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LGA Should be Adjusted to Keep Up With City Costs

May 05, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

A sensible way to maintain the property tax relief value of city Local Government Aid (LGA) is to annually increase the aid appropriation to keep pace with growth in city costs, as proposed by the Minnesota House of Representatives in its second tax bill of 2014. Without such an adjustment, property taxes increase, tax rate disparities grow, and funding for city services shrinks as inflation and population growth erode the real per capita purchasing power of LGA dollars. The cities hurt most under this scenario are low property wealth communities with the greatest need for state assistance.

Some state policymakers reject this common sense approach, preferring instead to freeze the LGA appropriation indefinitely—a policy which translates into a shrinking LGA appropriation in real (i.e., inflation-adjusted) dollars per capita. Proponents of a frozen LGA appropriation offer three justifications for this position.

The first reason for opposing an annual adjustment to the LGA appropriation in favor of frozen funding is more of a complaint than a justification. Some legislators argue that cities did not use the $80 million increase in LGA funding provided by the legislature in the 2013 tax act to reduce property taxes, but instead used the additional dollars to increase city spending. For this reason, they are reluctant to approve an ongoing adjustment to the LGA appropriation.

In truth, cities did use a significant portion of the 2014 LGA increase provided in the 2013 tax act to increase spending (to make up for a decade of declining LGA), but they also used a significant portion to reduce property taxes. An examination of 2014 final levy information shows that the rate of nominal (unadjusted for inflation) property tax growth was much lower and the rate of real (inflation adjusted) property tax decline was much greater among cities that received a 2014 LGA increase than among cities that did not.

A statistical analysis shows that the larger the 2014 LGA increase, the greater the reduction in 2014 city property taxes.* This is clear proof that the 2014 LGA increase did contribute to property tax relief in 2014.

It is certainly true that some of the LGA increase went to pay for increased city spending, as demonstrated by the fact that real per capita city levies plus LGA increased by 1.9 percent from 2013 to 2014. However, this growth in city budgets must be considered in the context of the sharp decline in city revenue that occurred in preceding years. From 2002 to 2013, real per capita city levies plus state aids declined by ten percent; the increase from 2013 to 2014 was sufficient to replace less than one-fifth of that decline. The 2014 revenue increase was justified to restore a small portion of the cuts to public safety, transportation, parks, libraries, and other city services over the preceding decade. A modest spending increase under these circumstances is certainly no justification to freeze LGA in perpetuity.

The second reason offered for not adjusting the LGA appropriation to keep pace with inflation and population growth is that the state cannot afford it. During the April 30 tax conference committee deliberations, one legislator observed that the annual inflation and population growth adjustment to the LGA appropriation would cost the state nearly $900 million cumulatively over the next decade based on current projections.

The $900 million cumulative LGA increase over the next ten years sounds like a lot of money. However, any amount can appear astronomical when projected into the distant future and then summed over the entire period. However, in all likelihood, LGA will shrink as a percentage of total general fund spending over the next decade even with an inflation and population growth adjustment. It is difficult to see how a continually shrinking slice of the state general fund pie is unsustainable.

The $900 million cumulative ten year total also represents the amount by which property taxes will need to increase and/or city budgets will have to be cut in order to compensate for the decline in the real per capita purchasing power of LGA due to a frozen appropriation. Legislators need to be honest about the fact that a perpetually frozen LGA pot will inevitably translate into city property tax increases and a return to a cycle of perennial city budget cuts that have harmed the quality of life in many Minnesota communities over the last decade.

Finally, frozen LGA proponents argue that the state should not put LGA funding on “auto-pilot” by annually increasing the appropriation. They further argue that LGA should be increased only when the state has sufficient resources to invest in property tax relief.

The “auto-pilot” argument ignores two critical facts. First, state policymakers have the ability to alter any statute, including the LGA appropriation adjustment, at any time should financial conditions warrant. On numerous instances in the past, state officials have stepped in to reduce LGA funding in response to a state budget shortfall and they could do so again in the future. An annual adjustment to the LGA appropriation would in no way restrict the ability of the legislature to alter LGA funding in response to future fiscal exigencies.

Second, a frozen LGA appropriation is also an auto-pilot. Under this auto-pilot, the property tax relief value of LGA is eroded every year due to the effects of inflation and there is no aid adjustment to reflect the increased service demands resulting from population growth. Given the choice between an “auto-pilot” that recognizes realistic growth in the cost of city services versus one that will inevitably contribute to city property tax increases and funding cuts, smart policymakers should opt for the former.

In regard to the argument that LGA should only be increased when the state has sufficient resources, it should be noted that the state budget for the next biennium (which would include 2015 LGA funding) is currently showing a $1.5 billion surplus even after adjusting for inflation. Given the significant surplus, a modest increase in the LGA appropriation at least for 2015 and 2016 is warranted to ensure that LGA keeps pace with inflation and population growth.

Arguments in opposition to an LGA appropriation adjustment ultimately fall flat. Increasing LGA funding to keep pace with inflation and population growth will not only reduce the likelihood of property tax increases and city budget reductions, but also provide additional stability in state costs and city revenues. Governor Dayton and the Minnesota Senate should go along with the House proposal to adjust the LGA appropriation for inflation and population growth beginning in 2015.


*This relationship was statistically significant at the 0.01 level.

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