City blues: MSU study finds state tax policies cripple cities

Michigan and California don't often land in the same sentence for economic comparison, but a new report concludes that both states share a dubious distinction: Their tax policies help cultivate financial crisis in their cities.

“We contend that they have structured local fiscal policymaking in a way that effectively incubates financial distress,” states a Michigan State University analysis.

While an improving Michigan economy is helping to boost local tax revenues, the report concludes that state policies also contribute to the likelihood that cities in Michigan will continue to face fiscal trouble. The problem, according to the report, is that Michigan tax policies restrict how much revenue cities can collect while, at the same time, placing more of a burden on local government to provide services.

“Michigan’s particular mix of stringent limitations on local revenue and its relatively low level of financial assistance to cities, coupled with spending pressures stemming from spiking local service burdens and increased labor costs, creates conditions that drive up the potential for local fiscal distress,” the report states.

The report, funded by the C.S. Mott Foundation, examined nearly a half-century of state and local financial data and weighed input from analysts, state officials and legal experts in concluding that Michigan, when compared with similar states, “provides a particularly difficult environment for its cities.”

The findings are not embraced by some in the state’s Republican-controlled leadership, who contend that local governments can in some instances do more to control costs while also noting a recent increase in tax revenue the state shares with municipalities.

MSU researchers say no one policy fix will solve the financial stress faced by cities; they instead recommend changes that will more readily align state policy priorities with what cities need to remain financially stable. That would include, the report suggests, a more collaborative environment between local and state leaders, what the report calls “a partnership and culture of trust.”

“For me, that's the bottom line here,” MSU economist Eric Scorsone, a co-author of the report, said of Michigan’s tax policies. “Why have we had so much fiscal distress? Yes, we have had a massive recession. But it is really beyond that story.”

Among the report's key findings:

Michigan is one of just eight states to impose three different tax limitations on local governments. Those limits include the Headlee Amendment, a measure approved by voters in 1978 that puts a strict cap on municipal tax revenues, and Proposal A, approved in 1994, which prevents the taxable value of property from rising as quickly as property values. State law also limits cities to a maximum tax rate of 20 mills, though city charters often set a lower limit.

Michigan is second only to Colorado in the increased severity of its tax restrictions from 1970 to 2005.

Michigan cities are also likely to incur higher labor costs than those in many other states, largely because many are heavily unionized. The report finds that states including Michigan, California and others, have public employee unionization rates in excess of 50 percent, while states such as North Carolina and Virginia have public employee unionization rates of about 10 percent. Union workers, in general, earn higher wages and better benefits than nonunion workers.

“To be clear, we do not suggest that a non-unionized workforce is the key to a fiscally sustainable city,” the report states; it is merely noting that the higher the labor costs in local budgeting, the tighter the budget constraints for cities.

Scorsone said the combination of high labor costs and restrictive state tax policy amounts “to the worst of both worlds” for Michigan cities.

Republican leadership in Lansing defended its record on municipal finance, noting for instance recent increases in revenue sharing for cities ‒ from just over $200 million in fiscal 2012 to nearly $250 million projected in fiscal 2016. A spokesman for GOP House Speaker Kevin Cotter suggested cities incurred some of the fiscal stress by agreeing to expensive retiree health care and pension benefits in better times.

Referring to that debt, the spokesman, Gideon D’Assandro, said, “There do appear to be some bad deals out there. Speaker Cotter and his fellow lawmakers put the taxpayers first when they first took office by cutting our own pay and benefits to make the budget work. We could see more of that from our local governments, too.”

Tax reform forerunners

But is it coincidence that Michigan is home to the first major U.S. city – Detroit – to declare bankruptcy? Or that California leads the nation in the number of municipal bankruptcies, with four of the 13 U.S. cities to have filed for bankruptcy by 2014?

Michigan and California were early adopters of the tax reform movement that picked up steam in 1970s, as taxpayers took their ire over escalating property tax bills to the polls.

