In a nutshell:
- The recession caused by the COVID-19 social distancing requirements is projected to create a $100 million hole in the City of Detroit FY2020 budget. Economic assumptions for the FY2021 budget will have to be revised downward.
- The city’s financial troubles relate not to the heavy human toll being felt by the city, but to its reliance on income and casino wagering taxes and state revenue sharing. These sources are susceptible to economic changes and the effects of social distancing.
- At the same time revenues are in peril, the city is confronted by additional overtime costs for public safety workers, the cost of personal protective equipment, and unbudgeted hazard pay for frontline workers.
Mayor Mike Duggan gave an early glimpse of Detroit’s pending financial troubles at an April 8 press conference. The coronavirus and subsequent stay-at-home requirement are severely affecting Detroit’s finances. A second bankruptcy is not imminent, but impending financial challenges threaten a major setback to the city’s tenuous financial condition, seven years removed from its historic restructuring.
The financial consequences of social distancing are affecting all aspects of the nation’s economy, including government finances. Among Michigan local governments, Detroit stands to be hurt by the downturn more than other governments.
The human toll is considerable; many Detroit residents have been afflicted by COVID-19, and hundreds have died. But the threat to the city’s financial recovery is rooted in its revenue sources.
Property taxes and state shared revenues are the primary revenue sources for most Michigan local governments, but Detroit generates its revenues from a much broader menu, including income and casino wagering taxes that are being directly impacted by the economic slowdown.
The tax revenues collected by most local governments, what we call own-source revenue, will not decrease as they did following the Great Recession. Notwithstanding the declines in new housing development and threats to commercial and industrial property values that could result if businesses fold, we do not expect the current recession to harm residential property values, as it did 10 years ago. Michigan local governments other than Detroit should monitor property values and remain frugal with their spending, but they need not plan for the worst.
Detroit’s Revenue Sources
Detroit’s own-source revenue faces a very different short-term future. Detroit is one of 24 Michigan cities that levy a city income tax. Most others use their income tax to supplement property tax revenues. In contrast, Detroit’s income tax is its largest source of revenue; of the $1.1 billion in total resources collected in the fiscal year (FY) ending June 30, 2019, $361 million (32 percent) came from the income taxes levied on businesses, residents, and nonresidents who work in the city.
Wagering taxes are the second largest source of revenue. Detroit is the only city that hosts non-tribal casinos. The wagering tax, which yielded $183 million in FY2019 (16 percent of the total), has been one of the city’s most reliable revenue sources.
Detroit also benefits from state taxes shared with it and other local governments. Those shared revenues provided more than $208 million (19 percent of the total) for city operations.
Each of these sources stands to be severely impacted by the recession triggered by the COVID-19 pandemic.
How bad it gets for each income tax levying jurisdiction will depend on how many lose jobs, the length of the recession, and the pace of recovery when our work and social lives return to some level of normalcy.
The timing of the pandemic will cause unique hardship for Detroit income tax revenues. Consider the ripple effect of major events, such as the Detroit Auto Show, the Detroit Grand Prix, along with others forced to postpone or cancel. Not only did these employ people in the city who were required to pay non-resident city income taxes, but those people and spectators stayed in hotel rooms, ate at restaurants, and did other things that provided means of income for other workers.
Some city businesses remain open, but the three casinos came to a dead stop to reinforce social distancing. Assuming the revenue collected in FY2019 were the norm, each day Detroit’s casinos are closed costs the city about $500,000 in tax revenue. The casinos closed March 16 and will remain closed at least until April 30, marking $22.5 million of foregone tax revenue.
The effect on state revenue sharing remains to be seen. Michigan has two unrestricted state revenue sharing programs. The Michigan Constitution requires the state to share 15 percent of revenue from the 4 percent sales tax. With retail spending way down, so is this revenue, and there will be less to share with cities, villages, and townships. Detroit received $61.6 million from constitutional revenue sharing in FY2019.
The second program, colloquially termed statutory revenue sharing, shares sales tax revenues at the discretion of the budget makers. This funding has commonly been diverted during recessions to maintain spending on other state services. Budget makers took this to a whole new level in dealing with Michigan’s single-state recession. Since FY2002, more than $12 billion was diverted, almost $1 billion a year in recent years.
In the state’s FY2019, Detroit received $141.1 million, almost 55 percent of the $255 million distributed to all local governments. Expect cuts to statutory state revenue sharing to be discussed as a means of balancing the state budget. It is clear that Detroit will be hit hard by those reductions.
Cities and villages in Michigan also share in the motor fuel and vehicle registration taxes collected by the state. Detroit received $66.6 million from this pool in FY2019. With less driving, less fuel is being purchased and less taxes are being collected. Recessions often result in decreased auto purchases, which will affect vehicle registration tax revenues.
Detroit is less dependent on property tax revenues than other Michigan local governments, but if the recession is prolonged and the recovery weak, it will affect sustainability of many of the small businesses taking root in the city. That would translate to declining commercial and industrial property tax collections.
It is too soon to know the magnitude of these expected revenue reductions. In aggregate, they are likely to be meaningful.
On the other side of the ledger, cost cutting is challenging. Whereas many private sector businesses face economic fluctuations and are able to adjust employment to reflect changing demands, the demand for services from the public sector, such as cities, varies little because of economic fluctuations.
The cost cutting already underway will have to go further than might otherwise be the case because the city is facing increasing costs to provide some services.
Nearly a fifth of the Detroit Police Department was quarantined in recent days, because of exposure to the COVID-19 virus. The need to maintain public safety staffing meant that some officers who had not been exposed to the virus were asked to work overtime, driving up overtime costs.
Extra costs were borne by the city to provide protective gear to city workers, and to sanitize public places, including DDOT buses, and to cordon off recreation centers, parks, and playgrounds.
A recession also puts the city’s ability to manage its retiree costs in jeopardy. The “Grand Bargain,” a key part of the 2013 bankruptcy settlement, provided that the state, foundations, and private donors would contribute $800 million over 20 years to shore up city pension funds and protect a sell-off of the Detroit Institute of Art’s collection. It allowed the city to temporarily reduce pension contributions until 2024 to provide budget relief.
In a display of prudent financial management, the city has been preparing for the major amounts of funding that will be necessary starting in 2024. The Retiree Protection Trust Fund (RPTF) was created for the city to set money aside for this purpose Funds in the city’s pension trust funds and those in the RPTF are invested with the goal of investment earnings growing.
Wall Street’s rocky ride has eroded gains of recent years. Funding invested in 401K plans, IRAs, defined-benefit pension plans, and trust funds has evaporated with these losses, at least until, and if, the markets recover
Detroit’s fiscal year runs from July to June, so most of the FY2020 revenues have been collected (or are due) and expenditures have been made. Still, the impact is stark for this fiscal year. The city estimates a $100 million revenue shortfall for this year that will need to be offset by expenditure reductions. The finance department and City Council will have to revise assumptions with lower revenue estimates for the FY2021 budget.
Likewise, as the state takes stock of its financial condition, it must recognize that its largest city is being hit hard and work as a partner to navigate these difficult times.
Source: City of Detroit Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2019. See page 127. .