# Implementation of the New Formula and Remaining Issues in Michigan’s Unrestricted State Revenue Sharing Program

**In Brief**

After nearly two years of deliberation and debate, in December 1998, the Michigan Legislature approved a new set of statutory revenue sharing formulas to distribute more than $800 million annually to cities, villages, townships, and counties. The new formula reflects a general decision to shift shared revenue payments *gradually* from urban areas to suburban and rural areas, from southeast Michigan to out-state Michigan, and from cities and villages to townships. The changes included in the new legislation will take ten years to be fully implemented. In the interim, a new census will create new population counts and the bill will sunset. For most units, the reflection of the new census counts in FY2001 will cause the largest year-to-year change experienced during the phase-in period. The law containing the new formulas is scheduled to sunset on June 30, 2007. The new revenue sharing formulas create, as do most significant public policy changes, winners and losers.

- Generally, townships and villages gained both individually and collectively in share of statutorily defined payments and cities lost share.
- The somewhat complicated mechanisms intended to smooth the changes over many years and protect units from abrupt decreases in payments generally work.
- A recession will more adversely affect units receiving payments under the payment increase cap mechanism than other units. These units will be more adversely affected in a recession than they would have been affected in the same recession under the previous formulas.
- In order to formulate a revised program, special treatment for the City of Detroit was necessary. The bargain Detroit struck has two parts. Its annual payments are frozen at $333.9 million until June 30, 2007. In exchange for the protection against declining payments afforded by this provision, the city personal income tax rates on resident and non-resident taxpayers are reduced by one-third over a ten-year period. This is accomplished in even percentage point decrements each year.
- The new revenue sharing formulas are scheduled to expire June 30, 2006, 15 months before the phase-in of the new formulas is completed. If the legislature chooses to continue the plan beyond that date, the payment cap mechanism would need to be continued or another form of safety net implemented in order to avoid significant drops in payment levels for a few units.

This Memorandum is a distillation of a longer and more detailed analysis that may be obtained by contacting the Citizens Research Council or by downloading it from the CRC website. Also available on the CRC website is the Revenue Sharing Calculator. CRC, with financial support from the Michigan Municipal League, developed an online calculator tool that may be accessed by anyone at no cost. Users of the calculator may substitute their own 2000 population figure for a unit or run the calculator several times using a range of population figures. The calculator produces statutory, constitutional, and total payment figures for state fiscal years 1998 through 2006. The calculator address is http://calculator.crcmich.org.

# I. Introduction

The State on Michigan distributes more than $1.4 billion annually to counties, cities, villages, and townships in no-strings-attached financial aid derived from 36.3 percent of the portion of the Sales Tax at a four-percent rate. It comprises shared state tax revenues that are distributed to cities, villages, townships, and counties based on formula calculations. The expenditure of these funds may support any programs the individual units operate. Over 1,800 local units of government benefit from these revenue allocations, which, for many units, is their largest source of revenue.

During the 1980s and through the middle of the 1990s, the revenue sharing distribution methods stayed relatively constant. The amount distributed under the statutory formulas was reduced from time to time, usually in association with budget difficulties experienced by the state. During that period, criticism of the statutory distribution formulas, relative tax effort (RTE) and inventory reimbursement became widespread.

In an effort to bring closure to the criticism and debate, the Legislature, in June 1996, passed a bill establishing a bipartisan task force of legislators charged with identifying alternatives to the RTE and inventory reimbursement formulas and recommending changes in existing law. The legislative task force was to submit a written report to the legislature by the end of September 1997. Failure by the task force members to reach agreement on recommended changes caused the report to be delayed, and after one formal legislative extension of the deadline, certain task force members introduced legislation reflecting their individual points of view.

Finally, in December 1998, legislative leaders and the Governor forged a compromise that became the current law. It reflects a general decision to shift shared revenue payments *gradually* from urban areas to suburban and rural areas, from southeast Michigan to out-state Michigan, and from cities and villages to townships. The changes included in the new legislation will take ten years to be fully implemented. In the interim, a new census will create new population counts and the bill will sunset. For most units, the reflection of the new census counts in FY2001 will cause the largest year-to-year change experienced during the phase-in period. The law containing the new formulas is scheduled to sunset on June 30, 2007.

