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CRC Column

The right to criticize government is also an obligation to know what you are talking about. 
-Lent Upson, 1st Executive Director of CRC  

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Using State Shared Revenues to Incentivize Local Government Behavior
July 2012
State Budget Note 2012-03

Governor Snyder's first state budget (FY2012) is significant for a number of reasons: the breadth of appropriation reductions enacted to address a projected $1.5 billion General Fund deficit, the effects of the business/individual income tax reform package (a net tax cut) on the amount of state resources available, and the interchangeable use of the School Aid Fund and General Fund to finance education appropriations. Also notable is a not-so-subtle shift in how the state shares its financial resources with sub-state entities - K-12 school districts and general purpose local governments. The main thrust of the shift requires these entities to engage in certain behaviors as a condition of receiving state funding, as opposed to the state's previous practice of providing state collected resources without "strings" attached. The FY2012 state budget established the foundations for this policy shift and the FY2013 budget expands the practice to other entities.

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The State of Michigan shares state-generated resources with local units of government - cities, villages, townships, counties, community colleges, and school districts - using a variety of methods. State revenue distribution payments are financed as a share of a specific state tax or from a state fund which receives revenue from a variety of taxes. Some state revenue distribution programs are spelled out in the 1963 Michigan Constitution, while others are contained in statutory provisions, some of which are subject to annual appropriation decisions.

State revenue distributed to local governments is a significant share of the overall state budget: it represents nearly three-fifths (almost $15 billion) of all state spending from state resources in FY2012. Chart 1 summarizes the major categories of state payments to local units in the current year. The school finance reforms of the mid 1990s replaced local property taxes with state distributions and as a result, K-12 state aid comprises nearly three-fourths of total state distributions today. Unrestricted general revenue sharing to cities, villages, townships, and counties (statutory and constitutional payments), once the second largest portion, has declined to the fourth largest component (6 percent of the total) because of reduced state sales tax collections over the Great Recession and the sizeable cuts made to statutory payments throughout the 2000s.

Michigan, like many other states, has a long history of sharing state-generated revenues with local units of government. State aid for schools is the oldest program, dating back to the early years of statehood. Initially, the state distributed the Primary School Fund among schools based on the number of students in a township; these funds were supplemented with locally-raised taxes. The state began sharing nearly all of the retail liquor license tax receipts with cities, villages, and townships as unrestricted revenue sharing in the early 1930s. This was followed, in 1939, by sharing state intangibles tax on a per-capita basis with cities, villages, and townships, in exchange for the removal of intangibles property from local tax rolls. Over the years, the state developed a host of programs to share state revenues with all types of local governments.

The school finance reforms enacted in the mid-1990s materially changed Michigan's state-local intergovernmental fiscal relationships. The shift in funding responsibility for K-12 school districts (from local property taxes to state distributions) was large enough to increase the share of state payments made to all local governments, as a group, and decrease the reliance on local own source general revenues (taxes, fees, charges, etc). Prior to the reforms (in 1992), state payments accounted for 31 percent of total local government revenues and own source revenues made up 66 percent of the total. Immediately following the reforms (in 1996), the state-local mix changed to 50 percent and 47 percent, respectively.

Also, the school finance reforms changed Michigan's rank among all states in terms of state-local fiscal relations. Today, Michigan local governments, as a group, rely on state shared revenues to a greater degree than local governments in other states to finance local services. Local government reliance on state shared revenues as a percentage of total general revenue for the 50 states is shown in Chart 2. For the most recent year (2009), U.S. Census figures reveal that Michigan local governments of all types and as a group received 43 percent of their total general revenue from state intergovernmental transfers, while 53 percent came from own source revenues (the remainder, less than 4 percent, came from federal intergovernmental transfers). Across all states, the split for local governments as a group was 33 percent from state shared revenues and 62 percent from own source revenues. In 2009, Michigan ranked fifth highest in the share of total local government general revenue coming from state payments (Vermont - 67 percent, Arkansas - 54 percent, New Mexico - 52 percent, Delaware - 47 percent).

For Michigan, as well as other states, these aggregate figures can disguise the experience for different types of local government. In the case of local school districts in Michigan, the U.S. Census reports that state revenue accounts for 54 percent of the total $19.4 billion revenue in 2010, a full 10 percentage points above the average figure for all Michigan local governments in 2010.

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