California went first, as voters in June 1978 approved Proposition 13. Championed by anti-tax activist Howard Jarvis, it rolled back property assessments, froze them at 1976 levels and limited their increase to 2 percent a year. Just as critically, it prohibited state or local government from raising new taxes without a two-thirds vote of the governing body.

Michigan followed suit, as voters in November 1978 approved the Headlee Amendment, which limited state spending and capped local property tax millage rates to the rate of inflation.

Sixteen years later, Michigan voters approved Proposal A, a school funding reform measure that capped increases in the taxable value of property to 5 percent or the rate of inflation, whichever is less. That meant municipalities would suffer huge losses in property tax revenue when taxable values plunged – as they did in the Great Recession – but they could not reap full benefit from the economic rebound when increased values exceed 5 percent or the rate of inflation.

As Michigan's economy imploded, state and local governments levied $1.3 billion less in property taxes in 2011 than 2007 because of declining property values and exemptions from the tax, according to Treasury Department figures. Municipalities scrambled to balance their budgets, in many cases by neglecting parks, streets and laying off police and firefighters.

There is no consensus in California on the impact of Proposition 13. Advocates contend it reeled in excess spending while protecting taxpayers. And clearly, like Michigan, the fiscal stress in many of its cities is linked to a precipitous drop in property values that accompanied the Great Recession.

Nonetheless, critics say Proposition 13 has made things worse for cities, while gutting spending on public schools.

Indeed, in a 2012 analysis titled, “Why Some California Cities Are Choosing Bankruptcy,” Moody's Investment Service concluded: “The depressed housing market has also significantly affected property tax revenues, since Proposition 13, the state’s constitutional property tax limitation, restricts the ability of municipalities to adjust tax rates, thereby capping property tax revenues at a time when flexibility is most needed.”

A 2011 report by Bloomberg Business stated that California fell from seventh place before passage of Proposition 13 in K-12 spending per pupil among states to 27th place, according to the U.S. Census Bureau.

Anthony Minghine of the Michigan Municipal League, which has been critical of the state’s tax policies toward cities, particularly regarding revenue sharing, said the combination of Headlee and Proposal A is likewise choking off revenue streams for Michigan cities as they try to dig out of the recession.

“You have double limitations on that,” Minghine told Bridge.

Under Proposal A, municipal property tax revenue falls in lockstep with taxable value, so that if homes in a given community lose 20 percent of their value, the city's revenue drops by 20 percent as well. It doesn't work in reverse. With homes in places like Ann Arbor rising in value this year by nearly 10 percent, taxable value can only rise by 1.6 percent – the 2015 inflation rate as calculated by the State Tax Commission.

A little-known provision of Proposal A further crimps municipal finances, the MSU report notes. Under the Headlee Amendment, cities were required to roll back their authorized millage rate if taxable property value, excluding new construction, exceeded inflation. But they could “roll up” their millage rate the following year if the rise in taxable was less than inflation. Proposal A prohibits such roll-ups.

“You only have a gate that swings one way. We have a broken municipal finance model,” Minghine said.

State priorities

Michigan's municipal fiscal plight has also been aggravated by political choices, as state legislators for more than a decade have chosen to balance the budget on the backs of municipalities, according to Minghine. In a 2014 analysis, Minghine noted that projected statutory municipal revenue sharing had been cut by more than $6 billion from 2003 to 2014, falling from about $900 million a year to about $250 million. Municipalities rely on revenue sharing for everything from police and fire to roads and park maintenance.

“What's most shocking is the difference those revenue sharing dollars would have made at the local level,” Minghine’s analysis stated.

The Municipal League’s analysis found that more than $700 million in projected revenue sharing had been taken from Detroit during that time, more than $70 million from Grand Rapids, $55 million from Flint, more than $40 million from Pontiac and $31 million from Dearborn. Hamtramck, which came out of emergency management in December 2014, lost $13 million.

