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October 22, 2006
Property Taxes and School Funding
Completing the 2006 Citizens League Property Tax Review led me much further down the path of education property tax levies than I ever set out to explore. It is with good reason that I have not previously ventured into the most complex area of fiscal policy in Minnesota. An analysis of property taxes can reveal shifts and areas of growth in the use of property taxes, but cannot answer questions about education funding, need and accountability.
Beginning with the creation of a state sales tax in 1960s, Minnesota's state-local fiscal system has been most intimately tied together in the area of funding K-12 education. In fact, a great deal of early Citizens League work was focused on devising methods to provide fiscal equity for important public goods such as K-12 education (see the report "New Formulas for Revenue Sharing in Minnesota" from 1970 that laid much of the fiscal groundwork for the so-called Minnesota Miracle).
Over the last three decades Minnesota has consistently struggled with the best ways for the state to be responsible for public education as required in the state constitution and the best ways to keep property taxes in check (particularly for homeowners and farmers; more recently for businesses and cabin owners). The property tax reforms of 2001 are another major marker in this ongoing policy struggle.
What can we conclude from an analysis of the property tax side of the equation? After the vast majority of homeowners did receive property tax cuts in 2002, the state share of education funding stood at about 87 percent. This historic high was achieved through a large infusion of state money at the tail end of a remarkable period of economic growth. Since that high point, the state share of education funding has consistently moved downward and stands at 80.5 percent in 2006. This is still significantly above the 72 percent share that the state funded in 2001, but if there is a threshold that the state should not sink beneath, I would argue that 80 percent is it.
The 2002 high point in the state share of K-12 education was accompanied by a major restructuring that sought to contain future increases on commercial-industrial (business) and seasonal-recreational (cabin) properties by creating a state property tax to for these property types. In exchange for paying property taxes to the state, seasonal-recreational property owners are exempted from school operating referenda and commercial-industrial property pays on equal footing with homes (market value levies) for school operating referenda. There is no direct connection in law (or the constitution) between property taxes paid to the state and education funding, yet a clear part of the change was a greater commitment in state education funding via the "takeover" of the K-12 general education levy.
If the state continues to decrease its share of education funding, the result will clearly be felt by homeowners to the degree that they approve market value levies for school operations (74 percent of such levies were approved in 2005) and to the degree that the state allows market value levies to continue without voter approval. The key question here is how well can a new level of accountability between school districts and property taxpayers be established unless there is a clear, stable share of funding from the state? Citizens must already try to understand an extremely complicated funding relationship between the state and their school district, let alone get a good sense of how efficiently their schools are spending tax dollars.
If the 2001 reform also sought to permanently reduce the share of property taxes that fund education, that gain has also eroded since 2002. School funding was 38 percent of net property tax revenues statewide in 2001. After reform, that dropped to 21.5 percent in 2002. Counties were at 33 percent, cities at 21.4 percent and the new state property tax was 12.7 percent of net property tax revenues. By 2006, the school portion of net property taxes rose to 25.7 percent, while the state property tax has dropped to 10.5 percent, counties have dropped to 31.5 percent and cities have risen slightly to 21.8 percent (see Net Property Tax Revenues by Type of Jurisdiction, House Research).
Of the $614 million increase in school property taxes from 2002 to 2006, more than $330 million are levied on market value, which more strongly impacts homeowners than other property taxes. About $246 million of this is voter-approved, but the state has also dubiously allowed $84 million in market value levies to continue without voter approval in order to avoid cuts to some school districts while state finances were tight (see the K-12 Education Finance Conference Committee spreadsheet from the House Fiscal Analysis Department and look at lines 7, 9 and 16 that are titled Transition, Equity and Referendum). Such action by the state further obscures the intended relationship between homeowner property taxes and school operating referenda.
Has the 2001 reform been successful? It is tempting to draw conclusions, but the jury is still out in my view. There has clearly been a shift toward homeowners in overall property tax burden, but part of that shift has been due to the extraordinary market value increases in residential homestead property. The "bubble" created by market value increases on homes was not accompanied by a similar bubble in commercial-industrial values. The stage may be set for a rise in commercial-industrial property values while residential values are flat, and a corresponding shift in taxes.
The other major factor is the state share of education funding and how often school districts will go to their voters for operating referenda in lieu of state funding. Market value levies for school operating began in the early 1990s when the state class rates for different types of property varied widely. The reforms of 2001 were the most final most significant step in "compression" of these rates. If the state share of education funding continues to decrease from current levels, policymakers should examine whether future operating referenda for school should continue to be levied on market value, or if a return to net tax capacity (where the state class rates are applied) is in order for those levies.
This view from the property tax side of the equation does not address the difficult issues inherent in determining need in school funding: The cost of unfunded mandates, the efficiency of school district administration, and the management of either declining or increasing enrollments.
Posted by Bob DeBoer at October 22, 2006 9:33 PM