Local sales tax proliferation is lousy policy

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Minnesota's cities and their property taxpayers are under severe stress because of the same inflationary pressures faced by Minnesota businesses — compounded by the need to make catch-up infrastructure investments that were postponed during the pandemic. At the same time, the property tax burden has shifted from businesses to housing as the value of homes skyrockets while the value of offices plummets due to the rise of teleworking.

To cope, cities are searching for alternatives to the property tax to raise revenue. Many Minnesota cities have been attracted by the lure of municipal sales taxes.

Several of the largest cities in the state were granted authority to enact small municipal sales taxes as far back as 1970, including Minneapolis, St. Paul, Duluth and Rochester. Since then, other cities have sought legislative approval to fund their infrastructure through temporary municipal sales taxes, which must also be approved by local voters.

A relatively small number of these Local Option Sales Taxes (LOST) have been approved by the Legislature over the years, mostly for small cities in greater Minnesota to fund local needs generated by seasonal visitors to their communities. However, over the past few years, the Legislature has been inundated with requests for sales tax authority from cities large and small, and from every corner of the state, all seeking to reduce their reliance on property taxes. The amount requested has exploded from $226 million in 2017 to $699 million in 2022 to requests from 35 cities totaling over $2 billion so far this year.

What makes this option so appealing to cities?

This is the only reason any city ever wants its own local sales tax. Sales taxes are both regressive and volatile. Property taxes are less regressive (especially after progressive tax credits are considered) and they are a city's most stable revenue source. However, a city's own voters and businesses have to foot the whole property tax bill.

The first public policy problem with this strategy should be evident: It is inequitable, favoring cities with a strong retail base over cities without one. There will be winners and losers. When MnDOT built the Hwy. 371 bypass around Brainerd, all the regional big box retail migrated to the new Hwy. 371 retail strip in neighboring Baxter. Guess which city now has a local option sales tax?

The second problem is that municipal planning and zoning strategies are influenced by the mix of taxes available to cities, a phenomenon known as "fiscal zoning." Municipal finance expert Michael Pagano famously compared zoning strategies for cities in three different states with different municipal finance laws. He found that cities zoned to attract commercial development when they were dependent on property taxes; particularly for office buildings when a payroll tax was in play; and for high-volume retail in sales-tax-dependent states.

Not only did sale-tax-dependent cities over-zone for retail, but they also consciously zoned for retail at the periphery of their cities to maximize the collection of sales tax revenue from surrounding areas.

On a visit to Salt Lake City, I noticed that there were car dealerships or big box stores adjacent to many of the region's light rail stations. When I asked the development director in one suburban city why this was so, her answer was that these uses provided the highest sales tax yield. The city didn't care that these uses contributed very little to transit ridership — that was the regional transit agency's problem.

In these states, big box retailers pit cities against one another to extract tax incentives designed to influence store location. Then, when the financial incentives have expired, the retailer abandons the first store and builds a new one in the next city, leaving abandoned big box stores littering the landscape.

Couldn't happen here? Duluth, a city with a local option sales tax, granted Costco a total of $2 million in tax abatement subsidies in 2020 to build a store near its boundary with Hermantown. The opportunity to garner sales tax dollars from the surrounding region was openly discussed during the City Council meeting where this subsidy was approved.

The Legislature first implemented a sales tax as part of the "Minnesota Miracle" in 1967. Wide disparities in the strength of local property tax bases among school districts had translated into huge per-pupil disparities in school district funding. When the Minnesota Supreme Court ruled that this violated the state Constitution's requirement for a "uniform" system of public education, the state sales tax was enacted to underwrite the transfer of education finance from local property taxes to the state general fund budget (where the sales tax's regressivity can be offset by the progressivity of our state income tax structure).

It would be far more appropriate to alleviate the general pressure on local government property tax levies by using state sales tax dollars to fund increased local government aid to cities, counties and school districts statewide, and by providing "circuit breaker" tax credits to individual homeowners and renters stressed by property tax increases — measures which the Legislature is poised to enact.

As a Bloomington resident, I would selfishly love it if Bloomington could use sales tax dollars from the Mall of America to buy down my local property taxes. But I know from observing the experience of other states that a proliferation of municipal sales taxes would, over time, seriously degrade our quality of life.