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MN2020 - 2013 Legislature Enacts Major Reforms to LGA
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2013 Legislature Enacts Major Reforms to LGA

October 07, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

After a decade of eroding aid to cities and rising property taxes, in 2013 state policymakers made significant city Local Government Aid (LGA) reforms. It included not only more money for cities, but also a fairer system for distributing aid. Previous installments in this series described trends in LGA funding since the inception of the program in 1972 and the process by which major city organizations reached consensus on a single set of LGA reforms. This final installment will describe three specific reforms that the city organizations agreed to and that state policymakers ultimately enacted.

New Revenue Need Formulas

The primary LGA formula distributes aid to cities based on each city’s “unmet need,” which is equal to a city’s “revenue need” minus its local “revenue raising capacity.” A positive unmet need is an indication that a city’s revenue raising capacity is insufficient to meet its revenue need and thus the city qualifies for state aid. Revenue raising capacity is measured through the average statewide city tax rate multiplied by each city’s local tax base. The measurement of “revenue need” is more complicated.

Since 1993, city revenue need has been determined through statistical equations that correlate the demographic characteristics of each city (age of housing stock, population decline, etc.) with each city’s per capita “revenue base.”* This approach helps to ensure that the revenue need of each city is based on its demographic characteristics and not on discretionary taxing and spending decisions made by city leaders.

The last time that the revenue need equations were updated was in 2003. Over the intervening decade, the ability of the 2003 equations to successfully predict city revenue need had diminished, so students of LGA were in agreement that it was time to update the equations. The new need equations included in the LGA reform package are based on a combination of new factors as well as factors from the old need equations that were reweighted based on updated information. The most significant reforms to the measurement of revenue need under the new law include:

  • A new need equation for medium-sized cities. Prior to the 2013 reforms, city revenue need was measured through two separate equations: one for small cities (under 2,500 population) and one for large cities (over 2,500). The new reformed LGA program includes a new revenue need equation for cities with a population between 2,500 and 10,000; this new equation does a better job of identifying and quantifying factors that are particularly relevant to medium-sized cities.
  • Inclusion of new demographic characteristics in revenue need equations. Among the new factors in the revenue need equations are (1) a measure of the percentage of housing units built between 1940 and 1970 (helps to identify costs related to aging infrastructure in older suburban communities), (2) a new population decline factor that measures the decline in city population since 1970 (solves volatility and other problems with the previous population decline factor), and (3) the number of jobs per capita (helps to identify additional public costs in cities that have a large day-time population of worker-commuters).
  • A substantially revised small city need equation. The small city need equation in the old law was complicated and did a poor job of predicting city revenue need. The new small city need equation is simpler and easier to understand.

No More Side Pots

Most LGA dollars are distributed through the “unmet need” model described above. However, prior to the 2013 reforms, a significant portion† of LGA was also distributed through “side pots” that had nothing to do with a city’s unmet need as measured by the primary need-minus-capacity formula. These side pots included a “regional center aid,” “small city aid,” and “jobs aid.”

The presence of “side pots” can be seen as an indication that the primary formula is not doing—or is perceived as not doing—an adequate job of identifying cities’ need for state assistance. With the LGA reforms passed during the 2013 session all side pots were eliminated, apparently an indication that state policymakers felt that the new formula was doing a reasonable job of distributing state aid without the use of supplemental aid formulas.

A New Approach to Funding Unmet Need

The single most significant change to the LGA program during the 2013 session is also the least discussed and the least understood. Throughout recent history, the total LGA appropriation has not been large enough to fully fund every city’s unmet need; this continues to be the case under the new law. However, the manner in which LGA payments are scaled back so that the total aid sent out does not exceed the total appropriation has changed.

Under the old law, every city would receive a uniform percentage of its unmet need (always less than 100%). Under the new law, every city with unmet need greater than its prior year LGA‡ will receive an aid increase equal to a uniform percentage of the gap between its unmet need and its prior year LGA.

A comparison of the old approach and the new approach can get complicated. Suffice it to say that the new approach produces the following benefits relative to the old approach:

  • The amount of LGA that cities receive in future years will be much more stable and predictable. Some of the approaches used in the old law to reduce aid volatility—such as averaging the unmet need over two years—are no longer necessary.
  • No city with an unmet need greater than its prior year aid amount would have its LGA cut in future years unless there was a cut in the LGA appropriation. As a result, the number of cities that experience aid reductions is dramatically reduced.
  • The cities with the largest gap between their prior year LGA and their current unmet need will receive the largest aid increases. This has the effect of providing the largest aid increases to the cities that need it most based on the criteria of the new formula.
  • The maximum aid increase cap is eliminated. A city’s aid increase is based on a uniform percentage of the gap between its prior year aid amount and its unmet need, unconstrained by caps.

With an $80 million LGA appropriation increase in 2014, the new formula will allow cities with aid levels less than their unmet need to receive significant aid increases. However, in the absence of an appropriation increase in future years, cities in which unmet need is below their actual aid amount will make only glacial progress toward more adequate funding of their unmet need. During the next legislative session, city organizations are expected to seek an annual LGA appropriation increase equal to the rate of inflation and population growth to ensure that the property tax relief value of LGA dollars does not erode over time and to ensure that cities can continue to make progress toward more adequate funding of their unmet need.

The changes enacted by the legislature represent the trifecta in LGA reform: a significant increase in funding, a new formula that provides for a more rational distribution of state aid, and near unanimous support among city organizations and bi-partisan support within the legislature. Thanks to these reforms, Minnesota’s city Local Government Aid program should remain alive and vibrant for the next decade.

 

*“Revenue base” is equal to the sum of a city’s property tax levy plus its state aid.

†Because of the way in which the LGA formula and the side pots interact with the maximum and minimum aid caps that were part of the old LGA program, it is difficult to say precisely how much of the total LGA appropriation was distributed through the side pots. However, the side pots distributed $46 million (12 percent) of the total preliminary LGA amounts prior to imposition of the caps under the old LGA program used to distribute aid in 2013.

‡For cities in which the prior year aid amount is greater than their unmet need, the 2014 LGA amount would be frozen at the 2013 level. Beginning in 2015, the LGA of these cities will be reduced by the lesser of $10 per capita or five percent of the prior year property tax levy until the aid is reduced to the level of unmet need.

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