Government in Minnesota is shrinking, but not as one would expect. After adjusting for inflation in the price of government purchases, total per capita state and local government revenue in Minnesota has declined by 2.9 percent from fiscal year 2003 to 2008.
Even more striking is how this contraction in public revenue has occurred. The shrinkage in government over the last five years is not the result of cuts in the state budget imposed by “no new tax” state leadership. Rather, the decline in revenue has occurred primarily among Minnesota counties, cities, and schools as the impact of state revenue shortfalls were shifted on to local governments through cuts in state aid and state-paid property tax relief.
Editor’s note: Today Minnesota 2020 welcomes Jeff Van Wychen as our newest fellow. Jeff will be focusing primarily on property tax and state and local budget issues for Minnesota 2020. Click here to read his bio.
Fiscal year 2003 is a milestone year in public finances. Not only is it the first year of major changes in the property tax system—including the state takeover of general education funding and the elimination of the general education property tax—but it was also the last year before the ascendance of Governor Pawlenty and the “no new tax” agenda.
At first glance, it might appear that state government is shrinking. After all, from 2003 to 2008 total state government revenue declined by $268 per capita. (All amounts are in constant 2008 dollars.) However, the cut in state aid to local governments over the same period is $497 per capita—far more than what was needed to make up for the $268 per capita decline in revenue. Revenue retained by state government after netting out cuts in aid to local governments actually increased by $229 per capita from 2003 to 2008.
These numbers tell a story that is not widely understood. State government revenues have certainly fallen since Governor Pawlenty came to office, but the revenue loss has been dealt with by cutting state aid shared with local governments, not by reducing the revenue retained by state government. Total real per capita revenue retained by the state has increased by 7.1 percent under the tenure of Governor Pawlenty.
This, of course, means that the real burden of dealing with declining government revenues has fallen upon local governments, not state government. The graph below shows the percent change in real per capita revenue or—in the case of school districts—per pupil revenue from fiscal year 2003 to 2008 for various levels of government in Minnesota. For state government, retained revenue (total revenue minus aids to local governments) is shown. Fiscal years 2003 to 2008 correspond to calendar years 2002 to 2007 for counties and cities.
Total government revenues have indeed fallen since Governor Pawlenty came to office, but the pain of budget cuts have been borne by local governments, not state government.
To the typical taxpayer, these findings may seem counterintuitive. Haven’t school, county, and city property taxes been increasing since 2003? If so, shouldn’t local revenues be increasing?
Local property taxes certainly have increased since 2003, but the increase in property taxes has not been sufficient to replace the decline in state aid. Consequently, real per capita revenue of counties and cities and the real per pupil revenue of school districts have fallen.
The graph below provides an illustration of these trends for Minnesota school districts. The first bar in the graph represents the per pupil decline in state aid from 2003 to 2008. The second bar represents the increase in per pupil revenues from property taxes and other sources. The difference between the two bars represents the net loss of revenue.
State aid to Minnesota school districts has fallen by $1,118 per pupil over the last five years, while school property taxes have increased by $633 per pupil and all other school revenues increased by a net of $41. Because the revenue increases were not sufficient to offset the aid losses, total real per pupil school district revenue has declined by $445 or 3.5 percent. In this way, school property taxes have risen at the same time that school revenues have fallen.
Counties and cities show a similar pattern. Real per capita property taxes have increased, but this increase has not been sufficient to offset the large cuts in state aid. Consequently, real per capita county and city revenues have declined.
Whether the decline in government revenues is beneficial or detrimental to Minnesota’s economic vitality and quality life is a complicated question that will not be addressed here. However, the shrinkage in government revenue over the last five years underscores some curious features of the state-local fiscal relationship in Minnesota:
1. While real per capita state and local government revenues in Minnesota have been declining, the decline has not been evenly distributed between state and local governments.
2. Governor Pawlenty and his “no new tax” allies have succeeded in holding down state taxes. However, this has been achieved by shifting the burden of dealing with revenue shortfalls to local governments and local property taxpayers through state aid reductions. In this way, the various state aid appropriations serve as a de facto reserve fund for state government.
3. As a result of these aid cuts, local governments have been forced to cut spending for public safety, increase class sizes, postpone investments in roads and infrastructure, and make other reductions in public services. Meanwhile, state leaders manage to avoid the need to make comparable cuts in state spending.
4. In what can only be regarded as a system of tortured accountability, the levels of government that have shown the most fiscal restraint—local governments—must increase taxes, while the level of government that has shown the least fiscal restraint—state government—manages to avoid significant tax increases. Minnesota has established a system in which state government monopolizes the income and sales taxes. This allows state government to generate more revenue than is needed to fund the functions of state government. The justification for the state monopoly of sales and income taxes is that the state will share the revenue it generates with local governments in an effort to hold down regressive and unpopular property taxes.
However, this seemingly benign arrangement has morphed into a strange and complicated beast. In the hands of “no new tax” devotees, aid payments to local government function as a slush fund that can be raided in order to compensate for state revenue shortfalls and to avoid the need for a state tax increase. Meanwhile, local governments must cut services and reduce investments in infrastructure and citizens must pay higher property taxes.
It is time for Governor Pawlenty and other state leaders to administer the state aid system as it was intended—as a way of sharing state income and sales tax revenues with the local governments in order to hold down property taxes—and not as a political tool for forcing local governments to make the hard fiscal choices that state leaders do not have the courage to tackle.
*All revenue amounts in this paper are derived from the November 2007 forecast Price of Government report and are adjusted for inflation using the implicit price deflator for state and local government purchases. Population and pupil unit data for conversion to per capita and per pupil amounts are derived from estimates and projections prepared by the State Demographer’s Office and the Minnesota Department of Education.