# II. Features of the Old Formulas

Under the old law, statutory payments for cities, villages, and townships were calculated using two formulas. Each formula had its detractors and was subjected to ongoing analysis and criticism.

## A. Inventory Reimbursement

A unit’s inventory personal property tax base in 1975 was multiplied by the tax rate in the current period and the amount was paid to the unit. This mechanism was intended to compensate units for lost tax revenues associated with the repeal of the inventory tax when the Single Business Tax (SBT) was implemented. The source of State revenue used for this payment was, fittingly, SBT revenues.

The inventory reimbursement mechanism had some very obvious flaws. Since the tax base remained at the 1975 level, the mechanism’s ability to compensate local units for their losses in real terms declined over time. In nominal terms, inventory payments increased only 16 percent during a period when the overall property tax base increased 257 percent. Since inventory is no longer measured or reported for property assessment purposes, it is not possible to measure the degree of distortion that has occurred in the reimbursement mechanism over the years. However, it is not likely that the location of inventory remained static during that time period. Moreover, it is probable that some units that lost inventory continued to receive payments for revenues that would have declined as a result of migrating inventories.

Several units received substantial payments per capita and the prospect of losing that revenue source created concern and resistance by these units. In FY 1998, 25 communities, mostly cities, received per capita payments of $30 or more from this source. Fifteen of these units received more than one-fourth of their total revenue sharing from inventory reimbursement payments.

## B. Relative Tax Effort

Each unit’s payment under the Relative Tax Effort (RTE) was determined by computing its population weighted by the ratio of its local tax effort in mills divided by the local tax effort statewide. In most units the local tax effort is the local property tax rate; in 22 cities that levy a city income tax the millage equivalent of the resident tax collections was added to the calculation, and in Detroit the excise tax on utility payments was converted to mills as well.

It was argued that RTE reflected needs in the community, ability to raise revenues to support services, and the willingness of residents to tax themselves to pay for their government. However, it was also argued that the RTE calculation encouraged higher taxes and an unfair redistribution of state revenues to high tax areas.

**The criticism of the RTE formula that it encouraged increased taxes was probably exaggerated. The “revenue sharing match” per capita for each mill of tax levy was only about $2.50 in the final year of the formula. An average unit with taxable value (TV) per capita of $20,000 would raise $20.00 per mill per capita from their property tax levy, eight time the revenue sharing payment per mill. For most units the state payment was probably a small inducement to raising taxes. However, for units with low tax bases per capita, increased mills were matched at effectively a higher percentage, although the same dollar amount. A unit with TV per capita of only $10,000 would raise $10.00 per mill per capita in property taxes and would still receive $2.50, effectively a 25 percent match. In FY1998, 136 units, only eight percent of all units, had taxable value per capita of $10,000 or less. While the prospect of increased state aid probably was considered as tax increases were being discussed by local unit legislative bodies, it seems unlikely that it would have been a controlling consideration in decisions to raise taxes.**

Because the constitutional portion of revenue sharing is distributed on a per capita basis, per capita payments became a benchmark to gauge the RTE formula and other proposed alternates. Each unit received nearly $61 per capita constitutional payments in FY1998. Compared with that per capita payment, the RTE formula generated very wide variations. A unit with one mill of local tax effort received about $2.50 per capita, while Detroit, with approximately 92 mills of local tax effort received about $230 per capita. More than 200 units, almost all of them townships, levied one mill or less in FY1998.

Higher tax communities tend to be (1) communities with a more extensive array of services, (2) cities and villages (rather than townships), and (3) communities with lower taxable value per capita. Because of this, the RTE formula tended to provide a degree of equalization of revenue-raising capacity. However, if the principal objective of the formula was equalization, it had a fundamental flaw. The level of state support was entirely independent of any direct relationship to revenue raising capacity, as measured by taxable value per capita. Many examples exist of communities with virtually identical levels of tax effort with very large differences in taxable value per capita and correspondingly differing levels of tax revenue. Since the RTE formula has the effect of adding a constant amount per capita to the revenues available to two units with the same tax effort, the formula maintains the absolute difference in resources while narrowing the relative difference.

# III. The New Revenue Sharing Plan

The compromise reached in December 1998 included elements of the formulas proposed by individual members of the legislative task force. The compromise that emerged from the legislature created a new formula for all cities except Detroit and all villages and townships. The new formula, which has three components, changes the payment shares significantly from the old two-part mechanism.

