For four and a half decades, the Local Government Aid (LGA) program has provided assistance to Minnesota cities to pay for essential services and infrastructure and to help hold down property taxes. In recent years, some state policymakers have attempted to increase funding for LGA, while others have said it is time to phase-out the program. Given the ongoing prominence of LGA in state policy debates, we offer North Star readers a brief history of the Local Government Aid program, as well as speculation as to where the program may be going.
The LGA program was enacted in 1971 on a bi-partisan basis as part of an array of property tax relief programs that came to be known as the “Minnesota miracle.” LGA was first distributed in 1972 as a replacement for a number of pre-existing aid programs and shared state taxes. All levels of non-school local government (i.e., cities, counties, towns, and special taxing districts) initially received LGA, although since 2002 LGA has gone exclusively to cities. The remainder of this article will focus on the portion of LGA directed to Minnesota cities.
Historically, LGA has been distributed to cities based on the difference between a city’s “revenue need” and its “ability to pay.” The greater a city’s revenue need in relation to its ability to pay, the more LGA the city would receive, all other things being equal. “Ability to pay” has generally been measured based on the size of a city’s property tax base; cities with a large per capita property tax base are considered to have a greater ability to generate revenue locally than cities with a small per capita base.
The measure of city revenue need has evolved over time. Prior to 1989, revenue need was measured in terms of a city’s levy plus state aid from previous years. This approach was criticized because it assigned a higher revenue need—and hence higher LGA payments—to cities that chose to levy and spend more. As a result, a new approach to measuring city revenue need based on a city’s demographic characteristics was developed; this revised method of measuring revenue need severed the connection between city spending decisions and subsequent aid increases (or decreases).
Early demographic measurements of city revenue need were crude, based exclusively on the number of households in the city. This approach was soon abandoned in favor of a more sophisticated and rigorous approach that involved the use of statistical regression analysis to select and weight the characteristics that determine revenue need. Since the 1990s, the regression equations used to determine city revenue need have been updated every ten years. The most recent city revenue equations were designed and enacted during the 2013 legislative session.
The chart below shows state LGA payments to cities each year since 1972. In order to adjust for the effects of inflation and population growth, the annual aid payments are shown in constant 2016 dollars per capita.† In this chart, per capita aid totals for 2016 to 2018 are based on current law aid appropriations and projected city populations. In order to provide a more “apples to apples” comparison over time, other general purpose city aids in addition to LGA are included; these “other city aids” include disparity reduction aid, equalization aid, homestead and agricultural credit aid, local performance aid, and the city share of the market value homestead credit. Some combination of these “other aids” were paid in addition to LGA each year from 1989 to 2011.
Funding for city LGA has fluctuated significantly over the years. As a general rule, growth in total city general purpose aid—of which LGA is the largest component—outpaced inflation and population growth from 1972 to 1990. The exception to this rule occurred during economic recessions, when LGA was cut in response to state budget deficits; however, these cuts were restored as the economy recovered and state finances improved. From 1990 to 2001, real (i.e., inflation-adjusted) per capita city LGA remained essentially flat, although total real per capita general purpose aid eroded. In 2002, LGA was increased significantly, although other general purpose aids were greatly reduced; the net result was a modest increase in total real per capita city aid from 2001 to 2002.
The period from 2002 to 2013 saw a steady and steep erosion in state funding for LGA and other general purpose city aids, as the state was hit by two economic recessions, lackluster recoveries, repeated budget deficits, and a reluctance on the part of state policymakers to reverse the effects of permanent tax cuts enacted near the turn of the century. Modest aid increases in 2006 and 2009 were quickly overwhelmed by subsequent aid cuts. During the period from 2002 to 2013, state aid fell by 24 percent in nominal dollars (i.e., unadjusted for inflation) and by 56 percent in real per capita dollars.
During the 2013 session—effective in 2014—state policymakers enacted the largest increase in general purpose city aid in over twenty years, along with significant reforms to the LGA distribution formula to better target aid to cities with the greatest need. As a result, real per capita city LGA increased by over 15 percent from 2013 to 2014. Another much smaller LGA increase followed in 2015. However, even after the 2014 and 2015 aid increases, real per capita general purpose city aid is less than half of what it was in the peak year of 1990 and 18 percent below the 1972 level—the first year of the LGA program.
After a slight increase in city LGA in 2016, the LGA appropriation is frozen in 2017 and 2018 under current law. Consequently, the LGA appropriation is not expected to keep pace with inflation and population growth during this period and, as a result, real per capita LGA will likely decline, barring any changes to state law.
Should a larger portion of past city LGA cuts be restored? Or should the current LGA appropriation at least be adjusted annually so that it keeps pace with inflation and population growth? Or should LGA be reduced? These are questions that the legislature may address during the 2016 session, although the outcome is far from clear. Leaders in the Senate have proposed a permanent increase in LGA, while the House has endorsed cutting LGA for Minneapolis, Saint Paul, and Duluth. Meanwhile, Governor Dayton has proposed a one-time LGA increase in his 2016 supplemental budget recommendation.
†The conversion from nominal (i.e., unadjusted for inflation) to constant 2016 dollars in this article is based on the implicit price deflator for state and local government purchases. The use of this implicit price deflator was the subject of a recent North Star article.