Problems with Minnesota's state aid system

As noted in yesterday’s Minnesota 2020 article, the state provides aid to Minnesota local governments in order to pay for state mandates, equalize the ability of local governments to generate revenue, and reduce property taxes. However, the state aid system is not without problems-both real and perceived.

Problems with the state aid system fall into two broad categories: (1) local government behavior in response to the aid system and (2) state administration of the aid system.

The most common criticism of state aid programs from anti-tax advocates is that they encourage wasteful local government spending. This criticism is directed primarily at aid programs that provide general purpose dollars to local governments that are not tied to any specific state mandate, such as city local government aid (LGA) and county program aid (CPA).

To some extent, general purpose aid programs do result in higher local government spending. For example, if a poor community with a very small tax base receives state aid, it will almost certainly increase spending on essential services that it could not afford in the absence of state aid.

However, it is not the use of aid by poor cities and counties to pay for necessary services that critics of LGA and CPA have in mind when they complain about wasteful spending. Rather, critics contend that local governments, regardless of need, spend more in the present so that they will receive more aid in the future.

At one point in time, the LGA program did contain features that could conceivably stimulate local government spending. However, these features were purged from the LGA system as part of reforms enacted in the late 1980s and early 1990s. Under current law, a city or county will receive no additional LGA or CPA in current or future years if it decides to increase spending. In other words, the current LGA and CPA programs do not promote unnecessary spending increases, since 100 percent of the cost of a spending increase will be borne by local taxpayers, not by state government.

Since the aid reforms of the late 1980s and early 1990s, real per capita city and county revenues and expenditures in Minnesota have declined in absolute terms and relative to other states, despite the fact that Minnesota has a more extensive state aid system than most other states. Thus, the criticism that Minnesota’s general purpose aid programs stimulate unwarranted spending increases is no longer valid.

The second category of problems with the state aid system pertains to how the system is administered by state government. All too often, state aid appropriations are used as a de facto slush fund that the state can drain in order to solve state budget problems.

Recent Minnesota history provides clear examples of this practice. Most of the state’s financial woes since 2002 have not been resolved by increasing state taxes or by cutting state government expenditures, but by shifting the problem on to local governments through cuts in state aid. From 2002 to 2008 (school fiscal years 2003 to 2009), per pupil state aid to Minnesota school districts has declined by 13.4 percent, while per capita state aid to Minnesota cities and counties has declined by 36.7 percent and 31.3 percent respectively after adjusting for inflation in government purchases.

The magnitude of state aid cuts has had two pernicious effects. The first was an increase in property taxes. From 2002 to 2008, real per pupil school property taxes increased by 47.9 percent, while real per capita city and county property taxes increased by 10.0 percent and 5.7 percent respectively. (The percentage increase in school property taxes since 2002 is exceptionally large because school property taxes payable in 2002 were extremely low due primarily to the state takeover of all general education costs.)

The second harmful effect of state aid cuts was a dramatic reduction in local government revenue. On a statewide basis, local government property tax increases were not sufficient to replace state aid cuts. Consequently, total real per pupil school revenue declined 3.4 percent from 2002 to 2008, while real per capita city and county revenue declined by 11.6 percent and 13.0 percent respectively.

Over the same six year period, real per capita state government revenue-net of the dollars transferred to local governments-increased by 5.6 percent.

Some degree of retrenchment in state aid payments is inevitable when the state experiences a serious budget crisis. However, since 2002 state government has shifted a disproportionate share of the state’s financial woes on to the backs of local governments and local property taxpayers.

Related to the problem of aid reductions is the problem of increasing state mandates without providing the aid dollars to pay for them. For example, in recent years the state has shifted responsibility for incarcerating short-term felony offenders to counties and mandated that counties pay ten percent of the medical assistance costs for nursing homes stays in excess of 90 days for people under age 65.

Shifting the cost of state mandates to local governments without providing the dollars to pay for them has the same net effect as state aid cuts: the state’s financial problems are solved at the expense of local governments and local property taxpayers.

State aid performs valuable functions within Minnesota’s public finance system. The current problems with the aid system are not the result of any inherent flaw of that system, but rather are the consequence of the administration of the system for short-term political gain as opposed to the long-term interest of the state. These problems will be resolved only by pressuring on state leaders to operate the aid system in the manner in which it was intended.