## A. Freeze Detroit Allocation

Detroit’s combined constitutional and statutory revenue sharing payments are frozen at $333.9 million for fiscal years 1999 through 2006. In exchange for the protection from declines in payments resulting from census reductions and the new formulas, the city’s personal Income Tax rate will be reduced by one-tenth of a percentage point per year from its 1998 rate of three percent to two percent. The rate on non-residents working in the city will be reduced from 1.5 percent to one percent over the same period of time. The city also obtained legislation lowering the population threshold from 1,000,000 to 750,000 for its Income Tax rate and authorization to levy the Utility Users Excise Tax.

## B. The New Formulas

Statutory revenues are subject to three separate distribution formulas with each formula operating on one-third of the revenue base. The amounts from each formula are combined to determine the total statutory payment.

### 1. Unit Type Population Weighting

This component is based on the contention that service delivery costs depend on the type of unit and population size within a given unit type. Cities are regarded as the most complex unit type, followed by villages and townships. A separate table of weights is used for each type of unit and the weights are different for intervals of population size. Weights increase as population increases and weights are progressively higher for a given population as the unit type moves from township to village to city. A unit’s population is multiplied by a weight ranging from 1.0 (small townships) to 7.46 (City of Grand Rapids).

### 2. Taxable Value Per Capita Weighting

This component provides greater state support to units with smaller per capita tax bases. The state average TV per capita is divided by each unit’s TV per capita and the result is multiplied by the unit’s population to obtain the unit’s weighted population (see **Figure 1**). By providing higher payments to units with lower TV per capita, the formula adjusts for revenue raising capacity.

### 3. Yield Equalization

This component is intended to create a minimum guarantee on combined state and local revenue per mill of tax levy. The amount necessary to guarantee the total revenue proceeds (tax collections plus state payment) from each mill of local tax effort up to a maximum of 20 mills is computed. The guarantee is expressed in terms of a taxable value per capita (approximately $20,900 for FY2000 payments) that would pay out the entire amount of statutory revenues. The calculation is the local tax effort in mills (up to a maximum of 20 mills) times the difference between the guarantee and the actual taxable value per capita for the unit times the unit’s population. The formula payment amount is one-third of the amount computed by this taxable value guarantee calculation. Only units with taxable values per capita less than the guarantee amount ($20,900) receive payment under this formula. This component has the effect of creating a floor under the total state and local revenue yield for each mill levied, up to the maximum guarantee of 20 mills. The formula is illustrated by **Figure 2**.

## C. Ten-year Phase-in

In order to promote an orderly transition from the old to new formulas, a ten-year phase-in is included. This phase-in has two components. First, the amount by which each unit’s share may increase is limited. Payments may not increase by more than eight percent from year to year. Amounts in excess of eight percent are distributed in a way that a floor is created for year-to-year declines or increases in total payments. One important exception provides that a unit whose 2000 census population increases by more than 10 percent from the 1990 census is not subject to the eight percent growth limit for all years after FY2000.

Second, the program gradually changes from the former formula to the formula defined by the 1998 law. Beginning in FY1999, for each local unit, the shares of total statutory revenue sharing are determined for the FY1998 actual payments and the fiscal year for which the distribution is being made. In FY1999, 90 percent of the distribution is based on the FY1998 shares and 10 percent is based on the FY1999 shares. In FY2000, 80 percent of the distribution is based on FY1998 shares and 20 percent on FY2000 shares. This calculation progression continues throughout the statutory life of the program until FY2007. A unit’s preliminary statutory allocation is determined by adding the two amounts, based on old and new formulas, together. The unit’s constitutional payment is added to the preliminary statutory payment and any amount exceeding an eight-percent increase from the prior year is subtracted from the total unit payment. The amounts in excess of eight-percent increases are distributed to units so that a uniform floor in the percent decrease or increase is created.

Beginning in FY2001, the 2000 census population counts are used for the calculations for the new formulas. Any unit whose population increases by ten percent or more from census to census is not subject to the eight-percent increase limit for FY2001 and years after.

