Shell game taxation

CAE’s Nelson helps a St. Paul church successfully thwart an onerous city assessment in Minnesota’s Supreme Court. The decision could shut down the way cities have quietly raised revenues without raising taxes.

Should a Baptist church in downtown St. Paul by charged over $15,000 annually to pay for general road maintenance when a 25-story office building just blocks away pays only $5,000? Should that same church be charged more than the next twelve Baptist churches in the city cumulatively?

Obviously no, but that is exactly what the City of St. Paul has been charging the First Baptist Church of St. Paul under the city’s right of way (ROW) assessment, a fee charged to all property owners in St. Paul to fund road maintenance. Other downtown churches received similarly exorbitant bills.

A handful of churches tried to negotiate lower assessments, but the city refused to budge and so these churches filed a lawsuit back in 2010.

Center of the American Experiment only became aware of the lawsuit in fall 2015, when the churches lost an appeal. After this loss, the church’s last hope was to convince the Minnesota Supreme Court to hear their case.

Upon reading the appellate judge’s opinion, Peter Nelson, the Center’s vice president and senior policy fellow, felt compelled to step in and help argue the church’s position before the Minnesota Supreme Court through an amicus brief. In August, the Court ruled unanimously in the church’s favor in an opinion that sets important limits on how cities can raise revenue.

The trick to raise revenue without raising taxes

Randy Kelly promised to not raise taxes when he campaigned to be mayor of St. Paul in 2001. Yet after winning the office, he quickly ran into demands to raise more revenue due to what he called “some of the most difficult fiscal conditions in 70 years.”

To keep his promise, Mayor Kelly introduced a new ROW assessment, which allowed the city to raise new revenue to fund roads without raising the property tax levy. The city applied the fee to all property owners, including churches, nonprofits and other properties that are otherwise exempt from taxation.

In a report on the ROW assessment, St. Paul officials admitted that “the changes in the ROW assessment since 2003 were all a result of policy maker wishes to control the growth of property taxes.”

Part of a trend

St. Paul isn’t the only city looking for ways to control the growth of property taxes by diversifying their revenue streams. Minneapolis has had a scheme to assess otherwise tax-exempt properties to fund road maintenance since the early 1970s. In 2014, the City of Duluth created a new Street System Maintenance Utility to help maintain city roads that was funded through a fee on all property owner’s utility bills.

The most popular fee in lieu of raising taxes is the utility franchise fee. These fees are generally applied to all electric and gas bills, which allows cities to raise revenue from tax-exempt properties. Burnsville, Rogers, and Brooklyn Park are all cities that have recently adopted or considered such fees. The League of Minnesota Cities claims these fees “can be used for any public purpose,” and, without exception, cities do use these fees to fund core public services that would otherwise be funded through a tax.

Fees violate the constitution

Using fees in these ways violates the Minnesota constitution, according to Nelson. State and local taxing power is limited within Minnesota’s constitution. Article X provides that taxes shall be uniform and shall be levied for public purposes. In addition, the constitution exempts various entities from taxation and circumscribes how local governments can levy special assessments for local improvements.

Importantly, taxation is the only method by which a city can raise money to pay for general public purposes. If this were not the case, the state constitutional limitations on collecting taxes for public purposes would be meaningless. The constitution’s uniformity protection and the various exemptions from taxation could easily be defeated if state and local governments could choose to raise revenue to fund public purposes outside the tax system.

To avoid letting a label defeat constitutional protections, fees charged by cities should be labeled a tax when they go to fund road maintenance and other services that benefit the public generally. Because the city fees discussed previously go to fund core public services, they are taxes. As a tax, these fees violate the state constitution because they fail to exempt certain properties. The ROW assessment also violates the constitution’s uniformity requirement.

Terrible budget policy

Not only are these fees unconstitutional, they are bad public policy. While keeping taxes low is generally a good policy, it’s a terrible budget policy to minimize tax increases by shifting revenue collection to various fees.

As a matter of good public policy, the tax system should be fair, transparent and accountable to the people. St. Paul’s ROW assessment is anything but fair, considering the wide disparity between what the city charged the downtown churches and other much higher-value properties.

Moreover, fees make budgets less transparent by dividing revenue into multiple, harder-to-track sources, which makes it harder for residents to compare what they actually pay for public services against what residents in other cities pay.

Less transparency leads to less accountability. The whole point of a fee is to give elected officials the ability to go back to their constituents and claim they haven’t raised taxes. While some citizens might be paying attention to line-items in a property tax bill or budget document, most do not. A quick look will reveal no tax increase and, with no change, taxpayers are led to presume everything is being run just fine. As a result, fees make elected officials much less accountable to constituents for how city funds are managed.

St. Paul’s position threatened to upend constitutional limits 

St. Paul officials vigorously argued their ROW assessment was a fee, not a tax. According to the city, they could charge the ROW assessment as a “regulatory service fee” under their general police power. A city’s “police power” is a legal label for the power to pass regulations for the purpose of preserving public health, safety, and morals, or abating nuisances. St. Paul claimed that the ROW assessment was an appropriate exercise of the police power because the program it funds “provides services that prevent various health and safety hazards in the right-of-way.”

