Why send state dollars to local governments?

Dollars transferred from state government down to local governments, commonly referred to as “state aid,” is a component of the state-local fiscal system in all fifty states. This is particularly true in Minnesota, where state aid comprises 38 percent of total local government revenue. Local government dependence on state revenue is greater in only four other states.

Given that dependence, let’s address why we have such a system in the first place.

First, state aid payments are made to local governments to pay for state-mandated services. The most well-known and largest state mandate is K-12 education. The Minnesota constitution charges state government with establishing “a general and uniform system of public schools.” The legislature requires school districts to fulfill this function and has traditionally provided most of the necessary funding.

More so than in other states, counties in Minnesota act as the arm of state government in carrying out mandates in health and human services and corrections. These areas consist of just over half of county current expenditures based on data from the Minnesota State Auditor. A large portion of those dollars go to state mandated health and human service and correction costs.

Minnesota cities are also subject to state mandates in environment, public safety, employee relations, transportation, general government, and record keeping areas. For example, the state requires Minnesota cities to meet expensive waste water treatment and drinking water standards. Many state mandates that apply to cities also apply to counties.

Second, state aid is used to help “equalize” the ability of local government to generate revenue. Local governments around the state vary tremendously in the amount of wealth and the size of tax base. For example, per capita income and local tax base in Appleton, a city of 2,700 in western Minnesota, are respectively one-half and one-third of the statewide average. Residents of Appleton could not provide public services comparable to that of other Minnesota communities if they had to rely entirely on local resources.

Urban core cities, older fully developed suburbs, and greater Minnesota regional centers generally have higher public costs due to crime and other social problems, older infrastructure, and the fact that large populations enter these cities on a daily basis to work or take advantage of other city amenities such as hospitals, schools, and recreational activities. The local tax base is often not adequate to pay for the higher cost of providing public services within these communities.

Aid programs established by the Minnesota legislature provide state assistance to counties, cities, and school districts based on variations in local tax base and revenue need. Under these programs, aid dollars are sent primarily to jurisdictions with relatively low tax base and high public costs. In this way, state aid dollars are used to equalize the revenue raising capacity of local governments.

The third reason for establishing a state aid system is related to the first two. State government provides aid to local governments in order to reduce dependence upon unpopular and regressive property taxes. As noted previously, the property tax is a regressive tax, meaning that it takes a larger bite from the pocket books of low and middle-income families than from high income families. In addition, property tax burdens often increase without a commensurate increase in taxpayers’ ability to pay.

In the early 1970s, state government addressed a mounting property tax revolt by transferring more state revenue to local governments so that property taxes could be reduced. The legislature enacted an array of new programs, including an expanded school aid equalization formula, aid programs for counties and cities, and the homestead credit. These programs-referred to collectively as the “Minnesota miracle” and funded with dollars generated by state income and sales taxes-successfully reduced property taxes across Minnesota.

Early in the current decade, the legislature again reduced property taxes by fully funding general education expenses for public schools with dollars from the state general fund, thereby eliminating general education property taxes. In the first year of the state general education takeover (fiscal year 2003), three-quarters of total school revenue was provided by state government according to data from the Price of Government report from the Minnesota Department of Finance.

In exchange for state aid, local governments are largely prevented from collecting income or sales taxes. (A handful of local governments collect sales taxes, but these are generally for limited purposes and of limited duration and at rates determined by the legislature.) By precluding local access to all major taxes except the property tax, the “Minnesota miracle” made local governments largely dependent upon state aid.

The State of Minnesota effectively monopolizes income and sales tax collection in Minnesota. The justification for this monopoly is that the state uses the dollars generated from sales and income taxes to provide aid to local governments to pay for state mandates, equalize the ability to local governments to generate revenue, and reduce property taxes. In the absence of state aid programs, the rationale for the exclusive state control of income and sales tax collections evaporates.

State aid programs address legitimate policy goals. However, this is not to say that aid programs function without a hitch.