Barring a legislative change, the City of Detroit’s municipal income tax rates (resident and nonresident) will be rolled back in July for the first time since 2003. These reductions will occur because the City failed to meet three of the four criteria in state law that would prevent the rollback from occurring. The rate reductions are estimated to cost the City $8.5 million on a full-year basis. The estimated revenue loss, while minor in the big picture of Detroit’s finances, comes at a time of considerable fiscal stress for the City.
State law (City Income Tax Act) authorizes Michigan cities to levy a municipal income tax on resident individuals, non resident individuals working in the city, and corporations. Twenty-two cities have availed themselves of this revenue option to supplement property taxes to support municipal finances. Generally, the Act limits the rate levied on resident individuals and corporations to 1%, and 0.5% on nonresident individuals. However, certain exceptions are allowed under the law, including for cities with a population of 600,000 or more (Detroit is the only city that qualifies). A special provision allows Detroit to levy the tax at a rate of 3% on resident individuals, 2% on corporations, and 1.5% on nonresident individuals. Prior to 1999, Detroit taxed individuals at the maximum rates allowed and corporations at 1%.
Public Act 500 of 1998 amended the City Income Tax Act to reduce the income tax rates for resident and nonresident taxpayers in Detroit. Beginning with a tax rate of 3% on residents (1.5% on nonresidents) in 1999, the law provides that the resident tax rate is to be reduced by one-tenth of a percentage point per year, with the nonresident rate reset to one-half of the resident rate. The City’s income tax rates were reduced each year from 1999 until 2003, until the rates were 2.5% for residents and 1.25% for nonresidents.
The reductions were to occur each year for a ten-year period until the new rates were 2% and 1% respectively, provided certain unfavorable financial conditions related to the city, as defined in the law, did not occur. The scheduled rate reductions were part of an agreement related to major changes in the state revenue sharing formula contained in PA 532 of 1998, which guaranteed Detroit a fixed sum of state-shared revenues for 8 years.
Under PA 500 of 1998, the scheduled rate reductions can be halted if the City applies to the State Administrative Board and demonstrates that any three of four conditions are met:
- Two consecutive years of withdrawals from the city’s budget stabilization fund or exhaustion of the fund balance;
- A year-to-year decline in income tax revenue, after adjusting for inflation, of more than 5%;
- A city unemployment rate of 10% or higher; or
- A provision which compares the growth ratio of the city’s taxable value with the comparable statewide figure and computes a ratio which must fall below .80.
The City met at least three of the criteria to halt the scheduled rate rollbacks for 2004 through 2007 and for 2010 through 2011. For 2008 and 2009, Detroit did not meet the criteria, but the City Income Tax Act was amended to freeze the rates at the 2007 level. Therefore, Detroit’s income tax rates have been effectively frozen at 2.5% and 1.25% since 2003.
The Citizens Research Council of Michigan recently did the calculations involved to see if the City of Detroit will meet the requisite conditions to pause the scheduled rate rollbacks for 2012 (scheduled to occur in July). The Citizens Research Council determined that the City only meets two of the criteria (budget stabilization fund and unemployment rate). From 2010 to 2011, Detroit income tax collections increased from $217 million to $228 million. Also, the property value change in Detroit from 2010 to 2011 was the same as the statewide average for the period.
Therefore, unless state law is amended, the municipal income tax rates for residents and nonresidents will fall from 2.5% to 2.4% and from 1.25% to 1.2%, respectively, in July 2012. The rate reduction will be the first of its kind since 2003. This will cost Detroit about $8.5 million in lost revenue on a full-year basis if the rates are not frozen at 2011 levels through a statutory intervention (similar to what occurred in 2008 and 2009). Although $8.5 million represents only a fraction of the nearly $1.2 billion General Fund revenue generated by the City in 2011, it does add to the current fiscal challenges facing the City.