Strapped cities taking aim at Proposal A

LANSING — Dan Gilmartin has a warning for Michigan’s policymakers: The way the state funds its cities is squeezing them dry.

Yes, local governments need to do a better job at sharing services and cutting costs, said Gilmartin, executive director and CEO of the Michigan Municipal League, which advocates on behalf of cities and villages. But cities also are limited in how much money they can collect, even if residents were willing to tax themselves more — and that, he said, is something Lansing has to fix.

One fix Gilmartin and some other leaders are floating: An update to Proposal A, the voter-approved 1994 Michigan constitutional amendment that caps property tax increases.

That solution would be politically tough, but the fact that they’re talking about it at all is telling.

It’s part of a backdrop of other extreme money measures being bandied about in Lansing, including proposals to roll back or eliminate the state’s income tax — to the concern of Gov. Rick Snyder — and restructure public retirement plans that have become a financial crisis. The outcome will have ramifications for Michigan’s competitiveness nationally, not least of which is the long-term fiscal health of the state’s cities and their ability to attract talent.

Backers of updating Proposal A are aiming for changes they say won’t change the law’s original intent. Adopted partly to rein in ballooning property tax bills in the 1990s, the provision works by capping annual growth in property values, but some local leaders say it’s holding down revenue in a way that hadn’t been seen until the Great Recession of 2008 sent property values plummeting.

In exchange for limiting annual growth in homeowners’ property tax bills, voters agreed to raise the state’s sales tax by two percentage points — it has been 6 percent ever since — and dedicate the money to K-12 schools.

Researchers estimated that just 14 percent of local retiree health care plans in Michigan were funded in 2014, compared with about 78 percent of local pension systems, with more than $10 billion in estimated unfunded health care obligations alone. That’s a big bill that will come due eventually or municipalities risk not being able to provide the promised benefits; unlike pensions, health care for retirees is not constitutionally protected. That could prompt tough decisions on how to spend limited local resources to avoid scaling back public services.

In a recent paper, two former Michigan fiscal experts who now run a consulting firm argued that deep property tax declines during the housing crisis combined with a slowly recovering tax base — in part because of the Proposal A growth caps — have created a no-win situation for cities that have lower tax bases: Either pass high millage rates to fund services, or keep tax rates low and cut services.

Both high tax rates and service cutbacks “would encourage residents and businesses to move elsewhere,” wrote Mitch Bean, a former director of the nonpartisan House Fiscal Agency, and former state Treasurer Robert Kleine, who formed Great Lakes Economic Consulting LLC. “Thus, cities are caught in a vicious cycle that results in ongoing serious financial problems.”

The most serious problems, as in Flint and Detroit, can lead to state financial oversight or bankruptcy.

Republicans in the state House have made reforming public-employee benefits a legislative priority this term. Gov. Rick Snyder appointed a task force expected to deliver recommendations this spring on how to address the pressure from pensions and retiree health care on local budgets.

Municipal advocates, Democratic lawmakers and the state Treasury have begun to raise the idea that local revenue streams should be evaluated as part of a multi-part approach to reform that includes containing costs and benefits obligations, improving efficiency in delivering services and making sure municipalities’ revenue is sustainable.

The magnitude of underfunded employee legacy costs statewide has brought greater urgency to finding a solution. Plus, economists have signaled a coming slowdown in the recovery. Michigan could take an early hit if that happens, if record auto sales start to stagnate.

“All three categories need to be addressed over the next year” while the economy is still growing, state Treasurer Nick Khouri said. “The thing I’m emphasizing, more than any specific policy proposal or principle, is: Now is the time to have these debates, when we have the economy at our back and we’ve got a little flexibility — not waiting until the next crisis.”

Thinking differently

That doesn’t necessarily mean action on revenue, including anything related to Proposal A, would coincide with retirement reform. The co-chairmen of Snyder’s retirement benefits committee, who have backgrounds in auditing and health care finance, told Crain’s it’s too early to say whether revenue will be among the final recommendations.

However it’s done, the state and its communities need to start thinking differently about how to strike a balance between a favorable tax structure and adequately funded local services, said Tony Minghine, chief operating officer of the municipal league. People generally don’t move to a state because it has low taxes, he added. They move because they like a particular community’s quality of life.

“For the first time in a long time in Lansing, we’re talking about this stuff,” Minghine said. “It’s really encouraging.”

Rather than repealing or replacing Proposal A, which would require a statewide vote, associations representing cities and townships believe changes could be made by the Legislature, rather than by going back to voters. Rewriting the law in its entirety also would be a difficult task, given the voter education campaign that would be required and the current tax-cut sentiment pervading in Michigan and in Washington.

More than two decades after the law’s landmark passage by voters under former Republican Gov. John Engler, the limits it forced on local revenue have been tested in ways that no one could have predicted in 1994, when the economy was growing.

Proposal A had two main goals — to lower property tax bills and to set up a state funding structure for public schools, which until then had been funded primarily by local property taxes. Before Proposal A, a wealthier community could have a richer school district, a gap that has shrunk over the past two decades but has not been erased.