# IV. The Formula Effects

In the aggregate, townships and villages benefit and cities lose under the new formulas. Approximately three-fourths of villages and townships are winners, while only about two-fifths of cities gain payment shares. **Table 1 **summarizes the numbers of winners and losers by unit type and provides the percentages in each category. In order to explore the formula effects in more detail and identify the characteristics of units gaining and losing, two groups of specific units were selected for review: the most populous units and a representative group of smaller cities, villages, and townships.

## A. The Most Populous Units

The first group is composed of relatively large cities and townships, the 100 units with the largest populations in 1990 or 2000. Larger units tend to face a different set of service delivery demands than smaller units and tend to levy higher tax rates than smaller units.

The analysis measures the change in payments that would occur if the new statutory changes were to occur in total in FY1998 in order to assess the effect of the new formulas without any changes in the amount of revenue distributed. (A way to isolate the effects of the new formulas from other sources of change is to compare the shares of the statutory payments in the final year of the old formulas with the combined payment shares with the new formulas using the 1990 population counts for both calculations. The result of such a calculation, in effect, abstracts the revenue growth, population change, and eight-percent growth limit factors from the analysis and produces a comparison of the final shares each community would receive if the new formulas were fully implemented.) Also included are the new shares in total revenue sharing, statutory plus constitutional, again *assuming the statutory changes were implemented all at once.* The addition of the constitutional payments to the measure narrows the range of changes in payment shares. Finally, the effect of the 2000 census counts is introduced into the analysis. The dynamics of population change, formula changes, and revenue growth are illustrated by the analysis and the generalized conclusions drawn from the analysis should apply to units with similar patterns of characteristics.

### 1. Winners and Losers

The range in the projected changes of the winners and losers among the individual units is very broad. The detailed report provides statistics for the 104 individual units included in the group. The change in statutory share ranged from a 540 percent increase for Summit Township to a 70 percent reduction for the City of Trenton. After factoring in the constitutional per capita payments, the largest increase in share is 52 percent for Mount Morris Township in Genesee County and the largest decline is 41 percent for the City of Trenton.

Trenton’s situation is affected significantly by the loss of inventory reimbursement payments. In FY1998, 23 percent of the city’s total revenue sharing payments came from this source. Only 19 units had a higher percentage than Trenton and only two were in the most-populous unit group: Brownstown Township in Wayne County and the City of Pontiac in Oakland County. Both units also record large losses in payment shares.

Units with relatively low taxable values per capita receive added weight in the payment computation in two ways.

- First, through the ratio of the state average taxable value per capita divided by the units TV per capita (one third of the formula). A unit with TV per capita below the state average has its population weighted greater than one.
- Second, yield equalization payments (one third of the formula) are received if the taxable value per capita of a unit is below the guarantee level (about $20,900 for FY2000). Up to a limit of 20 mills in the yield equalization calculation, units receive greater payments the greater the local tax effort.

In the unit type population weighting portion of the formula (one third of the formula), unit weights increase in intervals as population increases. For a specific population size, the weight is generally lowest for a township, higher for a village, and highest for a city. This pattern does not hold for townships with populations exceeding 20,000, which receive the same weight as cities with the same population.

Knowing the unit characteristics that result in greater payments does not necessarily enable one to predict how a unit will fare under the new formula relative to the old. There are only a few areas where winners or losers represent a high percentage of units with a given characteristic. The following summarize the findings for the most populous units:

- The strength of the unit’s taxable value per capita does not play a role unless it is at least 40 percent below the state average. Winners and losers are divided fairly evenly by taxable value per capita until the TV per capita falls 40 percent or more below the state average. Two thirds of the units in that group are winners.
- Local units are rewarded for maintaining lower taxes. For units with local tax effort (LTE) rates from ten mills (the state average) to 16 mills (60 percent above the state average), losers outnumber winners by almost four to one. For units with LTE rates more than 20 percent below the state average (eight mills or lower), winners outnumber losers by more than five to one.
- It helps to be bigger. Units with smaller population sizes tend to do better than those with larger populations. Comparing units by unit type population weights reveals losers outnumbering winners for units with populations exceeding 80,000 by two to one, units with population between 20,000 and 40,000 showing winners exceeding losers by two to one, and about 60 percent of units below 20,000 losing payment shares.
- Finally, comparing units on a broad geographic basis yields a somewhat surprising result. As changes in the statutory mechanisms were debated in Lansing, it was alleged that most proposals would benefit the western part of the state vis-a-vis the southeastern part of the state. While winners outnumber losers in west Michigan by ten to six, 23 out of the 66 units in the seven-county southeastern area are also winners under the new formula. Interestingly, nine out of the ten units in the I-75 corridor of counties north of the Detroit area are winners and eight of the ten units in the central part of the state gain. (See
**Map 1**.)

