State Aid Ups & (Mostly) Downs for Cities

Except for a few intermittent spikes, state aid to Minnesota cities has trended downward since 1990. In general, cities have dealt with declining state aid through a combination of property tax increases and budget reductions, although the city response to aid vicissitudes has varied over time.

The following analysis will focus on the total “revenue base” of all Minnesota cities from 1990 to 2017. (A small portion of 2017 state aid to cities and 2017 city revenue base is estimated.*) “Revenue base” refers to the sum city property taxes and state aids, and is often used as a proxy for the size of city budgets. In this analysis, city property taxes will be measured in terms of city certified levies (including referendum levies) after subtracting major property tax relief credits. State aid will consist of state aid to cities—the largest one being city Local Government Aid (LGA)—plus major credits.†

Whenever we examine public revenues and expenditures over time, it is important to convert amounts into real (i.e., inflation-adjusted) dollars in order to take into account erosion in the purchasing power of the dollar over time. All amounts presented in this article will be adjusted for inflation using the Implicit Price Deflator (IPD) for State and Local Government Purchases and expressed in constant 2017 dollars, unless otherwise noted. As noted in a 2016 North Star article, the State and Local IPD is the appropriate index to use when adjusting state and local government revenues and expenditures for the effects of inflation. Amounts will also be expressed in dollars per person (per capita) to adjust for the impact of population changes upon the need for city revenue.

In constant 2017 dollars, total state aid to cities—including major state property tax relief credits—in 1990 was $326 per capita. In that year, the programs that directed state-paid property tax relief and other forms of assistance to cities included not only LGA, but also Homestead and Agricultural Credit Aid (HACA), Disparity Reduction Aid, Equalization Aid, and municipal taconite aid. With the exception of LGA and municipal taconite aid, these programs morphed over time (for example, HACA was converted into the Market Value Homestead Credit and Market Value Agricultural Credit in 2002) before ultimately disappearing. Meanwhile, despite periodic and temporary increases, the overall trend in real per capita LGA over this period was downward.

During most years in the 1990s, the city LGA appropriation was adjusted for inflation (but not population growth); as a result, the decline in total real per capita city aid during the 1990s was relatively modest. Through 1996, the decline in aid was dealt with through reductions in the real per capita city revenue base (i.e., budget reductions and other cost-saving measures), allowing real per capita city property taxes to remain flat. From 1996 to 2001, cities compensated for a slow decline in real per capita LGA with slow growth in real per capita property taxes. (Modest growth in real per capita revenue base from 1996 to 1998 was offset by reductions from 1998 to 2000.)

Modest property tax growth in 2002, combined with a modest increase in real per capita state aid (driven by a large increase in LGA, which was partially offset by the elimination of HACA and the advent of the much smaller Market Value Homestead and Agricultural Credits), attributed to a significant revenue base increase in 2002. During the period from 2002 to 2013, however, real per capita state aid to cities declined significantly, punctuated only by one-time increases in 2006 and 2009. This period also saw fairly steady growth in real per capita city property taxes and an overall decline in real per capita revenue base, as cities struggled to maintain services and infrastructure in the face of dwindling levels of state aid.

Total state aid to cities increased by over $15 per capita in 2014, the largest annual real per capita increase since 1990. This led to a modest real per capita increase in city revenue base and reduction in property taxes. Since 2014, total real per capita aid to cities has declined slightly. Escalating city property taxes have been more than sufficient to replace the decline in state aid, resulting in an increase in real per capita city revenue base from 2014 to 2017.

Despite this revenue base increase, the total 2017 city revenue base is $60 per capita (8.9 percent) less today than it was in 1990. Clearly, the revenue base increase since 2014 was backfilling a portion of the decline in revenue base over the preceding years. City property taxes increased by $151 (44.3 percent) per capita from 1990 to 2017, while state aid decreased by $211 (64.5 percent) per capita.

In light of the three recessions since 1990 and increased demands on state resources driven by increasing health care costs and an aging population, it is perhaps unrealistic to expect state aid to cities to have kept pace with inflation and population growth over the last 27 years. Whether the state needed to cut city real per capita aid by so much (nearly two-thirds) is a matter of debate.

The recently enacted $15 million nominal LGA increase for 2018 should be sufficient to keep pace with inflation and population growth from 2017 to 2018. Based on current law, the slow decline in real per capita LGA will likely resume after 2018, as inflation and population growth erode the per capita purchasing power of the frozen LGA appropriation.

By focusing narrowly on revenue base, this analysis excludes changes in other categories of city revenue outside of property taxes and state aid. Analysis of a broader measure of city revenue from the periodic Price of Government report indicates that the decline in aggregate real per capita city revenues from 1990 to 2017 is significantly greater than the 8.9 percent decline in revenue base.

The above analysis shows that there is no simple one-to-one relationship between state aid changes and property tax changes, as some years with aid increases have coincided with property tax increases and vice versa; however, the increasing gap between shrinking real per capita state aid and escalating property taxes indicated in the above chart certainly demonstrates that there is a clear correlation between state aid reductions and property tax increases over the long-term. There is also a strong connection between the decline in real per capita state aid and the decline in the revenue needed to pay for city services and infrastructure.

This analysis has focused on the property taxes, state aid, and revenue base of all Minnesota cities combined. Such aggregate level data no doubt conceals trends for specific cities. The next article in this series will focus on the long-term trend for three specific Minnesota communities.

 

*The 2017 city property tax levies were certified late last year. The Local Government Aid (LGA) that cities are expected to receive in 2017 was certified last summer. (It is unlikely that the 2017 certified LGA will be reduced.) The only components of the 2017 city revenue base that are not available at this time are municipal taconite aid and the Market Value Agricultural Credit, which comprise approximately two percent of total state property tax aids and credits paid to cities and less than one-half percent of the statewide city revenue base. For purposes of this analysis, the amounts received by cities through these two programs are estimated.

Specifically, “state aid” as used in this article will refer to the sum of city LGA (distributed each year from 1990 to 2017), municipal taconite aid (also distributed each year), city Disparity Reduction Aid (distributed from 1990 to 1993), Equalization Aid (1990 to 1993), Homestead and Agricultural Credit Aid (1990 to 2001), Local Performance Aid (1997 to 1999), low-income housing aids (1999 to 2003), the Market Value Homestead Credit (2002 to 2011), and the Market Value Agricultural Credit (2002 to 2017).