BUDGET BREAKDOWN // A Journal series examining city finances // Part 2

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July 18, 2011
By: Nick Halter
Nick Halter
Four factors that contribute to property tax increases

The city’s budget is more than 600 pages long. The most important information is usually found in the fifth section, titled “Financial Overview.”

If you read that section, the city usually highlights the major financial issues facing Minneapolis and taxpayers. For the past several years, the city has plopped a chart on the first page or two detailing the decline of state aid coming into city coffers.  

While state aid makes up a significant portion of the city budget, it’s not the only factor that has led to tax increases.

The Journal looked at four factors that have contributed to the problem, including cutbacks in state aid.

State aid cuts

When the state created a revenue sharing program for cities in the 1960s, one of the intentions of the program was to help regional centers like Minneapolis pay for services used by people from outside of the city limits.

The city draws people from all over the metro who come to work, attend sporting events, eat at restaurants and drink in bars.

The city paves roads those people use. Its police respond to their calls. Its fire department protects the buildings they visit.

In 2002, the city received from the state $111.6 million in Local Government Aid (LGA). In 2010, the city received $64 million.

Those numbers alone show a $48 million LGA cut. But that’s not the whole story.

If LGA had never been changed and allocations to Minneapolis had never been reduced, the city should have received $136 million in LGA in 2011, if adjusted for inflation.

In real time dollars, the city took a $72 million hit to Local Government Aid.

Most LGA money — 80 to 90 percent — goes to the city’s general fund. The city has a $392 million general fund that is used mostly for police and fire protection as well as for city staff such as assessors, clerks, administrators and inspectors.

In 2001, property taxes provided 19 percent of the city’s revenue. In 2011, that number increased to 27 percent. During the same period, state aid went from providing 14 percent of the city’s revenue to 9 percent.

City officials say Minneapolis is losing out in the current LGA program because it sends more money to the state than it gets back. According to the city, the state of Minnesota will collect $456 million sales and property tax revenue from Minneapolis in 2011.  

“For regional centers, you have the burden of people coming in and using the city services who don’t pay for them,” said Heather Johnston, the city’s management and budget director. “Is it fair? At some point [it was]. Back in 2003, when we had that kind of Local Government Aid, it helped pay for the cost of services for this kind of an overburden.”

Pension costs on the rise

The city will spend almost three times more money this year paying for retired employees than in 2001.

Ten years ago, the city spent $33.2 million in pension-related costs for active and retired employees. Today, that number is $94 million. Back then, pension costs made up 2 percent of the budget. Now they make up more than 7 percent.

The increased costs have been driven largely by three closed pension funds.

The state Legislature in 2010 merged one of those funds, the Minneapolis Employees Retirement Fund, into a state plan.

The other two funds, which provide benefits to retired cops and firefighters, are managed by their own associations, but the city is required by state law to ensure that retirees get the benefits they were promised.

The state expects funds to generate 6 percent annually in their investments, but if the funds generate less than that, the city has to make up the difference. Likewise, if the funds overperform, the city’s contribution will decline.

In recent years, while the economy has tanked, those investments have suffered poor market performance. In 2008, the two plans had negative performances of roughly 29 percent each, driving the city’s contribution higher.

The problem may get worse. The city projects that closed pension costs for all three — which totaled $22.5 million in 2011 — will increase to $40 to $45 million annually for the next four years.

That’s why the city has made pensions its top priority in the state Legislature. During the 2011 session, the city lobbied hard to have two of its closed pension funds merged into a state fund that would lower administrative costs, increase the state’s projected investment returns and allow the city more time to fund the plans. Additionally, the state plan has a lower cost of living adjustment.

It costs almost $2 million to administer pension plans for about 1,400 retired cops and firefighters last year. That’s an average of about $1,400 per retiree, whereas retirees in the city’s active retirement plan that is managed by the state costs only about $23 per retiree.

The city estimates that merging the closed funds into the state plan would save Minneapolis taxpayers $20 million in 2012.

High employee costs

Ten years ago the city had a 483-person fire department and a 1,183-person police department. Today, those two departments staff 406 and 992 people,
respectively.

Those two departments today have higher personnel costs while employing fewer people than in 2001. The fire department employee budget has increased from $33 million to $44.5 million. The police department employee budget went from $76.7 million to $101 million.

Based on city stats from 2001 and 2011, compensation packages have increased heavily for public employees. The average compensation package for a fire department employee has increased from $68,000 a year in 2001 to $110,000 in 2011.

Police employees’ average compensation has increased from $65,000 to $107,000. Public works employees have increased from $65,000 to $90,000.

That’s not to say all that money is going into the pockets of public employees. In fact, the city’s health insurance costs have more than tripled since 2001, going from $19.4 million to $57.8 million.

“The biggest piece of that increase is going to be the health care cost increases,” Johnston said. “We were getting 16 to 20 percent increases annually.”

The city pays almost 90 percent the health insurance costs of its employees. For example, a single employee on a basic plan pays $40 a month while the city pays $372. For a family, the city pays $1,297 while the employee pays $138.

Homes suffering higher burden

The Legislature in 2001 changed the property tax system in order to lessen the burden on commercial property. The state lowered the commercial tax capacity to 1.5 percent for property valued under $150,000 and to 2 percent for property valued over $150,000. The rates in 1997 were 3 percent to 4.6 percent.  

At the same time, the state enacted the Limited Market Value law. Simply stated, the LMV law cushioned tax increases to homeowners by allowing home values to increase without requiring homeowners to pay taxes on all of their market value increases.

While home values skyrocketed in the mid-2000s (on average, home values in Minneapolis increased by 16 percent annually between 2002 and 2006), property tax bills did not skyrocket with them, because the LMV protected against major taxable value hikes. In other words, homes were being taxed for less than they were worth.

The problem, however, is that the LMV law was not permanent, and the state phased it out completely in 2009. That meant that homes lost their protection in the late 2000s and were forced to pay a higher share of the city’s tax levy.

In 1997, residential property taxpayers paid 33 percent of all city taxes. In 2011, residential taxpayers paid 56 percent of taxes. In a city like Minneapolis, where there is a much larger commercial sector than the suburbs, shifting the tax burden hit homeowners harder than elsewhere.

“Its like a balloon. If you squeeze it down on one side, it’s going to pop up on the other,” said Carol Becker, an elected member of the city’s Board of Estimation and Taxation. “If the city wants a (certain amount of money) and the commercial sector is going to contribute less, that means that homeowners have to contribute more.”

About this series

The Journal’s Budget Breakdown series is a project designed to help readers better understand how the City of Minneapolis’ budget works. The multi-installment series will look at property taxes and spending from several different angles.

    In August, Mayor R.T. Rybak will release his 2012 budget recommendation and the City Council will vote on a budget in December.

    The next installment of the series, to be published in the Aug. 1–14 edition, will answer questions from community members about the city budget. How much do City Council members earn? How much does the city spend on the Target Center? What is the Civil Rights Department and what is its purpose?

    The Journal welcomes questions from readers. If you have any questions about the budget and property taxes, send them to Nick Halter at nhalter@mnpubs.com. We also welcome your letters to the editor.