### 2. The 2000 Census

In FY2001, the impact of the 2000 census will dwarf any effects of the changes in formulas on unit payments. A pattern of relatively large increases and decreases mixed with more moderate changes will occur. The magnitude of change for any unit is important for two reasons:

(1) All of the payment components, with the exception of residual shares of inventory reimbursement payments, are population-driven. In FY2001, all of the constitutional payments will be based on 2000 population. Statutory payments will be based 70 percent on old formula shares and 30 percent will be based on new formula shares and 2000 population, reflecting the status of the ten-year phase in of the new formula.

(2) Complicating the situation is the provision that exempts from the yearly payment growth limit of eight percent any unit with population growth from 1990 to 2000 exceeding ten percent. Several hundred units will exceed the ten-percent growth threshold. The population growth for the state as a whole, excluding Detroit, is likely to exceed eight percent. CRC calculations indicate that about 1000 of the nearly 1800 units, serving 45 percent of the state population, excluding Detroit, will grow by more than ten percent.

The ten-percent provision will have the effect of removing about $8 million from the pool of money used to create a floor under units who face significant losses in statutory payments.

## B. The Less Populous Units

In order to illustrate the effects of the new formulas on smaller units, 63 cities, villages and townships were selected that reflect variations in local tax effort, taxable value per capita, and population size. The population sizes were selected so units in each population interval of the unit-type population weighting formula are represented. The detailed report provides statistics for the individual units included in the group.

Of the 63 units in the analysis, 25 are winners while 38 lose shares. When the changes in payment shares are examined in groupings based on the LTE and TV per capita measures, only one strong pattern emerges. All 19 units with low TV per capita experience significant increases in statutory payment shares and the increases average 116 percent. After adding the constitutional payment shares to the computation, the average increase is still a significant 33 percent. The emphasis given to TV per capita, which appears in two of the three formula components, translates to these gains for the low-value units. Of the 44 units with medium or high TV per capita, 38 lose payment shares while six gain.

## C. Detroit

The final solution to the revenue sharing debate involved special handling for the City of Detroit, potentially the biggest loser in most of the formulas under consideration. This compromise reached protects Detroit from reductions resulting from the likely population decline in the 2000 census and the effects of a new statutory formula that would have reduced Detroit’s share of the statutory revenue pie. From the standpoint of the city budget only, the city will have less revenue over the period than if the Senate bill that had received approval and would likely have been adopted had this compromise not been reached had passed. However, if the city and its taxpayers are viewed collectively, the new mechanism is beneficial vis-a-vis the Senate bill.

# V. What Path Has Revenue Sharing Change Taken? Where Will It Go In The Future?

The new formulas resulted from a number of concerns and policy considerations:

- It was perceived by some that a formula that encouraged units to raise taxes should be eliminated.
- The mechanism to reimburse local units for lost inventory no longer was appropriate.
- Large units face more complex and expensive service demands than small units.
- At the same population level, the complexity and cost of different governmental forms declines from cities to villages to townships. This is often reflected by the less complex forms depending on other units, usually the county, to provide services typically performed by cities.
- The state should somehow reflect revenue-raising capacity in the distribution mechanism.
- Revenue sharing is such an important component of local government finance that changes resulting from new formulas should be moderated.

The formulas that that Legislature approved arguably reflect these considerations. But in the final analysis, what has this meant so far and what will it mean in the future to the payments received by nearly 1,800 cities, villages, and townships in Michigan? The following material summarizes the path revenue sharing has traveled since the changes were first implemented and identifies some policy problems likely to confront the legislature as the sunset provision of the act approaches in 2007.

