Challenges facing Michigan local governments
Since the late 1990’s Michigan local governments have experienced significant fiscal setbacks in their ability to provide critical public services to the residents of Michigan.
Since the late 1990’s Michigan local governments have experienced significant fiscal setbacks in their ability to provide critical public services to the residents of Michigan. This shortfall in public services has real impacts on people’s lives from deteriorating roads and infrastructure, a lack of public safety in some communities and even extreme events like the Flint water crisis.
Recent Governors budgets and the Legislative actions have been a welcome change in trends since 2020. That said, there is still a significant gap between the revenue needs and revenue availability for local governments in Michigan. This gap was built over the last several decades and won’t be resolved in a few budget cycles. The state should continue its most recent actions to invest in local governments as key partners. Local governments are not merely another special interest group; they represent one component of the system that is Michigan government.
A note should be taken regarding the current state of local finances in 2023 following on from the global pandemic and 2020 recession. In the last two years, local governments have been able to exercise fiscal responsibility and build fund balances despite the structural problems in the local public finance system. These short-term gains in local fiscal health do not mean that the problems are resolved. The one-time Federal stimulus programs including the CARES Act and ARPA have been an important stabilizer during the pandemic crisis.
The current local public finance system has serious flaws that restrict local revenues and continue to pile on state mandates for costs. The architects of the Michigan local public finance system are the Michigan constitution, the legislature through statues, the Michigan Department of Treasury through rule making and enforcement and local governments themselves through charters, ordinances, and resolutions. It is a very complex system to untangle, and one must be careful about unintended consequences.
Local public finance system
The Michigan local public finance system is built on a three-legged stool. The first leg of the stool is state revenue sharing. State revenue sharing makes sense in economic terms. It is more efficient for taxpayers for the state to collect taxes and then redistribute those monies to local governments. The problem is that some of the money is subject to the legislative discretion. This discretion has meant major reductions in state revenue sharing over the last two decades. It is estimated that over the past twenty years $8.3 billion has been lost relative to what was promised. In fact, if you look at this from an inflation adjusted standpoint, state revenue sharing dollars purchasing power has fallen even more. From this perspective, local governments are down almost $13 billion in purchasing power between 2000 and 2022.
The second leg of the stool is local property taxation. All local governments collect some form and level of property taxes. This system is heavily impacted by state decisions to regulate and limit both the rate and level of collection along with who and what can be taxed. The state has continually cut local property tax revenues with carve outs and rarely replaced such revenue.
Local governments have been able to offset some state revenue sharing reductions with local property taxes especially extra-voted millages, Headlee overrides or greenfield growth. Property tax revenues have grown over the past twenty years despite Michigan having some of the most restrictive laws with regards to property taxation in the nation. This growth has not kept pace with inflation and in fact both counties and cities are short almost $1 billion in each over the past twenty years in property tax purchasing power.
State revenue sharing cuts and property tax cuts do not hit all communities equally. It is certainly true that some communities can withstand state cuts, but many other cannot. Our general estimate is that any community with a taxable value of less than $20,000 per person is subject to potential fiscal distress. Our work has shown that at least 10 percent of Michigan cities fall in this category and are potentially at-risk. These communities cannot afford to offset state cuts with local purchasing power and thus are at risk of fiscal distress. It requires extremely nimble leadership to manage these difficult structural constraints. This is the primary explanation for why Michigan so many communities in fiscal distress following from the global financial crisis in 2008-09.
For example, the city of Flint can levy one mill and raise $700,000 in property tax revenue. In contrast, one mill in Ann arbor raises $6.6 million. The same tax burden does not equate to the same amount of buying power for each city. This is especially problematic given that Flint public services are much more expensive to provide than Ann Arbors. Our legacy cities are crucial to the future of the state. We need policies that promote reinvestment and growth and fiscal stability for these communities. We see advances occurring in Detroit but that same progress is needed in Saginaw, Flint, Highland Park, Benton Harbor, and many other communities.