“It was the solution to the problem at that particular time,” said Judy Allen, government relations director for the Michigan Townships Association, which represents the state’s 1,240 townships. “I’m not saying it should be eliminated or thrown out. But I think it is always good to review to see if the mechanisms we have in place are working.”

Under Proposal A, annual growth of an individual property’s taxable value is limited to the lesser of the inflation rate or 5 percent. While it has slashed tax bills for Michigan residents, last decade’s recession exposed a flaw that municipal leaders say has hindered cities’ ability to recover: Property tax collections can tumble along with the housing market, but growth is capped — meaning tax revenue doesn’t grow as fast as a rebounding economy.

Two strategies are under consideration. The state’s Headlee Amendment, approved in 1978, requires communities to roll back their millage rates if their total property tax revenue growth exceeds inflation. Under Proposal A, when a property is sold, its taxable value reverts to the state-equalized value — equivalent to half of the property’s cash value and generally higher than its taxable value. If a community has a strong real estate market in a given year, that bump in revenue could have the adverse effect of triggering a Headlee rollback that lowers its millage rate. That could lead to a less-than-inflationary growth in a community’s revenue. The first idea would exclude so-called “pop-up” values from being used in Headlee rollback calculations.

The second would be to allow a community that is growing at less than the rate of inflation to “roll up” its millage rate under Headlee — in essence, allowing a community to offset stagnant growth or declines in property values with slightly higher millage rates. A community only would be allowed to “roll up” millage rates if it hadn’t already hit its taxing cap under state law, and it wouldn’t be able to net more in tax collections than inflation.

While local government leaders understood in the mid-1990s that an economic downturn could have devastating consequences for revenue, Minghine said, a healthy economy might have led them to underestimate the effect: “You never experienced those declines like that, so you never saw the math play out the way it did.”

“One of the things that became really, painfully apparent during the recession was how severely limiting that was,” he said. “When you have markets that are always trending upward, those limits are masked.”

No specific legislation has been introduced; rather, municipal groups have said the idea so far is a policy goal.

Gideon D’Assandro, spokesman for House Speaker Tom Leonard, said House Republicans would need to see a specific proposal before they could comment. They’re focused for now on restructuring benefits, D’Assandro said.

A matter of benefits?

An unsuccessful run last year by the Republican-led Legislature at the retiree benefits issue is expected to resurface this year. Snyder’s task force is made up of city and township leaders, labor groups, lawmakers and people with expertise in accounting, auditing and health care.

The revenue idea is one response to solving the problem, as municipal groups contend that simply restructuring benefits won’t help them pay for benefits promised years ago.

Still others say cities can’t afford the benefits that have been offered, and finding ways to adjust pension and health care benefits is the first priority.

“I believe there is a need to revisit Proposal A and how we fund local municipalities, but that doesn’t take away from the fact that we have a spending problem in local government,” said James Freed, Port Huron’s city manager, who estimated that 22 percent of the city’s general fund — or an $8.2 million annual contribution — will be going to address a $103 million pension liability in the next three years.

Freed said his city will face a $3 million deficit on a $22 million general fund budget within the next three years, which he said is solely the result of rising annual contributions to unfunded pension liabilities. He wants to see the Legislature first reform what kinds of benefits municipalities can offer, and then authorize cities to restructure payments through bonding or revolving loan funds that could reduce annual contribution amounts.

“Until we address the benefits and our spending, I don’t see how you go to the taxpayers and talk about revenue,” Freed said. “If we had every dollar of revenue sharing back, we would still be in the crisis situation.”

The state hasn’t fully funded revenue sharing to local governments since the 2001 fiscal year, according to an analysis by the House Fiscal Agency.

The April 2016 report by Great Lakes Economic Consulting included estimates that cuts to statutory revenue sharing, the type not provided for in the state constitution, for cities, townships, villages and counties topped $7.5 billion since 1998.

Snyder proposed no increase to statutory revenue sharing next year. Instead, he proposed allowing local governments to share in $122 million in surplus funding, which is the result of the state overestimating how much money was needed to prevent funding losses for municipalities after the elimination of Michigan’s personal property tax on some business equipment.

“I have no problem looking at how we deal with long-term liability issues facing local communities. But it has to be done in context of a broken municipal financing system,” House Democratic Leader Sam Singh said.

Revenue sharing cuts and the recession led mayors and city managers to downsize staff to balance budgets and minimize cuts to services. That decision today means fewer active employees are paying into municipalities’ retirement systems, Singh said.

Other solutions

Other policy ideas that have circulated include updating the formula to distribute statutory revenue sharing payments to account for such criteria as population, per-capita income and the cost of services.

In addition, lawmakers could consider authorizing more local taxes, including local sales taxes; smoothing out annual declines in property values by using a multiyear average; and increasing municipalities’ tax caps, according to the Citizens Research Council of Michigan.

“There’s no reason to cling to anything we’ve done in the past, and anything and everything should be on the table,” said Eric Lupher, the research council’s president.

The longer a solution is put off because it’s politically difficult, Gilmartin said, “we will do so at our own peril.”

“There are other issues that play more in political campaigns,” he said. “But this is slowly strangling our state.”