## A. FY1999: 1st Year’s Experience

It is not surprising that the range of changes in total payments experienced by the units was relatively narrow when compared with the very large changes that the new formulas may ultimately bring. The first actual year of the new formula experience may be summarized as follows:

- The State failed to appropriate nearly $18 million of revenues called for by the statutory percentages. This amounts to about five percent of the statutory base for units excluding Detroit and about two percent of the total payment base for these units. This entire shortfall came from the new formula component causing the new formula distribution to be reduced by more than half from a potential payment of $34.8 million to $17.1 million. The effect of the new formulas on the redistribution of revenues was lessened considerably as a result of this factor.
- The provision holding all units harmless from year-to-year reductions in payments
*in the first year*provided protection to 54 units at a cost of less than $400,000. Four cities received the majority of the payments: Ecorse, Pontiac, River Rouge, and Trenton. - The distribution of change in payments was quite narrow when compared with the range that would have occurred had the new formulas been implemented without controls and phase-in of limits on increases. The payment increases ranged from no change (for 54 units) to seven percent. Without controls, the range of changes is estimated at a 58 percent reduction to an increase of 154 percent.

## B. FY2000: Projected Results

The following summarizes the FY2000 situation:

- The FY2000 appropriation provides sufficient revenue growth to fund eight-percent increases in total statutory and constitutional payments for all cities, villages, and townships (except Detroit):

¾ Approximately two percentage points of total potential payments were not appropriated in FY1999. This revenue was included in the appropriation in FY2000.

¾ The growth that Detroit would have received had there been no change in revenue sharing ($12.3 million) is available to distribute to the other units.

¾ The baseline growth in revenues reflected in the appropriations is 3.8 percent (subsequent revenue forecasts have raised the projected growth rate).

- Considerable redistribution between units occurs as the eight-percent cap mechanism operates. Nearly 300 units which would receive double-digit increases with no cap are held at eight-percent increases. A total of 806 units are subject to the eight-percent cap and 969 benefit from redistributed revenues.
- At the end of the second year of the new formulas no unit will have received less than an eight-percent increase in payments from the FY1998 distributions.
- As units face the prospects of the 2000 census and its effect on allocations, units likely to experience population declines and who also lose payment share under the new formulas are positioned more favorably than if the overall payment change pattern had been even.

## C. FY2001: Projected Results

The following summarizes the FY2001 outlook:

- The phase-in of statutory payment components is based 70 percent on a unit’s percentage share of the FY1998 statutory payments and 30 percent on the new statutory formulas.
- Shortfalls in the appropriation of sales tax revenue called for in the revenue sharing statute continue to come entirely out of the new statutory formula component.
- Units with population increases from 1990 to 2000 of ten percent or more are not subject to the eight-percent cap limitation mechanism in FY2001 or subsequent years. The population projections used in preparing this report have 914 of the 1,775 units (51 percent) exceeding the ten-percent threshold.
- The state’s population is expected to increase by about six percent and exclusive of Detroit by eight percent. Units failing to increase by at least as much as the overall state total (exclusive of Detroit) lose in their share of constitutional payments and generally lose in the new formula portion of the statutory payments. However, the old formula shares, although declining in weight by ten percentage points each year, provide a temporary cushion to units with declining population shares.
- For units whose 1990 to 2000 population change is less than a ten-percent increase or a decrease, the total amount received cannot exceed an eight-percent increase and amounts in excess of the eight-percent limit are redistributed as in previous years. Of the 1,775 units, 861 (49 percent) are projected to have a population increase less than ten-percent.
- The Governor’s recommended budget for FY2001reflects the consensus revenue forecast and allocates all of the earmarked projected sales tax revenues. The year-to-year growth in total revenue sharing allocations for units except Detroit is nine percent. This large increase pushes 301 of the units left in the eight-percent cap category beyond the eight-percent growth limit and produces $5 million for redistribution to units whose allocations would otherwise decline. Without the floor provided by this mechanism, year-to-year reductions as large as 28 percent would occur. Instead, the floor is estimated at a 0.5 percent decrease. From the standpoint of units whose population decline is likely to be significant, a large amount of eight-percent cap funds couldn’t come at a better time.

