Mitch Bean: Starving Michigan cities and the coming storm

Mitch Bean is the former director of the nonpartisan House Fiscal Agency and former chief economic for the Michigan House of Representatives.

If we don’t change the way we fund municipalities, the crisis in Flint may be a preview of coming attractions.

It should surprise no one that many Michigan cities are in fiscal distress, and it should come as no surprise when more issues arise in years to come. Why? Because state funding for municipalities have deteriorated to the point many cities cannot adequately fund basic services.

Since 2002 Michigan has led the nation in cuts to municipalities. The Census of Governments published every five years by the U.S. Census Bureau reported that from 2002 to 2012, municipal revenue from state sources increased in forty-five states and the average increase was 48.1 percent.

In Michigan, municipal revenue from state sources declined 56.9 percent from 2002 to 2012.

Only four other states reduced municipal revenue from state sources during that period. California, Minnesota, Kansas, and Kentucky reduced state sources to municipalities by an average of 9.41 percent. Kansas was the next largest decline at 14.3 percent – compared with a 56.9 percent decline in Michigan.

Six states increased revenues to municipalities by 90 percent to over 200 percent; and another fourteen states increased municipal revenue between 40 percent and 90 percent.

We only have numbers through the current budget year for Michigan so we cannot do a multi-state comparison past 2012. But from 2002 to 2016, as enacted, Michigan’s statutory revenue sharing has declined 61 percent. As other states are increasing municipal revenues, Michigan continues to reduce funding for municipalities and a comparison of all 50 states from 2002 to 2016 would likely show an even greater relative decline for Michigan.

Policy actions during the administrations of Michigan’s three most recent governors have degraded state municipal finance through tax changes that reduced the tax base municipalities rely upon by tens-of-millions of dollars; and by direct cuts to statutory revenue sharing that have reduced municipal finances over $5.5 billion since 1998.

A review of property tax cuts enacted from 2002 to 2013 shows changes to the property tax base reduced local revenue about $88.3 million. In addition to property tax cuts, changes to the sales tax base have reduced constitutional revenue sharing payments to cities, villages and townships (CVT) by $27.3 million in FY 2014 and by $181.2 million cumulatively since Proposal A in 1994.

The largest impact on local resources have been reductions to statutory revenue sharing. Statutory revenue sharing to municipalities in fiscal year (FY) 2016 alone is estimated to be $585 million below the full funding of the statutory dedication. The cumulative amount of cuts to statutory revenue sharing for CVTs from FY 98 to FY 16 is estimated to be $5,538 million.

Cuts to statutory revenue sharing shifted state funding shortfalls from the state to local units. It became standard practice in FY 1991 and, with the exception of FY 98 when the base was revised to incorporate previous cuts into a lower base, and FY 2001 when statutory revenue was fully-funded, actual statutory revenue sharing payments have been below full-funding each year.

It hasn’t always been this way. State revenue sharing began in the 1930’s when the state began taxing enterprises that held licenses for alcoholic beverages and returned 85 percent of liquor license tax collections to the CVTs of origin. The revenue sharing base changed and in 1946 the constitution was amended to provide a constitutional revenue sharing payment based upon a percentage of sales tax collections and distributed on a per capita basis.

There have been various changes to the statutory revenue sharing base since the 1930’s including dedications of revenue from the intangibles tax (repealed), the income tax, the sales tax, and the single business tax (repealed). However, statutory revenue sharing was fully funded until the state temporarily reduced statutory revenue sharing during the recessions of 1980-83.

In 1998, the Glenn Steil Revenue Sharing Act, Act 140 of 1971, was amended to provide that statutory revenue sharing would be based upon a percentage of sales tax collections. The statutory revenue sharing base was specified to be 21.3 percent of the sales tax collections at a rate of 4 percent. For CVTs, the base was specified as an amount equal to 74.94 percent of 21.3 percent of the sales tax collections at a rate of 4 percent.

Under current law, state revenue sharing consists of two parts: constitutional payments and what’s commonly referred to as statutory revenue sharing payments. Constitutional revenue sharing payments are based upon a percentage of actual sales tax collections. When money is collected a specified portion automatically goes out in constitutional revenue sharing payments.

That means when the Administration emphasizes they are “increasing” constitutional revenue sharing payments in a budget message it’s disingenuous at best – because the constitution mandates the payment be made.

Municipalities rely primarily on property taxes and intergovernmental revenue to finance essential public services, and in recent years, due the combination of restrictions and direct and indirect cuts, property taxes and intergovernmental revenue sources have failed to keep up with the current level of services – much less rising costs.

Cuts in state revenue sharing have been a major contributor to the fiscal problems of Michigan’s cities but Michigan has also imposed numerous constitutional and statutory limitations on municipalities’ ability to collect property tax revenue which according to 2012 census data, account for 43.1% of cities general revenue.

Property taxes provided a steady, growing source of revenue for cities from 1996 to 2008. Taxable value increased by 67 percent and property tax collections rose by 69.3 percent, and the average city millage rate changed little; 16.07 mills in 1996 and 16.29 mills in 2008. Over the same period, state taxable value (TV) increased 89.5 percent, as suburban areas grew faster than cities.

