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Let's Talk: What’s Up with LGA Reform?

A discussion with Eric Willette, property tax research director with the Department of Revenue.

The 2013 omnibus tax bill, passed into law as Chapter 143, included some major changes to local government aid (LGA) for cities. The total LGA appropriation was increased by $80 million starting in 2014, and the LGA formula was also revised. Minnesota Cities talked with Eric Willette, property tax research director with the Minnesota Department of Revenue, to get the details about these changes.

Minnesota Cities: Describe the status of the LGA program prior to the 2013 legislative session. What were some of the major issues or problems?

Eric Willette: Years Eric Willette, property tax research
director with the Minnesota Department of Revenue, sits outside the MN Capitol near a pot of pink flowers.of legislative cuts and gubernatorial unallotments (cuts to appropriations that were previously enacted), many of which occurred in the middle of cities’ budget years, made the program unreliable. Cities were unable to budget thoughtfully or to effectively use LGA for property tax relief. The formula was considered unpredictable because, under the old formula, many cities’ need measure changed significantly from year to year. The formula was also thought to be too complicated. Most state and city officials had a hard time understanding the formula or explaining it to citizens. Funding for LGA was considered to be inadequate by many state and local leaders. State cuts and inflation had reduced LGA from 35 percent of city revenue base (levy plus LGA) in 2002 to 18 percent in 2013. The loss of LGA was especially acute among older metropolitan suburbs and the Twin Cities.

MC: When was the last major reform to the LGA program implemented?
EW: The formula was 10 years old and needed to be updated. Years of cuts had reduced the amount of LGA and distorted the distribution among cities. Returning to the old formula at the post-cut appropriation level would have caused significant shifting of aid among cities. Additionally, a decade of increasing property taxes and city budget cuts had created broad support among state officials for reforming LGA.

MC: Describe the groups charged with working on LGA reform issues over the last couple of years (i.e., who served, goals/purpose, work completed, recommendations).
EW: The 2008 tax bill established the Local Government Aid Study Group comprised of legislators and city officials. The group met intermittently through 2012 and made several recommendations, including re-examining the special appropriations for individual cities; looking for a formula that takes into account how service needs and available revenue sources differ between cities; looking for stable formula factors; and increasing the stability of the appropriation so cities can rely on the aid amounts certified to them.
In February 2012, Gov. Dayton announced the formation of the Mayors Tax Reform Advisory Group on Local Government Aid, comprised of 15 Minnesota mayors, to advise the administration in its efforts on tax reform. The advisory group met six times and explored the history of LGA and the recent fraying of the state and local fiscal relationship. The group focused on the need to simplify the formula, increase the stability and predictability of the distribution, and increase the funding level. Because of the group’s work, the governor recommended an $80 million increase in the LGA appropriation and a new simplified formula in his budget proposal to the 2013 Legislature.

After the release of the governor’s budget, a group of legislators, legislative staff, and city representatives met to create an alternative distribution formula. After several weeks of intensive meetings, they came up with the formulas that ultimately were enacted into law. They had also recommended bringing back the automatic inflation adjustment to the LGA appropriation, but that was not included in the final legislation.

MC: What were the major changes enacted during the 2013 session?
EW: Chapter 143 created new LGA distribution formulas and increased the appropriation. It also eliminated the sales tax on most city and county purchases; increased aid to counties and townships; increased property tax refunds; decreased school levies; and imposed levy limits on cities with populations over 2,500 and counties with populations over 5,000 for taxes payable in 2014.

MC: How much LGA will cities receive going into the future?
EW: The program increased the total LGA amount from $428 million in 2013 to $508 million in 2014, $509 million in 2015, and $512 million in 2016 and thereafter.

MC: Will the system still compare a city’s need with its ability to pay?
EW: Yes. The LGA formula estimates how much revenue each city needs to provide an average level of core services and how much property taxes it can raise locally.

MC: How will the new system define city need? Ability to pay?
EW: Revenue need has three different formulas based on city size:

  • For small cities (population less than 2,500)—need per capita is based solely on city size.
  • For medium sized cities (population between 2,500 and 10,000)—need per capita is based on (1) percent of housing built before 1940, (2) household size, and (3) population decline from a city’s peak population in the last 40 years.
  • For large cities (population over 10,000)—need per capita is determined by (1) percent of housing built before 1940, (2) percent of housing built between 1940 and 1970, (3) number of jobs per capita, and (4) a sparsity adjustment for cities with a population of less than 150 per square mile.

For Transition cities (population 2,500 - 3,000 and 10,000 - 10,500) need per capita is based on a blend of two formulas.

  • Ability to pay: The city’s tax base (adjusted net tax capacity) times the average city tax rate. All cities have some capacity to generate revenue locally to support service needs. This measure is the same as in the old formula.
  • Unmet need: Revenue need minus ability to pay. Those cities whose property tax wealth does not exceed their revenue need are eligible to receive local government aid. The new LGA formula distributes additional money based on the gap between a city’s unmet need determined by the LGA formula and its aid in the previous year. Additional money is the amount of appropriation that exceeds the previous year’s appropriation plus any money available to be redistributed from cities whose unmet need is less than their previous year’s aid.

MC: The LGA system has been criticized for being too volatile. How do the reforms address that issue?
EW: First, the new formula factors Line graph showing total LGA paid to cities in millions from 2008-2016 will change gradually over time for most cities. In contrast, some of the old factors could change dramatically from one year to the next.

Second, the new formula does not redistribute all the aid through the formula each year as the old formula did. Instead, it uses a distribution mechanism called the Aid Gap Percentage. Here’s how it works: If a city’s unmet need exceeds its aid amount received in the previous year, the city is eligible to receive the amount it received in the previous year plus an increase in LGA if the total appropriation increases from the previous year. Any increase in appropriation is distributed in proportion to each city’s share of the total unmet need above the aid amount in the previous year. Cities whose previous year aid exceeds their unmet need receive a decrease in aid from the previous year. In years where there is no new money being added to the program, there will be very little change in most cities’ aid.

MC: The LGA system has also been criticized for being too hard to understand. How do the reforms address that issue?
EW: For cities under 2,500 in population, need is determined solely by their population. For larger cities, there are three or four variables to determine need, but the variables that were most confusing were eliminated.

MC: Will there be protections against big year-to-year changes for cities?
EW: Yes. No city may receive less aid in 2014 than their 2013 amount. In future years a city’s aid may decrease if its current aid exceeds its total unmet need. Decreases are limited to the lesser of 5 percent of the city’s levy in the previous year or $10 per capita.

MC: Where can cities go for information on their aid payment amount?
EW: The department certified 2014 LGA amounts in July, and notices were mailed to all cities. A table of LGA amounts for all cities is available at http://bit.ly/1ciiYJS.

Read the September-October 2013 issue of Minnesota Cities magazine

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