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Hard Out There for Michigan Cities: A View from the Revenue Side

Due to a mix of State policies and constitutional arrangements, the State of Michigan sets up cities to be financially fragile.  It should be no suprise then when cities experience severe financial distress or in the case of eight of the States most beleaguered cities, out and out financial emergency.

We often hear local officials in most, if not all of the nation’s cities complain that their state government either does too little, or too much, when it comes to local fiscal capacity. Yet no one has quantified what makes it so difficult on these cities, and how that compares across the United States. In 2015, we undertook a study (funded by the C.S. Mott foundation) to quantify the difficulty cities face in the State of Michigan compared to the degree to which 49 other states in the U.S. challenge their local governments. We found that Michigan makes financial life more difficult for its cities than virtually any other state in the United States.

State Aid to Cities per capitaTo explain how we came to this conclusion, we first need to cover some basics of city governments. Cities provide core services- garbage collection, water, police & fire protection, etc. These services cost money. Yet there is no standard way across cities or states as to how these services are funded. As a result, there is a wide variation as to what cities provide what services and at what levels these services are provided.

As much as there is variation in what and how much cities provide services, there is as much variation in how cities pay for these services. In general, cities rely upon three major sources of funding: (1) State Revenue Sharing, (2) Property Taxes, and (3) Service & Other Special Taxes. There is a wide variation in the levels that cities depend upon these three sources across the United States. In New York, the State provides a large amount of revenue sharing to its cities, meaning they depend upon this revenue source. In Massachusetts, the City of Boston is constitutionally prohibited from receiving a large share of revenue sharing, meaning that they rely upon particular property and tourist taxes. The ways in which cities vary in their tax structures is as diverse as the cities of the United States.  Figure 1 looks at the increases in state aid per state from 1970 to 2005. As we can see, the State of Michigan has not increased aid significantly, and falls under the national average.

Severity of Tax and Expenditure LimitsStates do not allow their cities to collect revenue any way that they desire. They impose Tax & Expenditure Limits (TELS), meaning that they limit how much tax a city can receive, and how much or how little they can spend. In practice, this means that states prevent cities from raising property taxes beyond certain levels, or taxing public transportation beyond what the state deems acceptable. Further, in some states, the expectation and cost of providing services varies. For example, due to its strong union history, personnel costs in Michigan are higher than in other states. Figure 2 shows the increase in tax and expenditure limits across US states from 1970 to 2005. As we can see, the State of Michigan has dramatically limited the ways in which cities can generate revenue, and has the 2nd most stringent TELs in the country. For example, the Headlee Amendment of Proposition A, which was passed in the late 1990’s in Michigan severely handicaps the way in which cities can collect property tax. It limits raising property taxes to a certain percentage of taxable value, and more importantly, limits how much cities can increase their tax rates annually. As a result of the 2008 financial crisis, property values took a major hit, and property taxes fell accordingly. Since that time, property taxes have not rebounded at nearly the rate of property values due to this rate increase limit.

 As we can see, there are two structures to consider when it comes to providing services: (1) How cities receive revenue to provide services and (2) What services cities then provide. In the State of Michigan, cities are pushed to their limits on both of these variables. As you can see from the two graphs, the State of Michigan has limited State Revenue Sharing while simultaneously restricting the ways in which cities can collect revenue (TELS). (Further exacerbating these issues, the State of Michigan drives up expenditure pressures, meaning cities have to provide services at a higher level than they may desire at a cost that is largely out of their control).

State Aid Policy GapIn Figure 3, we categorized states into two categories: ‘Carrot & Stick’. Carrot states, over the years, have chosen to both impose weaker than average TELs while providing some investment in cities via intergovernmental aid. Stick states, over the years, have cut local aid and have increased tax and expenditure limits, leading to increased revenue side pressures on their cities. These states harm cities’ abilities to stay financially solvent, especially during difficult times.  As figure 3 illustrates, Michigan is among the worst offenders when it comes to constraining the revenue capacities of local governments.

The result: a thin and fragile revenue picture for Michigan’s hundreds of cities. If legislators want to prevent the State’s next financial meltdown, they need to take a deep and hard look at these policies. The State of Michigan needs a major overhauling in how they treat their cities, and until that time, no Emergency Manager, or any local government for that matter, will be able to overcome the state imposed fiscal limits to provide services for residents in a way that makes financial sense.