What followed was the collapse of the housing and financial sectors in 2008 which resulted in the largest decline in Michigan property values since the 1930s. The taxable value of cities fell 18.1 percent from 2008 to 2012 and property tax collections fell 9.1 percent. Over the same period, state taxable value fell 13.1 percent.

Michigan’s largest cities were hit harder by the 2008-2009 recession than the state as a whole as the taxable value of the 15 largest cities fell 19.8 percent from 2008 to 2012. Most of the larger cities are located in Southeast Michigan, which was hit the hardest by the recession due to the heavy reliance on the auto sector.

During economic downturns, demands for state/local government services increases, but the resources available to local governments in particular decline, and limitations imposed on local governments effectively force service cuts when they’re needed the most.

According to a recent study by MSU Extension, Michigan imposes some of the most stringent limitations on local revenue of any state in the nation.

“A few states, such as Michigan and California, place strict limits on local own-source revenues while at the same time providing only meager intergovernmental aid and imposing costly labor and service obligations. We contend that these states have structured local fiscal policymaking in a way that effectively incubates local financial distress . . . state-imposed budgetary imbalances can engender recurring structural deficits and diminished local service capacity, particularly among the states’ older, industrial urban areas.”

Structural constraints, such as the interaction of the Headlee Amendment and Proposal A, have limited the collection of taxes on existing properties; while statutory revenue sharing payments, as well as other state grants to local governments, have been cut due to tight state budgets and a lack of understanding of the importance of revenue sharing to the fiscal stability of Michigan’s cities.

The impact of funding cuts on local services has been significant and will get worse if this trend continues. As discussed in a recent article in Bridge Magazine, Lansing is a typical example. As property values and state revenue sharing dropped, it had no choice but to slash payroll and cut costs where it could. From 2006 to 2013, the city cut its work force by 30 percent, from 1,220 to 852. It negotiated increases in employee health care premiums and pension contributions. It closed three fire stations and reduced minimum staffing requirements for firefighters. It closed two municipal golf courses.

Roads suffered as well. From 2004 to 2013, the percentage of federally funded roads in that city that were in poor condition soared from 4 percent to 40 percent. In November 2011, voters approved a 5-year, 4-mill tax increase to fund the police and fire departments – avoiding threatened cuts of 120 employees in the police and fire departments. They turned down the same request six months earlier.

Saginaw, on the high side of fiscal stress, has managed to avoid emergency management. But the city is barely recognizable from what it was decades ago.

According to the Municipal League, it lost more than $30 million in projected revenue sharing from 2003 to 2014. A 2013 report by Michigan State University on municipal legacy debt found that Saginaw’s unfunded retiree health care debt in 2011 was about $200 million. It had more than $100 million in unfunded pension debt and spent more than $8 million – a fourth of the general fund budget – on retiree health care in 2013, leaving much less to pay for basic services for residents.

That includes police and fire, normally the last services a municipality cuts. The city has slashed its police force to 55, a quarter of its staffing level in 1975 – and a cut twice as steep as the drop in population during that time. Its fire department is staffed at 50 – half what it was in 1995. In addition, its streets have steadily deteriorated, with 57 percent of its federal aid roads in poor condition in 2013.

The same year, city officials decided to stop cutting weeds in the hundreds of vacant parcels scattered around town – a measure to save $200,000 a year. The resulting weed-choked lots left many residents complaining the city no longer cared about its neighborhoods. The Saginaw Land Bank in 2014 agreed to pay the city $45,000 to cut some of the lots while the city mulls a long-term solution.

One can argue about an exact level of tax base a city needs to provide adequate services, but any city with a tax base much below about $20,000 per capita will struggle financially and be forced to levy higher-than-average property tax rates or income taxes – there are about 90 cities that do not meet this criteria.

For example, Troy, with a tax base of $52,783 per capita, levies only 11.5 mills and Kalamazoo, with a tax base of $19,622, levies a millage rate of 25.5 mills. This disparity illustrates why revenue sharing is so important.

A municipality with a lower per capita tax base must levy high millage rates to provide a reasonable level of services. High tax rates encourage residents and businesses to move elsewhere; but if tax rates were kept low, the lack of services would encourage residents and businesses to move elsewhere as well.

This illustrates why we need a strong revenue sharing program, like Michigan used to have. A strong revenue sharing program allows communities with low tax bases to maintain a reasonable level of services without needing to levy uncompetitive tax rates. Without revenue sharing cities trying to recover are caught in a vicious cycle that results in ongoing serious financial problems as demonstrated by the fact that, over the years, Michigan has had more communities under state control than any other state.

Although housing values are recovering from the sharp decline, it will take most cities years to recover their lost tax base due to the constitutional cap on the annual increase in taxable value. For example, taxable value in Farmington Hills fell 30.2 percent from 2008 to 2012. Assuming an annual increase of 3 percent, it will take 13 years, or until 2026, for taxable value to return to the 2008 level.

One could use a number of euphemisms to describe Flint: The canary in the coal-mine; the tip of the iceberg; or a preview of coming attractions. But unless and until Michigan has a stable and sufficient system of municipal finance, I fear that the Flint crisis is only the beginning.