In a nutshell:
- A new accounting rule requires governments to report the costs of property tax incentives for business
- Good Jobs First tabulated the costs of tax abatements for local school districts across the country; Michigan schools lost $106 million in property tax revenue in 2017
- Abating school operating taxes may increase economic activity in a local community, but the burden to finance these incentives falls to all other districts across Michigan
Michigan school districts are not in the business of granting tax abatements to business, but the overlapping local governments in which many districts are located regularly do. The decision to reduce a portion of a school district’s property tax levy has both short- and long-term fiscal consequences. A reduced tax levy means it will take longer (and cost more) to repay debt. Also, because of Michigan’s unique school funding model, tax abatements offered in one district do not reduce, dollar for dollar, the operating funding the district receives. Instead, the costs of financing abated school operating taxes are effectively borne by all school districts across the state.
The General Accounting Standards Board (GASB) is vested with the responsibility for establishing generally accepted accounting principles (GAAP) for state and local governments in the United States. GASB issued a new accounting standard (Statement No. 77), Tax Abatement Disclosures, in 2015 to provide more accountability and transparency in public finance. Many governments are using the new accounting standard now.
Michigan state and local governments, along with many school districts, included the tax abatement disclosures in their fiscal 2017 year-end financial reports. The disclosures provide a rich collection of data to elected officials, researchers, journalists, and others interested in analyzing the costs of business tax incentives and assessing the fiscal health of reporting units. (It should be noted that while state and local governments are required to follow GASB’s principles, there is no such requirement for Michigan public schools.)
Good Jobs First, a Washington D.C.-based think tank that tracks business incentives to promote economic development, issued a new report documenting the effects of Statement No. 77 on school finances across the country. Based on its query of districts in 28 states, Good Jobs First found that $1.8 billion in school funding was redirected to finance corporate tax incentives in 2017; 10 states accounted for nearly $1.6 billion of the total. Michigan was sixth on this “Top-10” listing.
Michigan has 542 local and 56 intermediate (county-wide) school districts authorized to levy school operating and debt-repayment taxes. Good Jobs First examined the financial statements of 347 districts in Michigan; 268 of them reported a total of $77 million in abated taxes for economic development in 2017. This does not include the state’s largest district, Detroit Public Schools, which abated over $28 million for the year, bringing Michigan’s total to $105 million in abated taxes. This probably understates the actual total because some districts do not follow GAAP.
What does this mean for school district finances?
These disclosures reveal an important piece of the funding puzzle, specifically an estimate of the direct fiscal effects of lost school tax revenue. What we can’t know is the economic stimulus generated from abating certain business taxes. This is an age-old conundrum, often referred to as the “but for” clause.
In simple terms, the argument in support of using tax expenditures to entice economic development is that development would not occur without public assistance. Assistance is required to make a project financially feasible. The “but for” name comes from the assertion that development would not occur but for the financial support provided by incentives. Because communities are not able to run true experiments where two exact same development projects are evaluated (one receiving an incentive and the other not), we simply don’t know the efficacy of the “but for” argument. In many instances, public officials in charge of doling out incentives must take developers at their word that a project can’t go forward without assistance.
Who pays for the price of abating local school taxes in Michigan?
That depends on what specific taxes are abated – operating or debt repayment. In the case of debt repayment taxes, the costs of abatements are borne by local taxpayers. If we assume that a development would have occured in the absence of the public assistance, then the abatement has the effect of lowering the receipts of taxing jurisdictions. With a smaller tax yield, either existing tax rates on non-abated properties will have to rise to meet the required annual principal and interest payments or the term of the debt will have to be extended. Stretching out the term will require additional interest expense to be paid by taxpayers.
When it comes to financing abated operating taxes, Michigan functions a bit differently. This is because of our unique school funding system adopted under Proposal A of 1994. Each district is guaranteed an amount of per-pupil funding, called a foundation allowance. Financing the allowance is a joint responsibility between the local district and the state. The first dollars used are the local property taxes levied by a district (i.e., generally, the 18-mill tax on commercial and industrial property, rental units, and second homes). The state School Aid Fund, which receives revenue primarily from the state sales and income taxes, is then used to “top off” the local share to ensure that each district receives its full per-pupil amount. The total amount of state funding received is the product of the state share of the per-pupil grant and the number of students enrolled by a district.
The mechanics of Michigan’s school funding model means that if a portion of the local tax levy is lost to a business tax incentive, the state share will increase dollar-for-dollar. For example, if an abatement is offered for a project in the City of Detroit reducing the school operating tax levy for Detroit Public Schools, the School Aid Fund will have to provide additional revenue to maintain the district’s per-pupil guarantee. More state funding for Detroit Public Schools means fewer School Aid Fund resources available to share with Muskegon, Manistee and Menominee. The bottom line with abated school operating taxes is that public schools across the state pay for the economic development incentives offered in another community.
While the Good Jobs First report provides helpful information about the scope and effect of business tax incentives on school funding in the United States overall, the report misses a key policy implication related to how these incentives interact with Michigan’s unique financing system. When local government officials provide school tax abatements to retain or expand business activity in Michigan, the benefits may be localized within the boundary of a district (e.g., new jobs, larger payrolls, new construction), but the costs to finance these business incentives are socialized in the form of fewer state resources to share across all districts.