This line of reasoning threatened to entirely upend the constitutional limits on taxation. If the courts were to allow St. Paul to assess annually for the payment of general, non-regulatory services under the guise of its police powers, they would provide cities and other local governments an unfettered path to charge fees to fund all government services and entirely avoid their obligations under the constitution. As a result, more local governments across Minnesota would be free and emboldened to adopt policies that reduce the fairness, transparency, and accountability of their revenue systems, just as St. Paul has done with its ROW assessment.

Filing an Amicus Brief

While Center of the American Experiment had great sympathy for the plight of the two churches fighting the ROW assessment, the possibility of more and more cities following St. Paul’s lead is what spurred the Center to step in and help.

After reviewing all of the lower court opinions and the opposing briefs in the case, Nelson concluded the case could create a strong legal precedent to limit how cities use fees and protect taxpayers if the Minnesota Supreme Court were to review it. As an attorney with policy experience in setting state and local budgets, Nelson was particularly suited to highlight and articulate the broader legal and policy issues at stake.

It was a rare opportunity.

Normally, a legal issue like this would never reach the courts, let alone the state’s highest court. Even when a government action clearly violates the law, someone needs to step up and challenge it. In the case of fees, the harm is almost always too slight to warrant any challenge. For instance, a utility franchise fee on a church might be just a couple hundred dollars a year. The time, expense, and disruption of a legal challenge is just not worth it. For the St. Paul churches, the size and unfairness of the ROW assessment created enough incentive to follow a challenge through to the end.

Moreover, it would be hard to imagine a more sympathetic plaintiff. If any church deserves an exemption under the constitution, it’s the First Baptist Church of St. Paul. In addition to serving as a place of worship, the church provides free child care to families experiencing homelessness while parents search for work and shelter during the daytime. First Baptist is also a refuge for new immigrant communities, hosts recovery groups, and provides other critical needs for the community.

Finally, two lower court opinions offered such confused analyses that they seemed to compel the Minnesota Supreme Court to review the case, which the Court eventually agreed to do.

Court delivers a clear definition

Oral arguments were heard before the Minnesota Supreme Court in April 2016. Usually it is difficult to glean from these arguments just where the Court will side, but one particular line of questioning seemed to guarantee a victory for the churches. If the city could fund road maintenance through a fee, the justices wondered if there were any limits to what type of service could be funded through a fee. Therefore, a justice asked the city attorney to name a specific city service that could not be funded by a similar fee. The attorney didn’t directly answer the question, which prompted another justice to repeat the question and still obtain no direct answer. It took a third justice to ask the question again before the attorney finally admitted that she could not think of an example. With no apparent limit to the city’s broad exercise of power, it seemed clear the Court would side with the churches and limit the city’s power to charge the ROW assessment. However, it remained uncertain just how the court would limit the city and how any limitation might apply to other municipal efforts to raise revenue through fees.

As predicted, the final opinion released in August 2016 rejected the city’s argument. In overturning the confused lower court opinion, Justice David Lillehaug delivered a clear statement on how to evaluate whether a revenue measure is a tax, which could bring an end to cities’ use of fees to raise revenue in lieu of taxes.

The Court’s opinion largely followed the arguments set forth in the churches’ brief and the Center’s brief. However, his opinion did not exactly follow the Center’s suggestion to adopt a formal judicial test as is done in other jurisdictions to determine whether a charge is a tax or a fee.

Not adopting one of these multi-pronged judicial tests may be for the best, because the Court’s approach may be even simpler and clearer for future courts to follow.

The Court cut to the chase and focused on applying just one factor: Whether the primary purpose of the charge is to raise revenue to accomplish a general benefit. Other jurisdictions also identified this as the key factor in their multifactor tests, especially when other factors were not determinative.

Ultimately, the Court concluded “the ROW assessment ‘benefit[s] the public in general’ in a manner characteristic of a tax.” Thus, the resolution of this case appears to have been as simple as finding the assessment went to fundservices that provided a “common benefit.”

This analysis is a logical application of the state constitution’s requirement that taxes “be levied and collected for public purposes.” As previously explained, if revenue can be raised to fund public purposes outside the tax system, then the state constitutional limitations on collecting taxes would be meaningless.

Immediate impact

The lesson for cities is clear: When a fee goes to fund a service that provides a common benefit, the fee is really a tax.

Within three weeks from the Court’s ruling, Duluth mayor Emily Larson applied this lesson when she proposed a budget that would shift current funding for streets raised from the Street System Maintenance Utility fee to the property tax levy. She specifically cited the Court’s ruling against St. Paul as the reason for the shift.

The Duluth News Tribune reports that “Larson referred to the decision as ‘unambiguous’ and said it also threw Duluth’s use of the street fees intoquestion.” The city’s chief administrative officer offered these additional comments on the impact of the court decision, “While Duluth’s street fee has differences from St. Paul, this ruling puts our current street funding at risk, and if continued, exposes Duluth taxpayers to potential liability.”

The immediate impact of the Court ruling on Duluth’s budget decisions is exactly the impact the Center hoped to achieve.

Getting other cities to follow will almost certainly take a stronger nudge, but hopefully not too much of a nudge. It will be best for all involved for cities to fall in line with the rule of law to avoid any need to resort to further litigation to protect taxpayers.