In a Nutshell

• Much of the revenues collected by the state are transferred from the state to other entities for the actual provision of services, including Medicaid, universities, K-12 education, highways and bridges, courts, enforcing liquor laws, and unrestricted state revenue sharing.
• Because this practice violates the fundamental and sound principle that responsibility for raising money should accompany the pleasure of spending of it, prudence is served with state oversight of the funding to ensure that the funds are used as efficiently and effectively as possible to meet the state objectives.
• Michigan citizens will benefit from intermittent legislative exercises to revisit the distribution of state resources to local governments (and others).

The State of Michigan collects taxes to fund many services, but it is responsible for providing a limited number of them. Most of the funds the state collects are transferred to others for the actual service delivery – e.g., Medicaid dollars for healthcare, university funding for higher education, and School Aid funding for K-12 education.

While the state legislature takes an active role in fine tuning the distribution methods for some funding – School Aid Funds and university allocations come to mind – other programs have largely been put on autopilot. The relatively low public profile of these programs (city finance managers may care about state revenue sharing or road funding distribution methods, but does the average voter?), may contribute to the low level of political priority. Unlike school funding that grabbed the attention of legislators when the Kalkaska Public School ended the school year early, leading to the school finance reforms of Proposal A in 1994, rarely are the methods of state revenue distribution associated with crises that provoke revision of the systems.

The lack of attention to the programs may also relate to the chronically scarce resources available for program funding. In the absence of new funding, changing distribution formulas is a zero-sum effort, creating winners and losers. In the context of a fixed size of the pie, efforts to direct funding to one set of service providers will result in another set receiving less. The politics of changing distribution formulas make change difficult.

Part of this can be blamed on the frequent turnover of legislators due to term limits. With the relatively short stints in office that characterized legislative terms between 1994 and 2024, legislators rarely developed the depth of knowledge to dig into these programs.

Legislators intent on reducing inefficiencies in the use of state-raised resources should set about systemically revisiting each of the revenue sharing programs to align distribution methods with certain guiding principles.

Guiding Principles

The circumstances vary that led to the state playing a role in funding many programs, but not in the delivery of the actual services. Sometimes state involvement was driven by certain guiding principles. At other times, state involvement was driven by convenience or out of necessity.

With the passage of time and changing state priorities, it is a good practice to assess why the state is involved in funding services that other governmental entities provide, how funds are distributed to achieve the state’s interest, and the means of revenue raising for local governments if changes to state programs affect some or all of the recipients.

One guiding principle that should be foundational to all state revenue sharing programs is the state’s interest in promoting the health, safety, and welfare of all its residents. The state government does not exist as a solitary entity. It is a collection of very diverse counties, cities and townships, and school districts. Collectively, the economic vitality, safety, and health of residents in each community represents economic vitality, safety, and health of Michigan overall. The state is only as strong as its weakest government subdivision, so it is in the state’s interest to ensure that all counties, cities, school districts, etc. are capable of providing a minimum level of services.

Along those same lines, the state has an interest in ensuring the adequacy of service provision among the multiple local units of government. Whether it is ensuring a quality education is available to all students in attending public K-12 schools, roads are relatively smooth and safe, courts provide equal justice, liquor control is efficient, or police enforce the laws of the state, sometimes that state has to use resources at it disposal to assist local governments in these activities.

In order to maintain the health, safety, and welfare of the state’s citizens and visitors and to best execute the provision of certain services, state policy has to recognize two important variances among local governments. First, local governments vary widely in their revenue-raising capacity. Basically, this boils down to the wealth of a community. Some local governments are endowed with richer tax bases – for property, income, or consumption-based taxes – than others. For this reason, it is in the state’s interest to work toward equalization of the resources available for local government service provision.

Second, there is considerable variance in the demand and consumption of services across communities. In its simplest form, the demand and consumption of services is related to population density and the density of buildings, for local governments service both people and structures. For example, more police protection is important in urban areas where there is more interaction between people. Zoning, refuse collection, and fire protection are needed more in urban areas to minimize the actions on one property negatively affecting surrounding properties.

Three maxims arise out of these guiding principles.

• First, whatever the merits claimed for programs that share state revenues with local governments, all of them violate the fundamental and sound principle that responsibility for raising money should accompany the pleasure of spending of it. That principle is bedrock in responsible government. Prudence is served with state oversight of the funding to ensure that the funds are used as efficiently and effectively as possible to meet the state objectives.
• Second, state revenue distribution formulas should emphasize funding for local governments with the least fiscal capacity – those with weak tax bases and higher levels of density. Funding formulas targeted to best meet needs are more efficient and equitable than those that spread funding across all local governments, generally on a per capita basis.
  • The corollary to this maxim is that local governments with the greatest fiscal capacity still need the tools of taxation to raise funds to serve their residents’ needs without relying on state resources.
• Third, local governments benefit from transparency and certainty in formulation and implementation of state revenue sharing programs.

Opportunities for Reform

Road Funding. Earlier this year we addressed one local government service – road funding – that would benefit from revisiting the revenue sharing methodology. Michigan is directing record amounts of funding to improve the roads and bridges, but the ongoing use of antiquated distribution formulas means that the use of the precious resources is used inefficiently.

Our report recommended that Michigan’s road funding law, Public Act 51 of 1951, should be repealed and replaced with new legislation that provides a rational formula for the distribution and allocation of state revenue-sharing based on the needs of today’s transportation system and citizens. The measure of needs should incorporate metrics that better reflect the role of each road and the relative cost of constructing and maintaining the roads and bridges. The report identified route ownership, the number of miles by road types, commercial traffic load, bridge features, construction costs relative to other parts of the state, drainage requirements, traffic volume, pavement area, climate, and population as key indicators of need that could be incorporated into a new state formula for distributing funding among the road agencies.