The third leg of the stool are user fees. The primary area of concern here is water and sewer user charges. These revenues can often be as large or larger than general fund revenues. Michigan has serious deficiencies in maintaining this most basic infrastructure that is not just for convenience but a core part of public safety and public health. Billions are needed to upgrade and maintain the current system. Billions more may be needed to transition these municipal sewer and water systems to meet climate policy commitments. Again, these problems do not fall equally on all communities. Our economically distressed communities are already beginning to experience unaffordable water and water user charges, and this is likely to worsen as time passes.
The Federal American Rescue Plan Act (ARPA) and Inflation Reduction Act (IRA) monies can be considered as only a down payment on the massive needs of America and Michigan public infrastructure needs. Further neglect of this system, along with the public road and transportation system, will only further degrade our economic potential.
Key policy alternatives
The current stability of local government should be seen as opportunity to fix the system and prevent future problems. Inertia should not be the order of the day in this policy arena. Many communities in Michigan remain at risk of insolvency should economic conditions change. As the key architect of the local finance system, there are several policies that the state should consider enacting to improve the overall health and resiliency of the Michigan local government finance system.
The legislature and Governor should strongly consider establishing a new Intergovernmental commission. This commission would assess unfunded mandates, track state funding for local governments and most importantly provide an official forum for an ongoing dialogue between state government and its partner local governments.
The state can make statutory changes to the property tax system. These changes will relieve some of the pressure for older and distressed communities in particular. The state can restructure implementing language that was put in place following the passage of proposal A in 1994. As mentioned earlier, these types of policies continue to hinder the ability of economically distressed communities to make up for state reductions in revenue sharing.
The state should make a choice between either full restoration of state revenue sharing or providing new local tax options. To date, the default choice has been neither and this is major cause of local fiscal distress. One options could include a county level income tax where revenue was shared with the cities, villages and townships based on a structured formula. Another option that should be considered is the sharing new property taxes from industrial and commercial development. This could reduce the need for sprawl and competition for jobs between communities in metropolitan areas. Finally, the state could consider allocating some portion of new revenue sharing dollars to communities where the taxable value is less than $20,000 per person so as to reduce potential fiscal distress and level the playing field.
A remark on the Michigan Emergency Manager law. The law as currently written is justified through the idea that the state must be protected from a wayward municipality or county failing to make a bond payment or ensuring ongoing provision of public services. Writing about Michigan and other similar laws, NYU Law Professor Clayton Gillette wrote that “I contend that by addressing the political underpinnings of fiscal distress, takeover boards may be more capable of satisfying interests of local residents for public goods than local public officials”.
I challenge this assertion and assumption. The predominant cause of local fiscal distress is socioeconomic distress. Local political decisions that be part of the problem are conditioned by state fiscal policy and this underlying economic distress. Gillette’s analysis represents a misdiagnosis of the problem. The emergency manager is not a necessary hammer to have in the toolbox to prevent or resolve a crisis from occurring. Home rule has been enshrined in the Michigan Constitution and should be viewed as a key part of the local public finance system.
A new restructured law should be considered by this legislature. This new law needs to be considered in the context of the tools the state already has in the form of the uniform budget act and municipal finance act. The Uniform Budget and Accounting act could be strengthened to ensure better oversight of local finances. Any local government that submits an annual financial audit with a deficit in any fund must file a deficit elimination plan (DEP’s). A new state oversight board could be established to monitor and enforce DEP’s. Failure to submit or comply with a DEP could have added teeth to ensure enforcement. DEP’s could also be strengthened by adding the consent agreement process from the emergency manager law that would give locally elected officials more power with oversight where necessary. This process is followed in other states and has proved to be successful.
There are other tools as well that can be strengthened. The revised municipal finance act has tools to address a situation whereby a municipality or county fails to pay an outstanding debt obligation. The process in the MFA Act could tie into this new state oversight board as well. Municipal bankruptcy could be retained as an option in the most extreme cases.
This testimony was delivered to the 102nd Michigan Legislature's Senate Government Committee on March 15, 2023.