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Minneapolis is staring down a money hole, and residents will likely be asked to pay for it through their property taxes next year.

Downtown real estate is tanking, pandemic funds have dried up and unionized workers are demanding raises to keep up with inflation, creating the kind of fiscal challenge the city hasn't faced in at least a decade.

In an interview with the Star Tribune, Mayor Jacob Frey and several financial officials laid out the challenge with a clear political calculation in mind: The ambitions of the progressive majority on the City Council could run up against Frey's relatively austere approach, so a potential budget battle looms in coming months.

"We've got work to do," said Frey, who will discuss the challenge of balancing the city's budget — and managing its tax implications — in his State of the City address Tuesday.

Frey now sees it as almost impossible to stick with his planned property tax levy increase of 6.1% or less. If the city can't rein in spending, that increase — the total amount of money raised through property taxes — could bust double digits.

"We're going to work hard to avoid that," Frey said.

To be clear, that levy percentage increase isn't the same as actual increases to property tax bills. That's a more complicated figure that depends on property values, and those numbers haven't been estimated yet.

It all comes down to spending versus revenue; the city — the mayor and the City Council — face a requirement to pass a balanced budget.

The spending problem

The fundamental problem is how the city will raise enough money to meet the rising cost of its roughly 4,200 full-time employee positions — the largest spending component of the city's $1.8 billion budget.

City budget officials don't have hard numbers yet. They're in the process of projecting spending for 2025, Budget Director Jayne Discenza said.

There aren't actually 4,200 people currently employed by the city; as of Thursday, 3,823 people were in those positions. But the nearly 400 vacant positions are hardly expendable, Frey emphasized.

From rank-and-file patrol officers to arson investigators, the staffing woes of the Minneapolis Police Department are well-documented. Court-mandated police reforms following the murder of George Floyd and a history of racist and unconstitutional policing require hiring additional staff. Elsewhere, the city payroll is checkered with vacant positions that have typified the public and private sector since the pandemic, and the city is actively hiring.

Bottom line for Frey: He wants layoffs to be off the table. "We value our staff and we're keeping them here," he said.

But the cost of keeping those workers is rising.

Last month, the city reached an agreement with the union representing about 440 public works employees, and they achieved record wage increases. Unions representing firefighters and laborers also inked contracts featuring raises. The city is currently in closed-door talks with the Minneapolis Police Federation, where Frey and others have publicly supported raising wages and giving incentives for hiring and retention.

Next year, at least 12 union contracts covering some 1,125 workers, ranging from attorneys to building inspectors, will be up for renewal, with unionized workers expected to demand higher wages after a period of steep inflation.

What about program cuts? Frey isn't going there now, saying only, "There won't be new major programs." He said he's asked department heads to prioritize existing programs.

The revenue problem

The pandemic upended the city's finances, with legions of workers being placed on unpaid leaves. A series of massive congressional spending packages sent piles of money that easily plugged those holes. The city knew that money wouldn't last, and Discenza emphasized that the city tried to use those funds in ways that didn't create permanent obligations.

But that's easier said than done. For example, the city spent federal American Rescue Plan funds as part of its response to homelessness, including support for projects like Avivo Village's tiny home community. Homelessness remains a pressing issue.

Last year saw a major increase in city revenues from local taxes associated with entertainment, anchored by performances from Taylor Swift and Beyoncé. But those taxes bring in less than $100 million.

Barring an infusion of outside money, the city will have to rely on property taxes to address the crunch.

The property tax problem

For the first time in at least a decade, the total value of Minneapolis property has fallen, the city assessor's office announced in March.

The 3.1% drop citywide included a 1.2% decrease in residential property values, but the real drag is the central business district downtown, where the impact of the work-from-home shift has been manifest.

The value of downtown commercial real estate — think: high-rise office buildings — plummeted 13%.

That change means a rapid acceleration of a trend that is already under way: Residential properties will have to shoulder a bigger share of the property tax burden. Here's a comparison: In 2020, residential properties — both single-family homes and multi-unit rentals — made up just over 66% of the total property tax base; now that figure has jumped to just over 71%.

Could that shifting burden be changed by, say, increasing taxes on commercial or industrial property owners more than residential?

Technically, yes, but that would require an act by the Legislature.

The political dynamic

The City Council, which holds the purse strings in city spending, is controlled by a progressive majority that came into office this year with their own policy and fiscal ambitions. Leaders have said they want to bolster their staff, including aides and auditors, to more effectively watch the city's finances and serve as a check on Frey, who is more moderate by comparison. In addition, they want fresh approaches to homelessness and drug treatment, possibly with more spending, and to explore new programs such as a municipal child care initiative.

The biggest budget battle last year was not over restraint, but how to spend a small windfall of $19 million in state public safety grants.

Neither Frey nor the current council leadership has yet been confronted with filling a budget hole.