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MN2020 - Looking Ahead: Fiscal Reforms Left Undone
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Looking Ahead: Fiscal Reforms Left Undone

May 22, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Yesterday’s Minnesota 2020 article noted the significant progress made during the 2013 legislative session in enhancing revenue adequacy, budget stability, and tax fairness in Minnesota. However, our work is not over. Several thorny problems have yet to be resolved to assure that Minnesota remains on the path toward fiscal excellence in future years.

Inflation in Future State Expenditure Forecasts

As the 2002 legislative session wound down, state leaders wanted to claim that they had produced a long-term structurally balanced budget, but they did not want to make the difficult decision of increasing taxes or cutting spending necessary to achieve this goal. They resolved this conundrum by adopting the fiscally dubious policy of willfully ignoring the impact of inflation on most state expenditures, while continuing to fully incorporate the impact of inflation on state revenues. The result was to overstate future state revenues relative to future expenditures, thereby creating the illusion of a positive budget balance in the out-years.

In the 2013 February forecast, the State Council of Economic Advisors observed that “The current practice of including inflation in projected revenues but not in spending projections is misleading and not consistent with either sound business practice or the methods of the Congressional Budget Office.” Despite the fact that the Council has made this recommendation in each of its written statements over the last ten years—and despite the fact that the same advice has been given by the non-partisan Budget Trends Study Commission—the ill-conceived practice of ignoring the impact of inflation on state expenditures has remained in place.

This misguided policy has contributed to the repeated budget deficits over the last decade, as expenditures turn out to be higher than officially projected as the inexorable impact of inflation ultimately manifests itself. State policymakers should follow the recommendations of the Council of Economic Advisors and the Budget Trends Study Commission by returning to the policy of fully incorporating the impact of inflation on projected state revenues and expenditures.*

Unfreezing State Aid Appropriations

During the 2013 session, state policymakers adopted important reforms to the city Local Government Aid (LGA) formula that made the distribution of aid among cities more rational and added stability to future state LGA payments. In addition, they provided for significant increases in LGA and County Program Aid (CPA) funding in 2014 (state fiscal year 2015) to replace a portion of the sharp state aid decline over the last decade. However, they failed to complete the job of state aid reform by ensuring that the LGA and CPA appropriations would keep pace with inflation and population growth after 2014.

The property tax relief value of state aid decreases over time as inflation gradually erodes the purchasing power of the dollar and population growth contributes to the demand for increased local government services. In recognition of these increased spending pressures, state aid appropriations should be adjusted annually for both inflation and population growth. In the absence of this adjustment, property taxes will grow faster than the combined rate of inflation and population growth even if local spending grows at the same rate as inflation and population, as explained in a recent series of Minnesota 2020 Hindsight posts.

The claim that the state cannot afford to increase state aid appropriations for inflation and population growth does not hold true. A recent Minnesota 2020 analysis demonstrated that even if city LGA is adjusted for inflation and population growth, the LGA appropriation will still grow less rapidly than projected state revenues for the foreseeable future. This is true, incidentally, regardless of whether the tax increases in the 2013 omnibus tax bill are factored in.

During the 2014 session, the Legislature and Governor should complete the job of state aid reform by ensuring that both city Local Government Aid and County Program Aid are adjusted for inflation and population growth.

Adjusting the State Business Property Tax

The state business property tax levy is adjusted upward each year in order to keep pace with impact of inflation on state expenses. However, the state business property tax levy has been insulated from the effects of population growth on state expenditures. As a result, real per capita state business property taxes in Minnesota have declined by nearly nine percent since its inception in 2002. Over the same period, total local property taxes have increased by 20 percent.†

The state business property should be adjusted each year not only for the effects of inflation, but also population growth. Even with this adjustment, the business property tax will continue to be a good deal for Minnesota businesses, since the tax will still be insulated from other costs that are pushing state expenses upward, such as the aging of the state’s population, which is contributing to rapidly escalating health care costs.

The list of reforms highlighted above certainly is not exhaustive. Numerous other avenues for improvement—such as eliminating unnecessary tax expenditures and simplifying the state’s property tax system—quickly come to mind. The important thing is that progressives not rest on the laurels of the significant tax accomplishments made during the 2013 session. A lot more work needs to be done.

 

*Fortunately, the effect of incorporating the impact of inflation of projected state spending may not be quite as costly as feared. While the official state budget forecast does not include the impact of inflation on most state spending, Minnesota Management & Budget (MMB) does include an unofficial inflation-adjusted state expenditure projection in each February and November forecast document. As noted in a previous Minnesota 2020 analysis, the methodology used by MMB in these unofficial projections may overstate the impact of inflation on state spending.

†Incidentally, the rapid growth in local property taxes over the last year is not due to rapid growth in local government budgets; real (i.e., inflation-adjusted) per capita city, county, and school district revenue have each declined over the last decade. The growth in local property taxes since 2002 is due primarily to the sharp decline in real per capita state aid.
 

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