State Business Property Tax Revisions
While the Governor and legislative leaders have worked out the broad outline of a budget deal, many important details have yet to be resolved. One of the decisions that the House-Senate Tax Conference Committee has yet to make involves the fate of the proposed expansion of the state business property tax in the Senate omnibus tax bill.
The Legislature and Governor Ventura enacted the state business property tax in 2001 as part of large scale changes to Minnesota’s property tax system. As part of the 2001 tax act, the share of local property taxes borne by businesses was reduced, while the share borne by residential property and most other classes of non-business property was increased. In addition, the K-12 general education property tax levy was eliminated and replaced with dollars from the state general fund.
The decrease in the share of local property taxes borne by businesses combined with the elimination of the general education property tax provided a massive reduction in business property taxes. To offset this windfall of property tax relief—and to generate additional general fund revenue to help pay for general education*—state policymakers enacted a state business property tax. On a statewide basis, business property was taxed at a uniform rate calculated by dividing the state business property tax levy, which is set in statute, by Minnesota’s total business tax base.†
During the first year of implementation (2002), the business portion of the state property tax was approximately $560 million. In subsequent years, the levy was adjusted for inflation based on the Implicit Price Deflator for State and Local Government Purchases.
Over time, the state business property tax has turned out to be a pretty good deal for Minnesota business. The portion of business property taxes paid to the state was insulated from the effects of the aid reductions that were driving local property taxes upward over the last decade. In addition, while the business levy was adjusted upward each year due to inflation, it was insulated from the increase in public costs driven by population growth. The graph below shows the percentage change in real per capita business property taxes in Minnesota relative to combined residential and apartment property taxes from 2002 to 2013.
Since 2009, business property taxes have increased relative to residential property taxes as a larger share of the tax shifted on to businesses due to a much less rapid decline in business values. Nonetheless, over the entire span of the last eleven years from 2002 to 2013, real per capita business property taxes have grown by only 1.5 percent, compared to 23 percent for residential and apartment properties. The relatively slow growth in business property taxes is in large part due to the nearly nine percent real per capita decline in the state business property tax levy.
The Senate tax bill attempts to capture additional revenue from the state business property tax by increasing the business property tax rate to what it was in 2002—the first year of the state property tax levy. In future years, the rate would continue to be frozen at the 2002 level. This change is projected to generate $49.7 billion in additional revenue in state fiscal year (FY) 2014 and $93.9 million in FY 2015.‡
While the Senate tax bill would allow the state to generate additional revenue through the state business property tax, it is not necessarily doing so in the most efficient manner. A frozen tax rate makes sense for the income tax because the ability to pay taxes increases as income increases. A frozen rate also makes sense for the sales tax because an increase or decrease in tax revenue will be associated with increased or decreased economic activity in the form of consumption of taxable goods. However, the same logic does not apply to ad valorem property taxation. A change in property value is not necessarily associated with a change in either the ability to pay or economic activity.
Typically, property tax rates are not frozen. Rather, the jurisdiction levying the property tax determines the amount of revenue that it needs. This amount is then divided by the known value of taxable property within the jurisdiction to determine a rate. This rate, when multiplied by taxable property value, generates the amount of revenue specified by the jurisdiction.
However, this is not the case when the property tax rate is frozen; a frozen rate will generate less revenue when values decline and more when values increase—although the change in revenue generated will not necessarily be linked to the ability to pay, the level of economic activity, or the jurisdiction’s need for revenue. In short, the principal advantage of the property tax—predictability—is undermined when the rate is frozen.
Rather than freezing the state business property tax rate, policymakers should consider an alternative: adding a population growth adjustment to the existing inflation adjustment to the state business property tax levy. Adding a population adjustment would allow the state levy to grow so as to keep pace with the increased need for state services associated population growth.
A population growth adjustment to the state business property tax levy retroactive to the year of the tax’s implementation—2002—would generate nearly as much revenue as the Senate’s frozen rate in the short term and provide greater revenue predictability in the long-term, while at the same time doing a better job of linking future growth in the levy to the demand for public services.
Due to the real per capita decline in the state business property tax levy over time, the Senate was prudent to include changes to this levy in its omnibus tax bill. However, the goals of predictability and future revenue adequacy could be better served by further adjusting the levy for population growth rather than by simply freezing the tax rate.
*The revenue generated by the state property tax is not formally dedicated to paying for K-12 general education. Nonetheless, the state takeover of general education funding resulted in a significant new general fund cost that the state property tax helps to offset.
†Actually, during the first four years of the state property tax (tax payable years 2002 to 2005), businesses and seasonal recreational property were part of the same tax base and taxed at the same tax rate, calculated by dividing the total state property tax levy by the combined tax base of business and seasonal-recreational property. Beginning with taxes payable in 2006, the business and seasonal-recreational portions of the state property tax were separated into two distinct levies, each with a distinct tax rate; since 2006, the state business property tax rate has been equal to the business share of the state property tax levy divided by statewide business tax base.
‡The amount of new revenue generated in the first fiscal year—FY 2014—is significantly less than the amount generated in FY 2015 and subsequent years because only the first of the two calendar year 2014 property tax payments are included in the state’s 2014 fiscal year. (Fiscal year 2014 begins on July 1, 2013—six months before calendar year 2014.) Not included in these amounts is the additional revenue that the Senate tax bill would generate by imposing the state business property tax on public utility electrical generation equipment; this class of property is currently exempt from the state business property tax. By expanding the state business property tax to include electrical generation machinery, the Senate tax bill is projected to generate another $11.3 million in FY 2014 and $20.8 million in FY 2015.