“We now have a record number of communities facing financial emergencies. It’s easy to blame local leaders, but you must consider all the facts. In most cases, communities that currently face large deficits would in contrast have general fund surpluses,” the MML analysis stated.

D’Assandro, the Cotter spokesman, preferred to focus on the recent gains in revenue sharing, saying Cotter is proud of the legislature's votes to increase revenue sharing “again and again in recent years.”

According to a Michigan Department of Treasury document, statutory revenue sharing funds for cities, villages and townships has increased from $209 million for fiscal 2012 to $248 million projected for fiscal 2016. But that’s still far below the amount allocated more than a decade ago.

Crushing legacy benefits

Michigan cities also continue to face the crushing weight of legacy pension and retiree health care obligations incurred during better economic times.

A 2013 MSU report co-authored by Scorsone concluded that unfunded legacy debt in Michigan cities, excluding Detroit, exceeded $10 billion in 2011. Nearly 80 percent of this debt was tied to retiree health care, Bridge reporting showed.

It found that legacy debt was equal to 30 percent of general revenue brought in each year by Ann Arbor, 25 percent in Grand Rapids, 38 percent in Lansing and 85 percent in Saginaw. The analysis cites 311 cities, villages and townships in Michigan that provided some kind of retirement health care benefits at the end of fiscal 2011, with a total liability of $13.5 billion. Just 6 percent of that was funded, leaving a net unfunded liability of $12.7 billion.

To be sure, auto-dependent industrial cities like Flint, Saginaw and Detroit have also been slammed by cascading losses in population over several decades. Detroit, with a high of 1.8 million residents in 1950, now has fewer than 700,000 residents. Saginaw's population fell from more than 90,000 in 1970 to barely 50,000 today. Flint's population is now just under 100,000, from more than 190,000 in 1970.

Given this constellation of factors, maybe it should come as no surprise that 13 municipalities in Michigan are in some stage of emergency management, receivership or transition under the emergency management act of 2012. Seven, including Detroit, are in Wayne County.

“It's not just the basket cases,” Scorsone said. “It's other cities as well.”

City of Lansing’s decline

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. 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.

Lansing Mayor Virg Bernero said municipalities are doing the best they can with limited resources. But he said there's a limit to how deep cities can cut. Its current general fund budget of $120 million, adjusted for inflation, is less than the city's 1999 budget, he said.

“There is a reason that our cities look the way they do. We are in a financial pressure cooker,” Bernero told Bridge. “How is the state going to grow when our cities are on life support? Our urban policy today is a prescription for failure.”

Bernero, a Democrat who was defeated by GOP Gov. Rick Snyder in the 2010 race for governor, said the Republican-controlled state Legislature is “somewhere between oblivious and callous about the needs of city government.”

Saginaw’s struggles

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.

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 their 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.

East side Saginaw homeowner Madeleine O'Neal has watched the neighborhood in which she has lived for 20 years slide into something of an urban wasteland. Weedy, vacant lots now outnumber the homes on her street.

She said she has called the city to complain, to ask that someone come out and mow the empty lots, to no avail.

“They say they don't have the funds. But they don't really care about our side of town. It's a shame the city doesn't do anything.

“If I had some money, I'd be gone.”

Minghine of the Michigan Municipal League said there comes a point where steep budget cuts only accelerate a city's decline. Property tax is a key revenue source, but one that hinges on the perceived value of property. Homes sitting next to weedy vacant lots are not likely to appreciate in value.

“The value is a function of the desirability of the community I live in. What I am doing (with severe budget cuts) is make that community much less desirable. It becomes a death spiral.

“Our goal should be places where people want to live.”

