A recent article in Bridge Magazine highlights the fact Michigan has almost 200 communities in financial distress despite the fact that the economy is experiencing the longest economic expansion in history. So why aren’t these communities benefiting from the economic good times? Our research provides the answer.

Local revenues are not designed to grow with the economy

Here at the Citizens Research Council, we’ve been discussing the problems inherent in Michigan’s local-government revenue structure for years. Also, we’ve been researching potential solutions. 

The two primary revenue sources available to local governments — property tax and state revenue sharing — have failed to meet the service demands placed on governments in both good and bad economic times.  What we found is that three key factors are responsible for the challenges of the current municipal finance system . 

First, local revenue sources are disconnected from the local economy. The property tax is the single tax available to most governments and it captures only a narrow segment of economic activity. The state, however, relies on several different kinds of taxes (property, income, sales, etc.) allowing it to capture varied segments of the economy and grow its revenues more broadly. Local communities lack ways to benefit from tourism, commerce and other economic activities.

It should be noted that cities can levy income taxes in, but few do. Our research indicates that income taxes are most effective at the regional or county level. Levying a regional tax will reduce some of the tax competition between neighboring cities if one levies and the other does not. 

Second, the property tax is an insufficient and overused revenue source. It serves as the sole source of revenue for many local units as it is authorized to counties, cities, villages, townships, school districts, intermediate school districts, community college districts, and special authorities. 

High property taxes are burdensome to taxpayers and generally unsustainable. This is evidenced by the passage of two different constitutional amendments to severely limit the growth of property tax revenues in the last 40 years: Proposal A and the Headlee Amendment. These constitutional amendments succeeded in limiting property tax revenue growth; however, many local governments have found themselves starting at a new, much lower, property tax base after a major recession affecting home values like the Great Recession.

Additionally, the property tax is regressive. Large variances in tax bases — which is to say, higher property values in a wealthy suburb vs. the poorer city nearby — enable some  governments to yield high sums at very low rates, while others must levy taxes at much higher rates to yield equal sums. These inequities affect the quality of services provided and the attractiveness of living or locating businesses in those communities. 

And finally, state revenue sharing is in peril. This is nothing new. Michigan’s single state recession, followed by the Great Recession, forced the state to make tough budgetary decisions. Between 2000 and 2010 state budget makers found revenue sharing an easy item to cut to help balance Michigan’s budget each year. State revenue sharing losses totaled more than $12 billion from 2002 to today.

Things have been looking up for revenue sharing — last year’s payments totaled $1.1 billion and the Governor’s FY2021 budget proposal calls for a 2.5 percent increase. However, that $1.1 billion is still $200 million less (in nominal dollars — not adjusted for inflation) than the FY2001 level. As history suggests, the increases are likely to last only until the next recession when the state will need those revenues to balance its budget.

New local revenues need to be part of the solution

Michigan’s system of unrestricted state revenue sharing, in addition to other revenue sharing programs (e.g., highway funding), was enacted as part of a state policy to share state-raised funds with local governments, thereby diversifying local government revenue sources, in place of local-option taxes. But things have not worked out as intended, and many locals have increased property tax rates to backfill reduced state payments, putting increased demand, once again, on property taxes.

The current finance system has been difficult for many local units and catastrophic for those that are out of options because 1) they already levy high property taxes and 2) they are largely built out and have no new construction to increase their tax bases. A total of 139 cities, 36 townships, and 15 villages are identified as “financially distressed,” and the number is likely to grow as more local units become built out and/or the economy slows down.

For years, the Research Council has identified diversifying local-source revenue options as one part of the solution to this problem. This means that the state needs to allow local governments to levy different kinds of taxes to meet their spending needs. Some communities may prefer income or sales taxes, others may prefer excise taxes on tourism-related services or gasoline to fund local roads. The possibilities are numerous, but new local taxes should be crafted to replace, not supplement, property taxes and allow local governments taxation options that can grow with the economy and meet their unique community needs. 

Changes to how local governments provide services another part of the solution

More revenue alone is not the answer. Local governments are generally operating efficiently within the current structure, but it is time to question whether the current service delivery model is appropriate for the 21st century. 

Michigan became a state in the 1800s and many services are provided by cities and townships because it was not feasible to have them done at the county level at that time. Today, advancements in technology, communication, and transportation mean that many more services could be provided at a more regional level. This has the potential to improve the efficiency and economics of local governments and provide both service and revenue side benefits to counties and local governments. 

Our report on county services details what could be provided at a regional level. Decision-makers at all levels of government need to think about how local government services can be delivered differently to be most effective and efficient in today’s economy.

Local government in the 21st century

It is important that Michigan and its local governments be able to adjust to the needs of today. That involves changing the local tax structure and providing services to residents in the most efficient manner. It does not mean that our cities or townships need to be consolidated into the county, rather that more services can be provided at the regional level. It also does not mean that the state or a local government should impose new taxes on the unsuspecting public, but that local governments need more revenue options to meet spending pressures and provide the quality of life desired by their residents. Any new tax options would need to be authorized at the state level, but could not be levied without local approval as well.

If we could be successful in expanding tax options and regional service delivery, we could have a shot at reducing the number of communities in fiscal distress as well as helping all communities weather the next economic downturn.