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2009 Property Taxes in Context

December 19, 2009 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Property taxes are going up.

Based on preliminary levy information from the Minnesota Department of Revenue, total property taxes for all Minnesota counties, cities, school districts, townships, and special taxing districts will increase by 6.6 percent from 2008 to 2009.  Preliminary property tax levies for local governments were set in September 2008.  Additional referendum levies approved in November are included in the 6.6 percent increase.

This statistic by itself might lead taxpayers to conclude that local governments are flush with cash.  However, as with all things involving the Minnesota property tax system, the truth is more complicated.

By state law, local governments can lower their preliminary levy amount, but they cannot raise it.  Thus, the final levy of a local government can be less-but not greater-than its preliminary levy.  With the probability of state aid cuts in the near future, it is unlikely that many local governments will opt to reduce their preliminary levies.

The following chart shows the levy increase from 2008 to 2009 broken down by type of jurisdiction.

The inflation rate for local government purchases in 2009 is expected to be less than one percent.  Similarly, population growth rate from 2008 to 2009 is likely to be well under one percent.  Clearly, statewide property tax growth in 2009 is outpacing both inflation and population growth.

The 2009 property tax increase needs to be interpreted in context.  There are several specific extenuating circumstances that must be considered.

The state-local fiscal relationship in Minnesota forces local governments to operate in an environment of extreme uncertainty.  This uncertainty has been particularly acute during the era of "new no taxes."

Back in the summer of 2008, the State of Minnesota told local governments how much aid they can expect to receive in 2009, a process known as "aid certification."  Based on these certified aid amounts, some aid programs-such as city Local Government Aid-would see significant increases from 2008 to 2009, although in general total aid to all local governments is expected to decline slightly from 2008 to 2009 even before adjusting for inflation and population growth.

However, the principal problem confronting local governments in 2009 is not so much the amount of the aid, but the uncertainty of its delivery.  As the summer wore into fall, the nation's financial crisis deepened, credit markets froze, and very real concerns emerged that the aid amounts that the state certified to local governments during the summer might not actually arrive.  Such fears were not idle speculation.  Several times in the past, the state reduced the aid level that it certified to local governments. Today, it appears, history will repeat itself,

A sad reality of the state-local fiscal relationship is that a disproportionate share of the state's budget problems are shifted on to the backs of local governments through state aid cuts.  This was particularly true back in 2003 and 2004, when real per capita local government revenues fell much further than state government revenue.  In short, when state government catches a cold, local governments catch pneumonia.

It now appears nearly certain that 2009 certified state aid to local governments will be cut.  (In fact, the final 2008 aid payment to counties and cities-which was certified in the summer of 2007-is also likely to be reduced.)  This leaves local governments in the precarious situation of not knowing if they will have sufficient revenue to fund necessary public services.  In this environment of uncertainty, local governments are more likely to depend more heavily on a revenue source they can count on: the property tax.

Even more uncertainty was introduced into county and city budgets with the passage of levy limits during the 2008 legislative session.  At the insistence of Governor Pawlenty, the 2008 tax act placed restrictions on local governments' authority to levy property taxes.

During Governor Pawlenty's time in office, local governments have cut their budgets far more than state government; this being the case, it was hypocritical for the Governor to foist revenue restrictions on local governments.  Once levy limits are imposed, local governments have an incentive to levy the maximum allowable amount out of fear that the state will intervene and permanently eliminate any unused levy authority in future years.  In the parlance of Minnesota government finance, this is known as "getting caught with your levies down."

As with the fear of aid cuts, the fear of "getting caught with your levies down" is not idle speculation.  In the past, state government has intervened to eliminate unused levy authority.  Expectation of this happening again provides local governments with an incentive to levy the maximum allowable amount.  In this way, levy limits can actually push levies higher, not lower, as local governments are forced to second guess state attempts to micro-manage local finances.

A final factor contributing to 2009 property tax increases is the large reduction in local government revenue prior to 2009.  The graph below shows the percent change in total real per capita local government revenue since 2002 (corresponding to school fiscal year 2003).  Total revenue consists of revenue from all sources, including property taxes, state and federal aid, fees, special assessments, and various other categories.

Despite an anticipated increase in revenue from 2008 to 2009, real per capita local government revenue in 2009 is still 8.6 percent less than it was in 2002.  The 0.9 percent growth from 2008 to 2009 also assumes no reduction in state aid to local governments in 2009; given the looming state budget crisis, aid reductions in 2009 are a virtual certainty.  This would make the total revenue decline from 2002 to 2009 even greater than what is indicated in the graph.

While local government revenue was falling, the state was shifting additional expenses, such as a larger share of corrections and medical assistance costs, on to local governments.  In addition, new federal mandates were dumped on school districts at the same time as the concentration of special need students was increasing.

All things considered, it is little wonder that property taxes are expected to increase in 2009.  Even with these increases, real per capita local government revenue is still significantly less than it was in 2002 (corresponding to fiscal year 2003), at the dawn of Minnesota's "no new tax" era.  In fact, real per capita local government revenue in 2009 is anticipated to be less than it was a decade ago.  So much for the myth of constantly expanding government.

If state leaders are truly interested in controlling property tax growth, they should restore some predictability and sanity to the state-local fiscal relationship by eliminating levy limits and stopping the practice of shifting a disproportionate share of state budget problems on to counties, cities, and school districts.

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