Closing city-state divide

The MSU report on Michigan's tax policies and municipal funding stops short of proposing dramatic change to the system, a frank nod to the political barriers to any major tax overhaul that would give a significant bump in funding for cities. The report archly notes that state “policymakers tend to focus more on short-term political gain rather than the histories and unintended consequences of policies that, over time, become increasingly difficult to alter.”

“It would be impractical to recommend major policy overhauls of Proposal A, the Headlee Amendment, collective bargaining rules and state revenue sharing,” it stated.

Amber McCann, spokesperson for Senate Majority Leader Arlan Meekhof, R-Ottawa County, confirmed as much, stating: “The Majority Leader has not considered undoing Headlee or Proposal A.”

She added, however, that he is “open to a discussion” about revenue sharing.

The report did recommend creation of a state agency to coordinate services to local government, offer technical support and fiscal monitoring and “help create a partnership and culture of trust between the state and its municipalities.”

It also said Michigan could learn something from Pennsylvania, whose Act 47 allows the state to place fiscally distressed communities in receivership, with an oversight board “that acts as a liaison between the local government and others to improve the financial integrity of the city and is typically able to broker additional state funding for the distressed community.”

Minghine, as well, acknowledges how difficult it will be to make fundamental change to Michigan’s municipal finance system.

“We're not naïve about the difficulties of doing that. Will we get to the Pollyanna place that's perfect? Not in my lifetime,” he said.

But he cautions that acceptance of the status quo in municipal finance is not a good long-term prescription for Michigan's cities. He noted what’s at stake, given a recent report by the Municipal League that metropolitan areas in Michigan account for 89 percent of the state’s jobs and 88 percent of its gross domestic product.

“Cities are the economic engine of Michigan. We need a fresh look at our finance system. We need a model that will allow locals to share in a prosperous economy.”

