Meeting Summary
- August 1, 2008

Minnesota’s property tax system – with 75 different class rates, more than any other state – may well be the most complicated in the nation.

And that complexity makes the system difficult to oversee while contributing to its unpopularity with taxpayers, according to Property Tax Research Director Eric Willette.

“There are a lot of bells and whistles that add complexity to the system,” Willette said in an Aug. 1 presentation to The Governor’s 21st Century Tax Reform Commission.

The 15-member panel was appointed by Gov. Tim Pawlenty to examine ways to improve Minnesota’s tax climate for businesses and encouraging economic growth. The group’s final report and recommendations, must be revenue-neutral, are due by Dec. 1.

Complex equation

Dating back to Minnesota’s territorial days, the local property tax is a stable source of revenue for local governments and special districts that depend on it – but less so for taxpayers. In a recent Department of Revenue survey, only 35 percent of respondents were satisfied with the predictability of their property tax bill.

Taxes in Minnesota (and elsewhere) are rarely (if ever) popular with those who pay them. But the property tax is highly visible, uncontrollable and hard to understand for many taxpayers, making them particularly hostile to it, Willette said.

The “black box aspects” of the tax – which is based on a complicated blend of geography, class rates, assessments and local rates that can vary each year – makes it seem less open than sales or income taxes and leads to mistrust among taxpayers. That complexity, with more than 6,200 possible rates in Minnesota, makes the property tax expensive to administer and often onerous for businesses and other taxpayers.

“From the business perspective, it is a difficult environment,” said Corey Haaland, vice president and treasurer of Target Corp., and a member of the tax commission. “It is burdensome [and] more complicated than every other state Target operates in.”

In its simplest (and largely theoretical) form, the property tax is a simple equation: Multiply the assessed value of a parcel by the tax rate to get the parcel tax. In practice, however, Minnesota’s assessment and classification system – combined with a long roster of exemptions, abatements and targeted tax breaks – is more complicated.

Each county assigns a “market value” (based on annual assessments) and identifies a “use class” (property type) for every parcel within its border. The state tax code sets a “class rate” for each type of property. The main categories are residential homestead (private home), other residential (usually an apartment), business, farm or cabin, with a number of subdivisions based on value and specific uses of the property.
Multiplying the market value of a parcel by the appropriate class rate yields its “tax capacity,” a feature that is unique to Minnesota’s system.

Local property tax rates are not constant. Each year, local governments and other tax district authorities hold a series of public hearings after which they certify their total property tax levy. Each district’s property tax rate for the year is determined by dividing that levy amount by the district’s total tax capacity.

The final tax rate for a parcel is determined by adding up all the rates for the city or township, county, school district and any special districts – such at mosquito control districts or regional authorities like the Met Council – in which it resides. Finally, the parcel’s tax capacity, multiplied by its tax rate, yields its final property tax bill.

But there several other wrinkles that can complicate the tax calculation for a given property:

Déjà vu?

The history of the property tax in Minnesota is one of tradeoffs and repeated tinkering, generally aimed at reducing the tax at the local level. Eventually, that tax tends to go back up.
In 1972, the so-called Minnesota Miracle bought down local property taxes with increased aids to schools and other local governments from the state in exchange for more state involvement at the local level. The state sales and income taxes were raised to pay for the switch.

As intended, local property taxes declined sharply. In 1971, property taxes comprised more than 42 percent of state and local tax revenues. By the early 1980s – when the impact of the Minnesota Miracle peaked – property taxes were down to less than 24 percent of tax revenues, Willette said.

The state’s property classification system shifts a larger burden onto commercial and industrial (C/I) and apartment properties from homes and farms. In 1997, for example, C/I properties (which comprised 15 percent of total market value) paid 35 percent of the net property tax, while homesteads (at 58 percent of total market value) paid 41 percent of the property tax and farms (at 15 percent of market value) paid 8 percent of the property tax.

Later changes to the class rates reduced that disparity, and the 2001-02 reforms compressed class rates even further.
Those reforms – former Gov. Jesse Ventura’s “Big Plan” – were another attempt by the state to buy down local property taxes, which had increased since the early 1980s to 29.3 percent of total taxes.

Under the reforms, the state assumed responsibility for local school funding, which brought a dramatic decrease in local property taxes. A new state property tax on C/I and vacation properties partially offset business tax reductions that resulted from lower C/I class rates. Proceeds went into the general fund to help pay for the state’s new education spending commitment.

Property taxes were reduced by $1.4 billion, although they have increased since 2002 for a variety of reasons, Willette said. Minnesota property taxes now rank 28th per capita and 35th as a percentage of personal income among all states and Washington, D.C. This is down sharply since 2001 (before the reforms took effect), when the state ranked 15th-highest per capita, and 24th highest as a percentage of personal income.
School, city and county property tax levies have risen more sharply in recent years than prior to implementation of the Big Plan, with many of them approaching their pre-Big Plan levels, Willette said. School district referendums approved by voters account for much of that increase; other local levy increases are also a factor. Local officials say the increases are necessary because state funding hasn’t increased enough to meet their needs.

“Has the ability of local governments to increase their levies defeated the Big Plan?” asked Mike Vekich, chairman of the tax commission.

It’s hard to say, Willette responded. Local levying authority is often limited by legislative caps, he said, including a three-year cap that just took effect.

In addition, local government aids were curtailed during the 2003 budget crisis, and the stagnant economy hasn’t helped. Finally, the state has struggled to meet its school funding commitment and education aids have grown more slowly since the reforms. “The state maybe overextended itself,” he said.

Hard to live with, harder to change

Minnesota’s complicated property tax code – with a number of exemptions, exclusions, abatements, credits and other incentives – poses difficulties for businesses and for tax officials.

The “dizzyingly complex” rules make it frustrating to navigate for businesses that crave predictability and simplicity to aid financial planning and help control administrative costs. The system is also inefficient and expensive to administer for governments and tax officials.

The long roster of special provisions can undermine the system’s legitimacy with taxpayers, since similar properties can end up with very different property tax payments, depending on where they are located.

Assessing business properties in a uniform, accurate way is a challenge, too. The C/I real estate market tends to be volatile, with infrequent sales in many areas and few comparable properties to help determine market values.

Since the Big Plan reforms, business property taxes make up a lower percentage of total property taxes, but class rates for business properties remain high compared to homesteads, and in relation to other states.

Currently, a $300,000 C/I property pays about 2.3 times the net tax of a $300,000 homestead, Willette said. Business properties also pay higher property tax rates in most other states, he said, but Minnesota is still near the high end of the spectrum. Minnesota’s ratio of 2.3 times is 12th highest among the states for taxes on commercial properties, for example, and 20th for industrial properties (although those with a higher proportion of machinery and other personal property fare better).

A high reliance on property taxes at the local level makes it difficult to provide relief for business without affecting other property types. Cutting the class rates for business properties, for example, would result in higher taxes for residential properties.

One possibility might be to lower the state’s property tax levy, Willette said, which would have no direct effect on local residential taxes. Any decrease in the state levy would result in a loss of revenue to the state’s general fund.

The commission may also want to consider ways to simplify the property tax code, Willette said. But he cautioned that such changes are difficult to accomplish since businesses or other taxpayers are often hesitant to give up their current exclusions, abatements or tax credits. “Everyone wants a change,” he said. “But not at the cost of what they have now.”