The basics of local government aid in Minnesota

Minnesota cities are bracing once again as policymakers deal with the state's long-term budget imbalance. For several years, local governments have seen state dollars shrink, and this year may bring more of the same.

Some city officials have argued that more state cuts will be too painful. But many also acknowledge that some kind of "new normal" has emerged. Bumpier roads and less policing may be inevitable; so might higher property taxes.

But there are also conversations about using volunteers more extensively, collaborating with other communities more intensively and thinking anew about what communities really want to do for themselves.


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To delve into how the slumping economy and state budget woes have forced cities to tighten their belts, it helps to have a basic understanding of the process of local government finance.

Cities are operating in 2011 under budgets that councils and mayors established in December. For most Minnesota cities, those budgets included expectations that they would receive state dollars under programs known as Local Government Aid and Market Value Homestead Credit.

In many places, city councils and mayors and staffs performed a delicate dance around how much to rely on that money, perhaps designating for things that would hurt less if the money disappeared this year.

The Minnesota Department of Revenue has given each city notice of how much it can expect in 2011 in Local Government Aid, the larger of two main kinds of state aid.

It's important to note here that a little over 10 percent of Minnesota cities do not receive LGA money. For the cities that do, it can be anywhere from a small amount to two thirds of their budgets. For most cities, state aid makes up less than 50 percent of all that they spend on police, streets, parks, animal control and other services.

But almost no one expects that the Minnesota Legislature will be able to get rid of a $6.2 billion biennial budget deficit without touching aid to cities and townships. Under existing plans, before any action by the 2011 Legislature, the state is slated to provide $527 million in local government aid.

In addition, factors beyond state aid, like the economy and political mood, are contributing to the financial strain on local officials.

While these forces are combining to make life difficult for city officials, some argue that reducing state help for cities makes residents feel the true cost of their local services and forces them to make better decisions about what they truly can afford.


Where it comes from:

Glance over any city budget and you'll see the money comes in from many places.

- The traditional source and usually the largest is property taxes. Overall, this accounted for 35 percent of city revenues in 2008, and budgets submitted to the state auditor show that figure has almost certainly risen since then.

- Aid from the state (collected largely from sales and income taxes) is often the second largest source; in some cities it is the largest.

- A variety of other sources, from water and sewer fees to liquor store profits to speeding tickets, make up the rest.

Here's the long-term squeeze for residents: Over the past decade or so, the portion coming from property taxes has risen 37 percent and the portion coming from the state and other governments has fallen 25 percent.

These two trends have combined to result, after adjusting for inflation, in a 7-percent decline in Minnesota cities' revenue between 1999 and 2008, according to the state auditor, even as property taxes were rising.

Another way to see the trend is to look just at the past year. For all cities with more than 1,000 residents, property tax levies increased by $69 million. At the same time, the amount cities received from the state dropped by $259 million, according to the Minnesota Department of Revenue.

Cities going to the property tax well for relief already know that revenue source is strained. Now even commercial property values are declining, which means the burden will shift to homeowners to pay more of the total tax.

Homeowners already are noticing bills on which assessments are declining but taxes are rising. Even though home property values appear to be stabilizing, cities are still worried.

"Clearly they are concerned about going to the property taxpayers for huge increases. But I think there are also long-term concerns about the viability of the property tax as the major revenue source for funding local services," says Rachel Walker, manager of policy analysis at the League of Minnesota Cities.

More detail on property tax trends by the League of Minnesota Cities.

Cities also raise money through a variety of fees and other service charges -- everything from selling maps at city hall to golf course fees -- and overall these represent from 10 to 15 percent of cities' revenue.

The big three of these other revenue sources -- general government fees like rental of city property, public safety contracts and park and recreation fees like golf and pool admission fees -- all have been rising in recent years as cities jack up charges.

One source isn't as big as some might think: speeding tickets and related fines and forfeitures add up to only about 1 percent of all cities' revenue in Minnesota.

Where it goes:

Just as revenue declined 7 percent in 10 years, so did spending, when adjusted for inflation. So where were the sacrifices communities made in terms of the service residents received?

Of all the services that cities provide, public safety is the big cost, some 25 percent of all city spending in Minnesota. From 1999 to 2008, spending on public safety actually rose, even after adjusting for inflation.

But next in line are a foursome of expense categories -- streets and highways, culture and recreation (parks, libraries, ballfields) general government (administrative costs, salaries, maintenance) and housing and economic development.

Spending in all four of these areas has declined over 10 years, according to the state auditor.

Also telling is another way to look at the spending, that is, in terms of when residents might see a payoff. Money spent on so-called "current operations" rose 14 percent over the 10 years after adjusting for inflation. But spending on capital projects -- typically longer range investments for the future -- fell 33 percent and spending on debt dropped 13 percent.


The biggest driver in the angst cities are feeling is the recent history of reductions in state help for cities and the expectation that more cuts are on the way.

State aid to cities comes in two forms: local government aid, the larger of the two, and market value homestead credit reimbursement.

Local government aid, sometimes called LGA, was designed to help cities that have greater needs than what they could reasonably cover in property taxes. The cities that came to depend on LGA also tended to serve as regional hubs, providing services for people not paying into property tax coffers. The vision was that no matter where you happened to live in Minnesota, the quality of services would remain basically constant.

As mentioned, not all cities receive local government aid, and some manage to do without the aid they once received. The city of Hanover, for example, places any aid it receives into a fund to pay for capital improvements. That way if the state-sourced revenue falls short, projects can be delayed or paid for with debt, but current operations are unaffected. How much a city receives in local government aid depends on a complicated set of formulas. It basically builds on a per capita base, for example, $8.50 for smaller cities, those under 2,500 population. Larger cities might receive an aid base that depends on jobs per capita. Since LGA amounts are supposed to bridge a gap between needs and ability to pay, a city's needs are determined by taking into account things like older housing stock, population declines and household size. There are lots of other factors than those three.

You can find a fuller explanation called LGA 101 at the League of Minnesota Cities website.

Above all, cities that receive LGA have to consider that the aid amount may change between the time they receive an estimate at the end of July and when they actually receive the money in July the following year.

In between those dates, cities set levy amounts in September and pass final budgets in December. Added to the difficulty is that cities operate on a calendar year, the state on a fiscal year.

In July, the Minnesota Department of Revenue certified a total LGA amount of $527,100,646. But many, if not all, city managers expect that amount will be cut when the Legislature returns in January and has to close an expected $6 billion budget gap.

The second form of state aid, market value homestead credit, is not actually an aid per se. The credit is given to the people who pay taxes on homestead properties and appears as such on their property tax bills. The cities receive a reimbursement from the state to bring them up to the amount they anticipated raising with the levies they set. The state nevertheless viewed the MVHC reimbursement as a fund to cut to help balance the budget. The legislature cut $25 million from the original $82 million for 2011.


Historically in Minnesota, local governments relied heavily on local property taxes to pay for the services they provided. In the 1960s, however, as some communities grew rapidly and demand for services rose, concern grew that such vehicles as local income taxes and local sales taxes would result in great disparity among haves and have-nots.

As a result, the nationally remarked-upon "Minnesota Miracle" was instituted in the 1970s. The state restricted cities from levying local sales and income taxes and, on the other hand, started supplying substantial amounts of state money for cities to meet increasing demand for services.

Stated simply, Minnesota's system aims to keep a lid on property taxes but nonetheless allow cities to provide residents with the services they need. It has done that by spreading money the state gets from income and sales taxes. It is that nearly 40-year-old arrangement that seems to be evolving.

You can find a brief history of the Minnesota Miracle compiled by Strong Towns blog.