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Tue, 11/17/2015 - 10:21am
This whole article has raised my blood pressure so much that I don't know where to begin. Cities are burdened with excess costs because of high levels of unionization. Cities are limited in how far they can reach into someone's pocket because of citizen adopted laws. Cities are receiving less revenue because of reduced revenue sharing. What? Why is it that all the cities mentioned are cesspools run by the democrats. Get the Republicans in charge like L. Brooks and the successful western Wayne county cities and you will have many amenities, efficient government, and balanced budgets.
Tue, 11/17/2015 - 11:11am
Nah, tain't so. The point of the article is that restrictions on possible tax revenue cause municipalities a source of revenue, even if the voters want to raise the money for something they support and consider a key investment.
Tue, 11/17/2015 - 12:25pm
Republicans are the reason for this mess.
David L Richards
Sun, 11/22/2015 - 12:52pm
Rich, do you think police and firefighters are overpaid? Most of municipal budgets go for public safety, so if you think too much is being spent because of unionization, you are saying that we should reduce compensation for public safety. Ironically, when the Republicans in Michigan, and other states go after unions such as with Right to Work legislation, they usually leave police and fire unions alone.
city fan
Tue, 11/17/2015 - 11:09am
It is a treat to read Ted Roelofs again from the days before the Grand Rapids Press faded. The city of Grand Rapids still enjoys benefits of past investments, but we cannot withstand the starvation by legislature ideologues whose only mantra is "no new revenue." Blind fanaticism allows them to close their eyes to the plight of the whole state community. They do not struggle to understand issues or make hard choices. They just sit in the legislature and vote the straight ballot "No" ticket on every issue. And we pay them to come to Lansing and do nothing. Term limits are no problem as they have plenty of friends, who know nothing, willing to come to Lansing and sit in their place, doing nothing.
Tue, 11/17/2015 - 12:27pm
Term limits have been a disaster for this state. In and out, grab as much money as you can, and don't worry about the long-term ramifications is the mantra for most repubs.
David Waymire
Tue, 11/17/2015 - 1:49pm
I guess I'm sort of baffled by this comment:Referring to that debt, the spokesman, Gideon D’Assandro, said, “There do appear to be some bad deals out there. Speaker Cotter and his fellow lawmakers put the taxpayers first when they first took office by cutting our own pay and benefits to make the budget work. We could see more of that from our local governments, too.” Looking at Senate Fiscal Agency data, the Legislature's budget has gone from $102 million in FY 10-11 to $136 million in FY 15-16. Perhaps I missed the part where they increased revenue sharing by 30 percent over the same period?
Tue, 11/17/2015 - 7:20pm
It always seems someone else's responsibility for cities lack of funds, no concern about what value we get for the spending, only a desire for more money. Weren’t the taxing restriction decided on by voters? If that is the case wouldn’t it make more sense to learn why the voters support the restrictions, and then address the issues rather than simply whine about the restriction? I wonder if those so badly wanting to raise taxes even believe the voters should have any say in what they are taxed. The tone of the article seems to be government entities and the people that work for them should be deciding on how much of other people's money they get to spend. That makes me wonder if those wanting more money trust the voters or even care about what the voters are concerns are. A couple of weeks ago we had a vote to raise taxes [law allowed an increase], but it seems the issues was more about confidence in those spending the money and what we would get for the money more than concern over the rise in taxes, vote was no. I wonder if more effort was invested in regaining the voters confidence in who is spending and what we are getting for our money might do more for raising taxes than whining about restriction on taxing.
Robert Kleine
Wed, 11/25/2015 - 9:46am
How do you expect cities to survive when their property tax revenues drop 30-40 percent as happened to many cities from 2008 to 2012 while the state was also cutting revenue sharing. Because of the cap on taxable value it will take some cities more than 20 years to regain what was lost.
Wed, 11/25/2015 - 1:53pm
Maybe it is time they try thinking differently about what the results the community wants for their money. They can start by deciding on what their purpose is and then determining how they can get best value for for the spending of other people's money. As an example, our City Manager wants more money for roads, but he has no clue what the best value is. He said the roads in Muskegon have deteriorated so badly that they have to be torn out and totally replaced. He said this what should happen to the Beach street loop, ride it someday and see if it is crumbling to the point of replacement. Maybe it is time there was some thoughts give to repairs and how they can be made more effective. Maybe it is time, at least in my town, that the government entities draw people from the community into structure conversations about results, about means and methods, about innovative approaches, rather then limiting the public to a formal few minutes at a podium. As best I can tell government entities are locked into an old culture and don't know that the world has changed, the people they serve have changed. The innovation has changed how we [outside of government] approach issues from results to methods for delievering those results to how we fund the means/methods. Government whines about the past, justifying all their spending request on the past, the voters live in the present and look to the future expecting better value for each dollar they spend. I wonder why government can only knows to threaten lose of firefighters and police and are never talking about how the government is delivering better results and getting better value for the money they are spending. What experieinces do you have where a government entity has delivered a better than expected results with the same funding or even lower than expected funding? If he were to try an determine what causes road problems and how to selected which ones and when they need repair.
