepin County would generate an estimated $144 million in sales taxes. After sharing 20 percent with the statewide pool, it would have $115 million to keep. This $115 million exceeds the amount of aids and credits that Hennepin County would lose by $44 million, leaving Hennepin with a sizable net revenue gain.

In 82 counties, revenue generated from 80 percent of the county sales tax would not be sufficient to replace the lost state aids and credits, although dollars from the shared pool would be sufficient to compensate counties for 64 percent of their revenue loss. After sharing, the five counties that are net revenue gainers would receive nearly $50 million in new revenue, while the other 82 counties would lose an equivalent amount.

The 82 counties that experience a net loss of revenue would have the option of either increasing property taxes (or some other revenue, although other revenue options for counties outside of the property tax are limited) or reducing expenditures or some combination of the two. If counties decide to replace their lost aid by raising property taxes, the estimated county property tax increase in four counties would exceed ten percent; the estimated average county property tax increase among all 82 counties that experience a net revenue loss would be 3.1 percent.

There is a distinct possibility that some counties might decline to impose the optional sales tax. Perhaps the most likely candidate for this course of action is Hennepin County. There are at least four reasons why Hennepin County might not enact the local option sales tax:

  • Hennepin County would generate $144 million in sales tax revenue but would only be allowed to keep $115 million. Hennepin County could opt to cover its aid loss through a property tax increase that it would not have to share, rather than through a sales tax increase it would have to share.
  • Because of the Twins Ballpark tax, the transit tax, and the Minneapolis convention center tax, the total sales tax rate in Hennepin County is already higher than in most other parts of the state. Hennepin county officials may decline to impose an additional 0.5 percent sales tax in order to reduce (or avoid increasing) the sales tax rate disparity between Hennepin County and the rest of the state.
  • Sales taxes are a more volatile revenue source than property taxes. Hennepin County may opt to rely on more predictable and stable property taxes rather than on sales taxes.
  • As described in yesterday’s article, during the 1990s each of Minnesota’s 87 counties adopted a 0.5 percent sales tax to fund property tax relief programs. After having voted for the sales tax, the revenue from the tax was subsequently transferred to the state general fund by state lawmakers. In short, counties got the heat for having voted for a tax increase, while the state ultimately got the revenue. Hennepin and other counties could legitimately fear recurrence of this experience.

 

  1. The impact of the proposal would change markedly if Hennepin County declines to implement the 0.5 percent sales tax.

Scenario 2: All Counties Except Hennepin Adopt the Optional Sales Tax
Click here for table with data for all 87 counties

Without Hennepin’s contribution to the sharing pool, the available resources would be sufficient to compensate counties for only 43 percent of their revenue loss instead of 64 percent. As a result, the amount of the property taxes or budget reduction among the 82 counties that are net revenue losers would increase. For example, the average property tax increase needed to replace the net revenue loss among these 82 counties would be nearly five percent and 20 counties would need to increase property taxes by more than ten percent to fully compensate for the revenue loss.

If Hennepin and other counties that contribute more to the sharing pool than they get back decline to enact the sales tax, the resources that other counties receive from the sharing pool declines and their net revenue loss increases. As the benefit of enacting the county option sales tax declines, the fear of once again having local sales tax revenue transferred to the state could begin to outweigh the advantages of adopting the tax, thereby further increasing the number of counties that decline the local sales tax option.

Of course, the Horner sales tax proposal does not necessarily have to conform to the parameters described above. For example, the array of aid programs to be eliminated could be modified; however, no matter which aid programs are eliminated, large and relatively prosperous counties such as Hennepin and Dakota are likely to have an incentive to decline to adopt the sales tax. The sharing percentage or the rules for distributing revenue from the shared pool could also be modified; while these changes would make participation more attractive for some counties, they would make it less attractive for others. It is difficult to conceive of a structure for the Horner proposal that would not be problematic.

Mr. Horner’s county sales tax/aid elimination proposal seems to be an elaborate scheme to provide incentives for local governments to enact tax increases to help balance the state general fund. Given that local governments have already been compelled to raise property taxes to help bail out the state and that counties have already been burned once through a county option sales tax in the 1990s, county officials in 2010 are understandably reticent regarding Horner’s county sales tax proposal.

A simpler and more transparent remedy would be for state policymakers to increase state revenue to deal with the state budget deficit. For this to occur, state policymakers need to be willing to increase state taxes to fund legitimate public functions rather than to shift the unpopular tax increase decisions down to local governments.


*In addition to County Program Aid, the aids and credits that would be cut include: the county portion of the Market Value Homestead and Market Value Agricultural credits, the recurring portion of Adult Mental Health Grants, county Disparity Reduction Aid, the Children and Community Services Grant, the county portion of PERA aid, and one-third of Community Corrections Funding. The combined total of these aids and credits would approximately equal the total amount generated by a 0.5 percent sales tax imposed in all 87 Minnesota counties. The statewide totals of these aids are listed in part 1 of this series.

**The 20 percent of each county’s sales tax revenue that is shared would be distributed so that the revenue shortfall of each county (i.e., the amount by which lost aids and credits exceeds 80 percent of the county sales tax revenue) is reduced by the same percentage.
 

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