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LGA Must Keep Pace with Inflation and Population Growth

March 25, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

At a recent House Property Tax Division meeting, Rep. Pat Garofalo of Farmington complained that the annual inflation adjustment in the city LGA reform proposal would be unaffordable in future years because LGA spending would grow faster than statewide personal income. Garofalo’s assertions are not borne out by the facts.

Under the LGA reform proposal agreed to by the state’s major city organizations and incorporated into H.F. 1608 and S.F. 1491, the LGA appropriation would be adjusted annually for inflation and city population growth beginning in calendar year 2015, corresponding to state fiscal year (FY) 2015. This is necessary to ensure that the real per capita purchasing power of LGA will stay constant over time. Without this appropriation adjustment, city property taxes will increase in future years even if real per capita city spending remains constant. The inflation adjustment to the LGA appropriation is based on the Implicit Price Deflator for State and Local Government Purchases (i.e., the S&L IPD).

During the Property Tax Division meeting, Rep. Garofalo argued that the S&L IPD is “…far more likely to grow faster than the traditional form of inflation, the Consumer Price Index, and what no one would dispute is that when you take that and track it versus personal income, that that implicit price deflator grows faster than personal income.” The fact that the S&L IPD is growing faster than personal income will lead to growth in the LGA appropriation beyond what the state can afford in future years, Garofalo argued, thereby leading to tax increases or spending cuts in other areas of the state budget.

As it turns out, however, Rep. Garofalo was completely wrong about the growth in the S&L IPD relative to personal income, as demonstrated in the graph below. All information in this graph is based on actual and projected data from Minnesota Management & Budget.

Growth in the S&L IPD has consistently been well below growth in statewide personal income and state income tax revenue since 1991, with the exception of recession years. Over the next four years (2013 to 2017), the growth in personal income and state income tax revenue is projected to be approximately double the rate of growth in the S&L IPD. Even if we add the population growth adjustment to the S&L IPD inflation adjustment, the combined rate of growth will still be well below the rate of growth in personal income.

Rep. Garofalo’s statement regarding the S&L IPD is also disputable on other grounds. His characterization of the Consumer Price Index (CPI) as the “traditional form of inflation” is not really accurate in the context of city governments. The S&L IPD, not the CPI, is the “traditional” measurement of inflation for cities. Statutes regarding levy limits, the supplemental truth-in-taxation statement, and the revenue need adjustment in the current LGA formula all rely on the S&L IPD, not the CPI. Furthermore, the House Research Department, Senate Counsel & Research, and the Revenue Department generally use the S&L IPD to adjust city finances for inflation.

The "market basket of goods and services" purchased by cities and other state and local governments is driven largely by wage and benefit costs (especially rapidly escalating health care costs) and is significantly different from typical household purchases. The S&L IPD exists to provide a measure of inflation that is more representative for the types of items that cities and other state and local units of government purchase.

The current Dayton administration and the previous Pawlenty administration advocated the S&L IPD as the appropriate measure of inflation for cities and other local governments. Governor Pawlenty’s senior policy advisory Dan McElroy had the following to say about the S&L IPD during a 2005 MPR interview:

"I would urge people not to use the Consumer Price Index to judge the cost of government. There's a more complicated measure of inflation called the Implicit Price Deflator for State and Local Government Services [i.e., the S&L IPD]... School districts and local units of government don't buy the same things that households buy. They don't have quite the same pressure on food costs and on a variety of other things and so they have their own measure of inflation..."

Rep. Garofalo’s claim that the S&L IPD is “far more likely to grow faster” than the CPI is somewhat overstated. While the S&L IPD has generally increased faster than the S&L IPD in recent decades, there have been significant periods when that has not been the case. In the late 1970s and early 1980s and during most of the 1990s, annual growth in the S&L IPD was below that of the CPI. In addition, during two of the last five years (FY 2010 and FY 2013), the annual S&L IPD increase has been less than the increase in the CPI.

Rep. Garofalo’s fear that LGA growth under the reformed city LGA proposal will be a budget buster is unfounded based on a comparison of projected LGA growth under the reformed city LGA proposal to projected growth in general fund revenue from the February 2013 forecast. The graph below shows the projected growth in three broad measures of general fund revenue versus projected LGA growth under the new LGA proposal from FY 2015 to FY 2017, the first two years that the annual appropriation adjustment would be in place.

[ graph: click blog title to view in browser ]

It is important to note that the general fund information in the above graph is based on current law and does not include any of the revenue increases proposed by the Governor, House, or Senate. Even without these revenue increases, the growth in LGA resulting from the inflation and population growth adjustment under the new reform proposal will be considerably less than the growth in general fund revenue. This is further proof that the modest annual increases to the LGA appropriation contained in the city LGA reform proposal will not be a budget buster.

After a decade of severe cuts, LGA funding should be increased not only for one year, but in subsequent years to assure that the property tax relief value of LGA does not erode over time. Failure to adjust the LGA appropriation for inflation and population growth will virtually guarantee that city property taxes will increase in the future even if real per capita city spending remains constant. The above analysis shows that the annual appropriation increase contained in the new city LGA reform proposal is affordable for the foreseeable future.

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