## D. Three Years in Summary

After three years of phasing into the new formulas there are no significant dislocations or hardships. The minimum increase in allocations over the three years is 7.5 percent, a little below the total rate of inflation for the period (about nine percent). The mechanisms in the new formulas designed to ease units into the new funding scheme have generally worked. However, the separation of units with growing population into two groups with an arbitrary cliff of ten percent has created some inequities and problems:

### 1. Problems with the Cap

The Legislature included the eight-percent cap to cushion payment reductions for units who are relative losers under the new scheme. However, units with slower growing or declining population were chosen to forgo some of their payments to assist the less fortunate units. Among those subject to the cap, 44 units have populations projected to decline between 1990 and 2000. While a decline in population, other things being equal, reduces revenue sharing payments, some units are such large winners under the new formula that the increase in formula share more than offsets a population decrease. Benton Harbor’s population is projected to decline about eight percent but its statutory formula share increases 135 percent and total payment share increases by 86 percent.

### 2. Should the Eight-Percent Cap Be Expanded?

The eight-percent cap is only available to provide a floor under payment changes for units whose population change is less than a ten-percent increase. However, some units with greater than ten-percent population increases would qualify for payments under the mechanism, if the statute did not exclude them. It is likely that this result was not intended. Consideration should be given to amending the statute. In FY2001, only one unit is adversely affected by this provision. After FY2001, if the exclusion remains in place, more than 50 units are projected to experience year-to-year payment reductions or increases below the floor created by the eight-percent cap.

## E. When The Sun Sets

On June 30, 2007, the statutory formulas defining payments for cities, villages, and townships expire. Legislative action will be needed to determine future payment amounts. The possibilities are many, but a continuation of the current law, with and without the eight-percent payment increase limit, is likely to receive consideration.

Continuation of the eight-percent mechanism would extend the period of controlled change for units that had not escaped the provision because their population increase exceeded ten percent. About $10 million is projected to be redistributed to 120 units by the eight-percent cap in FY2006. A total of 206 units contribute to maintaining a floor of a 1.4-percent increase. If the mechanism continues beyond the sunset of the act, it would take several years to eliminate all units from the cap. Approximately 20 units would likely extend beyond the 2010 census in terms of contributing to the cap fund.

An interesting possibility is the removal of the eight-percent limit. In order to analyze this possibility, projections of the payments in FY2008 were prepared under the assumption that new formula payment shares would be applied without any cushion provided by the eight-percent mechanism. Approximately 100 units would experience drops in total payments in FY2008 compared with FY2006, despite increases in revenue to be distributed of ten percent over the two-year period. Some of the reductions would be very large. They arise from multiple factors:

The 2000 population count reflects a very large drop in population in certain units, but the formula phase-in and eight-percent increase limit protection prevents payments from declining. A handful of units are likely to fall into this group. Such large population reductions are generally caused by significant shocks to their local economies from events such as the closure of K.I. Sawyer Air Force Base in Marquette County. Two townships in that county, Forsyth and Sands, have projected populations declines exceeding one-third.

- The new formulas significantly disadvantage a unit due to a specific set of factors combining to reduce its payment shares. A unit with (1) relatively high local tax effort (LTE), (2) taxable values higher than the threshold for yield equalization payments, and (3) relatively small population so its unit type population weight is low, would fall into this group.
- The unit received a significant percentage of its payments under the old formula from inventory reimbursement payments and no other factor rescues it from overall payment reductions when the eight-percent protection is removed.

Finally, 49 units in the model reflect reductions in total payments in FY2008 compared with FY1998. The majority of the units have projected reductions in their population, explaining some or most of the reductions in payments. However, six units reflect payment declines even though their population counts are projected to increase. Each of these units exhibits:

- Relatively heavy reliance on inventory reimbursement payments (from 15 percent to 37 percent of total revenue sharing payments in FY1998), and
- TV per capita high enough to exclude the unit from participation in the yield equalization portion of the new distribution mechanism and cause the TV per capita weight to be low.

## F. Effects of a Recession

Most of the analysis has assumed that the future changes in revenue subject to distribution through the formulas will increase smoothly throughout future periods. The rates of increase used by state agencies in their projections have generally clustered around four percent and the CRC model assumes increases of four percent each year after FY2001. However, while the state and national economies are experiencing a record period of uninterrupted economic growth, the possibility of recession in the future still exists. In order to investigate the effect of a recession on the flow of payments, projections were prepared that assumed the following:

- The Governor’s FY2001 proposed budget for revenue sharing is approved.
- The FY2002 sales tax revenues grow by four percent from FY2001.
- In FY2003, no growth occurs in sale tax revenues (roughly the equivalent of a two-percent decline in inflation-adjusted revenues).
- In FY2004 and FY2005, growth occurs at an even rate sufficient to bring FY2005 Sales Tax revenues to exactly the level that would be achieved if annual four percent growth occurred from FY2001 to FY2005. This rate is slightly over six percent.
- The simulated recession, in summary, is of a one-year duration and takes two years of accelerated growth to return to a non-recession level of revenues and growth path.