Because some local governments are capable of raising resources to fund highway needs locally, and not all roads rise to the level of serving state needs, the legislature should consider authorizing local-option revenue sources for local road funding such as motor fuel taxes and vehicle registration fees.

The state’s Fiscal Year (FY)2026 budget increases the amount of state funding for roads and bridges. It adjusted the allocation of the new funding for the state, county road commissions, and cities and villages, but it did not change how funding is distributed among the 83 road agencies or among the 500+ cities and villages. Instead of adjusting the formulas to efficiently spread the funding across all road agencies, $205 million per year of new revenue will be distributed through Michigan Department of Transportation (MDOT)-administered local grant programs. Some may get one-off funding to address immediate needs, but the inefficient distribution methods among those levels of government will continue to be used.

State Revenue Sharing. Unrestricted state revenue sharing also was a subject that garnered attention in the state’s FY2026 budget. On the whole, local governments will receive less funding from state revenue sharing, but the impact across governments of various sizes and types is uneven.

The diminishment of sales tax revenue dedicated to revenue sharing is the most noteworthy change for cities, villages, and townships. Under Article IX, Section 10, of the 1963 Michigan Constitution, 15 percent of all sales tax revenue collected at the (pre-Proposal A of 1994) 4 percent tax rate is dedicated to revenue sharing. Because changes made as part of the state FY2026 budget deal, exempted motor fuels are exempted from the state sales tax base and less revenue will be generated and available to be shared.

On the one hand, a 6.8 percent reduction in funds made available to local governments ignores the financial fragility of many local governments caused by restrictions on the growth of property tax revenues, the chronic underfunding of state revenue sharing through the statutory formula, and the scarcity of alternative means of taxation.

On the other hand, the per capita distribution of constitutional revenue sharing was flawed. As far back as 1946, when the education and local government communities colluded to introduce sharing of state sales tax revenue through a constitutional amendment, the Research Council has bemoaned the method of distribution as fostering waste and extravagance.

The state’s FY2026 budget does not backfill any of the foregone constitutional revenue sharing with statutory revenue sharing funding, but it does set aside $42.6 million ($35 million ongoing) for public safety revenue sharing. This is a grant program that recognizes various aspects of need in providing police protection and in the local governments’ ability to raise funding from their own resources for this purpose.

Between the increased road funding and the dedicated public safety funding, some cities are forecast to receive more than they lost in constitutional revenue sharing. Others will experience a net reduction in state-shared revenues under the new budget. Two issues arise for local governments from this swap:

1. The uncertainty of funding.
2. Antiquated distribution formulas that do not identify local governments with the least fiscal capacity.

A funding source that was guaranteed (as long as the economy is strong) is being replaced with a public safety funding program that is subject to the whims of legislative leaders and the executive branch.

Formulas that recognize fiscal capacity were incorporated into the laws that direct the funding for statutory revenue sharing as early as 1971. In 1998, the 1971 relative tax effort formula was replaced with a new formula meant to recognize fiscal capacity in different ways. Unfortunately, the state fell into deep recession and that formula was never fully implemented because resources were redirected for other state purposes.

Local government leaders now lack both the certainty of funding and the certainty of knowing how their fiscal capacity will be recognized through the distribution formula. The statute dictating the distribution of statutory revenue sharing has long since expired and the legislature simply bases distributions on the previous year’s funding or methodologies baked into the boilerplate language of the appropriations bills.

The discretion of local government officials to choose how to use funding sent from the state is replaced with public safety revenue sharing that can be used for limited purposes. This is yet another avenue the state has adopted in efforts to assist local governments and achieve state purposes. During the Snyder administration (2011 to 2018), the Economic Vitality Improvement Program attempted to improve transparency in local government finances and better the financing of retirement systems.

With the program created in boilerplate language in the appropriations bills, local governments lack the certainty that they will be available next year. Should local government leaders build them into their budget as ongoing resources, or use them for one-time programs?

A legislative exercise to reestablish statutory revenue sharing in state law might help to improve reliance on the funding, notwithstanding that it was in state law before, and the state simply chose not to fund it.

Recognize the Needs of Those not Benefiting from Revenue Sharing

As we’ve written about on several occasions in recent years, finance reform should be about more than addressing the distribution of state funds. As incorporated entities, municipalities bear responsibility for raising the resources to serve their residents. Our analysis of Michigan’s property tax system as it operates under multiple tax limitations found that the local governments experiencing new development, mostly on the urban fringes, are best suited to maintain services with property tax revenues. For others, a recurring pattern of property tax rate increases are maintaining service levels. Neither the urban sprawl nor the tax rate increases are sustainable.

At some point we’re going to need to examine the authorization of alternative taxes. Doing so will provide opportunities for property tax relief, offer local governments a means of funding services without dependence on state-shared revenues, and enable state revenue sharing programs to truly be targeted at communities is the greatest needs.

Summary

Michigan citizens and local government leaders will benefit from intermittent legislative exercises to revisit the distribution of state resources to local governments (and others). Not only do state interests evolve, but metrics are available that offer improved ways of measuring needs. Accountability can be improved if residents know how the taxes they pay are being used to meet the greatest needs. Efficiency can be improved when the taxes are focused on the greatest needs among the various service providers.