John S.
Tue, 11/17/2015 - 11:18pm
With respect to costs, the numbers don't lie. It's employee and retiree health care costs that put fiscal stress on governments at all levels. Nobody's doing much about these rising costs other than demanding that employees and retirees pick up a bigger share of the tab.
Bob Young
Wed, 11/18/2015 - 12:57pm
Great discussion regarding taxes, projects, and infrastructure. The 800 lb. animal in the room is the legacy costs or employee costs that are compounded by years of poor negotiations, which lead to enormous unfunded balances. When re-phrased in terms of real projects or capital expenses, the citizenry might approve spending and taxation for a cause. Just no funding forever wages and pensions. The private sector can't afford it, and the citizens will not stand for it. I'd vote for a solid plan to build and maintain infrastructure (roads, bridges, etc.), just not nebulous (undesignated) "taxing". RY
Thu, 11/19/2015 - 10:07am
This is a great article, but I'm honestly quite shocked that there's no info on the loss of the Personal Property Tax in Michigan. It's very important in the context of this article, as the Michigan Republican legislators are caught spreading misinformation about "increased" revenue sharing in the coming years on several occasions in this article. This "increase" is merely "replacement" funding for the Personal Property Tax that the State is phasing out. So the "increase" that Republicans are citing in this article is actually a "replacement" for other funds they eliminated, so the net gain to local municipalities is $0. Thank you for all the research and info about how our municipal finance system in Michigan is broken.
Allan Blackburn
Thu, 11/19/2015 - 4:43pm
I see a lot of pointing fingers along party lines. I hear a lot about legacy costs, which many did not contribute to in good times and further neglected in bad times. So what is the answer? Tell the people that we made promises to that we are not going to fund their pensions? Can we do that to your Social Security checks and leave you with nothing? What are the solutions because, if we neglect it long enough, people stop coming to our state for vacations and it starts looking like a third-world country.
William C. Plumpe
Sun, 11/22/2015 - 8:58am
Headlee and Prop A while originally well intentioned have financially hamstrung municipalities and given them very little wiggle room. Add to this decreases in State revenue sharing and unfunded mandates from Lansing and you have a recipe for financial disaster. The State should be willing to step up and provide adequate revenue sharing funding to assure proper municipal operations particularly in regards to any unfunded mandates. Anything less would be a serious breach of the State's responsibility to ensure that municipal operations are properly funded. You simply cannot continue to cut revenues and expenses to reach "prosperity" and "proper government functioning".
David L Richards
Sun, 11/22/2015 - 12:46pm
About 25 years ago I was on the City Commission in Royal Oak. The state legislature made changes to the personal property tax, which reduced revenues to municipalities. My local state representative then bragged about lowering taxes, when the lowering of taxes came entirely out of municipal budgets, not the state. Even when municipal services are kept intact, it is usually the result of the local officials having to raise taxes to compensate for the loss of state revenue. The folks at the state level (usually Republicans) then boast about keeping taxes down, when the actual result is the burden of providing public services is transferred from the state to the cities and townships, and while state taxes are reduced, local taxes are increased in order to compensate for that reduction.
Sun, 11/22/2015 - 3:32pm
Why did the cities and townships and counties support the change in taxing and where their money came from? Was it because they thought they would get more money from others and lower the cost to their residents? Is that why they encouraged voters to support the changes and their willingness to give up their voter accountability with their taxing authority? Or was your City one of those who were out spoken against the shift to getting the largesse from Lansing?
David L Richards
Sun, 11/22/2015 - 9:30pm
I don't know what other cities did, but we certainly didn't support the change. And if the state proposed to make up the loss, they reneged on the promise.
Sun, 11/22/2015 - 10:28pm
I expect your town doesn't have an employee benefits [pensions and the like] funding problem, but it seems many government organizations have significant employee benefit cost burdens. It seems they made promises in better times that the people today are paying for in more difficult times to the point of causing a reduction in services. The revenue sharing seems analogus to that, promises by others of what the people will have to pay for later. Do you think your town would like to be removed from the revenue sharing program [getting the old taxing back along with all fiduciary responsiblities]? Do you think the net change would be to increase funding or might they local taxes have to be raised? Simple guess, nothing formal.
David L Richards
Sun, 11/22/2015 - 9:32pm
I don't know what you are talking about with regard to encouraging voter support for the change. It was done legislatively, not by a vote of the public.
Tue, 11/24/2015 - 9:48am
You don't believe voters have any impact on government? It seems that many who feel that the legislature are doing what they want appeal directly to the voters through a Consitutional amendment, wasn't there a Prop A that was passes by voters. Couldn't a Constitutional Ammenedent process be a means of directly seeking voter support of a change in the 'revenue sharing'? I am still curious, do you know if you town has looked at what their revenues would be if they returned to the old revenue system and if they would have to raise local taxes?