Eliminating the growth from FY2003 revenues produces 466 units whose projected payments would decline by an average (unweighted) of 2.6 percent; with a maximum decline of 6.4 percent (the floor created by the eight-percent cap mechanism). A total of 1,309 units reflect increases averaging 2.6 percent with maximum increases of eight percent (the eight-percent cap). In the two years following the year of zero growth, the eight-percent cap mechanism produces more revenue to be distributed. The floor on the minimum increase is lifted from 2.1 percent and 1.8 percent in FY2004 and FY2005 in the even growth scenario to 7.5 percent and 7.1 percent respectively in the recession scenario. With the larger amounts of eight-percent cap money to distribute, more units participate in both parts of the mechanism: giving and receiving.

The projections for individual units reveal some surprising results. In the first year of the recession scenario, the reduction in revenues available from the eight-percent cap are significantly less than the even growth projections. Consequently, many units would suffer year-to-year declines in payments, due to their status as overall losers under the new formulas and the increasing weight given to the new formulas under the phase-in mechanism. But following the recession year, many more units benefit from the eight-percent cap payments and their payments grow to a level exceeding the even growth projections by the second year following the recession.

In the recession scenario, many additional units are brought into the category of contributors to the funds reallocated to units protected by the payment change floor.

## G. Notch Effect of Ten Percent Population Gain

The ten-percent population growth provision creates a notch or cliff effect that is potentially dramatic for units very close to that threshold. Units whose payments could grow very rapidly because of increases in payment share, but whose population change is less than a ten-percent increase are affected by this situation.

Two units illustrate this phenomenon. Kinross Township in Chippewa County has a population projection at an increase of 9.2 percent. By adding 35 persons to the 2000 projection, the township would gain over $1.3 million spread over the five years FY2001 through FY2006. The two populations are essentially the same numbers statistically.

On the other side of the ledger, the population of the City of Coleman in Midland County is projected to increase 12.6 percent in the model. Adjusting the populations down to just below a ten-percent increase results in significant reductions in projected revenue growth.

# VI. Issues for Further Analysis and Potential Action

The foregoing discussion has illustrated some of the idiosyncrasies of the new revenue sharing formulas. Despite the efforts to protect units from abrupt changes in their payments, especially declines, risks still exist that payments could decline significantly if certain conditions occur. The two greatest risks are recession and the sunset of the current legislation. Knowing in advance of the effect of sunset will permit policy options to be evaluated and deliberate action taken to continue revenue sharing, perhaps in modified form, in the future.

Unlike the past, when the rate of change in earmarked revenue essentially determined the rate of change in revenue sharing payments, a recession reflecting no change in nominal revenues would cause year-to-year declines in payments for many units. More severe downturns in Sales Tax collections could lead to very large declines in revenue sharing for a relatively small number of units. Being aware of this phenomenon should permit the State to provide advance notice to local units when revenue collections suffer from the effects of a recession.

The issue of sunset of the current law will confront legislators who are, for the most part, not currently serving in the legislature. Term limits mean that no current house or senate member will be serving in their present house by June 30, 2007. A handful of legislators may have crossed from one house to another by that time. Given this situation, it may be appropriate for the current legislature to take up the issue of changes that would avoid the significant financial disturbances that expiration of the formulas will bring.

As the sunset of the current act nears, the Legislature will have to confront the issue of whether units will be permitted to have their payments drop precipitously. The treatment of the City of Detroit will also have to be resolved. The starting point for this consideration will be the ending point of the current statute. The amounts received on a per capita basis for the statutory portion of the allocations will still exhibit large differences between units, although not as large as the when RTE was the principal distribution determinant. Perhaps a phase-in approach to a new set of formulas or continued use of the existing formulas could be considered. The final allocation amounts from the present act (before any sharp reductions had occurred) could be used as the starting point and a new phase-in period, perhaps with payment increase caps, would cushion any abrupt payment declines.

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