In a nutshell:
- Across the country, city tax structures are largely disconnected from the underlying economy; as a result local revenues have been slow to rebound following the Great Recession.
- Michigan local governments have fewer tax options than many cities, stressing local budgets across the state.
- One potential solution to this fiscal challenge: provide additional taxing authority to regional governments while shifting service provision from cities to counties.
A recent article for Governing magazine asks why city revenues are still lagging when the economy is booming? The same question can be asked of Michigan’s local governments: we are in our ninth year of an economic expansion; why haven’t local government revenues improved with the economy?
A national perspective
The author, Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago, uses data collected for the National League of Cities to show that cities’ constant-dollar general fund revenues are only now beginning to reach the levels they enjoyed prior to the Great Recession in 2007; by contrast, state governments’ general funds rebounded to pre-recession levels back in 2013. Why this delay at the local level? The answer lies in the structure of city tax systems.
Local government tax structures are largely disconnected from their economies. Federal government receipts have rebounded because of reliance on the income tax, which is very responsive to economic changes. Similarly, state coffers have grown because they rely largely on income and sales taxes (both general and selective sales taxes, e.g., alcohol or hotel rooms).
But city finances are much different; they rely largely on property taxes and user charges to fund services. These sources are not connected to the economy and do not respond as robustly to an economic rebound. To be fair, in most recessions, property taxes tend to be more stable, but this was not the case with Great Recession, the precipitating event of which was the collapse of the housing market.
For cities with access to sales taxes, the shifting economy has created challenges. True, these taxes are more closely connected to the economy than property taxes (as the economy improves, people tend to shop and go out to eat more), but that connection is weakening as the economy has shifted from one reliant on the consumption of goods to one more reliant on service consumption, which is more likely to escape sales taxation.
What about Michigan?
The Research Council’s recent report on Michigan local government revenues provides a stark picture of the problem many U.S. cities are facing.
Michigan’s local government revenue structure does not provide a sufficient level of revenue for local governments in times when the state economy is declining, nor, perversely, when it is expanding.
Michigan local governments rely most heavily on property taxes and state-shared revenue to finance services. Unlike many cities across the country, local-option sales taxes are not available in Michigan. Cities in Michigan do have access to a local-option income tax, and this has been a vital source of revenue for those cities that levy it, but it is not widely used across the state.
Many communities across the state are expanding or experiencing economic growth, but the economic recovery evident with bustling downtowns and job growth does not translate into growing revenue streams for most local governments. With the exception of city income taxes, which are levied by very few cities, and county hotel taxes, a minor revenue source, current local taxes do not capture economic activity (e.g., rising income, sales, etc.). Several state taxes do tax these forms of economic activity, but little of this money is returned to the communities experiencing economic growth.
The primary tax available to local units, the property tax, is used by all types of local units to fund all kinds of services, and it is insufficient as a single own-source revenue option for local governments. Furthermore, state revenue sharing, which was meant to supplement local revenues in place of local-option taxes, has been diverted to fund state services to the tune of more than $8 billion (30 percent) since 1998.
Problems are not only on the revenue side
While local units in Michigan have real revenue problems due to constraints on the types of taxes they can levy and the general slow growth of those revenues, Michigan’s current local government service delivery model is not providing services in the most efficient manner either.
A 2017 Research Council report discusses the current local government service delivery model, which includes over 1,700 municipalities and 83 counties providing services, sometimes overlapping, and recommends examining local government services in detail to see what could be provided more efficiently and effectively at the county, rather than local, level. With modern methods of transportation and communication, the county is in a good position to take over many back office and other functions currently provided by municipalities.
One potential solution: Couple regional service delivery with more access to local-option taxes
While it is important to keep service delivery part of this equation and review how local government services in Michigan can be provided more efficiently, it is clear that local governments need access to more revenue options.
When reviewing new local-option tax possibilities, the focus must be on the region because many local taxes can be levied more effectively at the regional level, just as services can be provided more efficiently at the regional level. For example, many cities do not take advantage of their ability to levy a local-option income tax because it makes them less competitive when compared with cities near them. If a local-option income tax is levied regionally, then local units’ tax structures would not be a reason for competition.
New revenue options do not need to mean higher taxes. These new tax options could be crafted to replace, not supplement, property taxes and could be revenue neutral, but more responsive to a growing economy. Furthermore, giving local units or regions more access to local-option taxes would not allow them to levy the taxes without voter approval. Every new tax, or increase in existing tax, requires voter approval.
A similar solution for local governments across the country is advocated by Dr. Pagano in his article, which states “most state and local tax experts agree that giving localities greater flexibility or breathing room [in reference to local tax options] — with appropriate controls by the state, of course — is solid fiscal policy.”