Can we fix municipal finance in Michigan? If so, how?

TLDR

Last weekend, I got involved in a discussion* on the Facebook page of former State Rep., State Senate candidate, friend and all-around good guy Ken Horn.  The discussion was about the upcoming vote on the replacement scheme for Michigan’s personal property tax. I am opposed to the proposed legislation, for a number of reasons; I seem to be a rather lonely voice. As part of the discussion, Ken had posed a very valid question:

What would I suggest as an alternative means to provide stable financing for Michigan’s municipal governments?

Here are a few ideas.

1. Increase flexiblity. And accountability.

If I could wave a magic wand, I would say it should be a totally free market-based system: allow municipalities total freedom generate the revenue they need; then take a closer look at how it’s being spent.

Under the system we have now, it’s the opposite. The state controls how – and, to a degree, how much – a local government can collect. State law dictates a maximum property tax rate, maximum income tax rates (one for residents, another for non-residents) and no local sales tax – something that 35 out of 50 states allow.

Yet until recent years there has been surprisingly little oversight of HOW it’s spent. There are accounting guidelines and audits are reviewed – but these are looking primarily at record-keeping practices, not on whether or not you spent your dollars wisely.

Gov. Snyder’s “municipal dashboard,” put in place when he turned revenue sharing into the Economic Vitality Incentive Program, is actually a huge step in the right direction. The state reviews a number of metrics to gauge how effectively a local government is spending its money.

The biggest problem with it is its approach: it was turned into a qualifier for money that, by 50 years’ worth of statutory intent, belonged to local governments. Instead of telling your kids: “If you clean your room and get good grades, you’ll get a special treat,” Gov. Snyder is telling his kids, “if you clean your room and get good grades, you get to eat dinner.”

So that would be my first choice: dump (or radically alter) the property tax system, and let local governments levy the revenue they need in the way that will work best for them. Some reasonable limits can – and perhaps should – be established. But develop a way to monitor the spending more closely. This would mean establishing a way to determine a need for financial intervention from the state at the first smell of smoke – instead of after the house is fully on fire.

Why do I want to dump the property tax system? There’s more on that here, but there are two major problems with it. It’s subject, as we’ve seen, to extreme instability (and the layers of tax-control legislation such as Headlee and Prop A that we’ve placed on it makes that instability even more dangerous). Worse, it creates a disincentive to do what municipalities most want property owners to do: maintain and improve their properties.

By the way, this also applies to the way we fund schools. Most people are surprised to find out that, among the other things they did when they passed Proposal A was to completely take away virtually any control their local school districts have to raise funds … and granted it all to the formula-keepers in Lansing.

2. If you can’t scrap it, fix it.

If we needed to keep some form of property-tax law in place, it needs to be completely overhauled, in order to ease the sting of its two greatest flaws: its instability and its disincentivizing nature.

We’ve fiddled with one side of the stability equation for decades – starting with Howard Jarvis’ property tax revolt in California. Its repercussions gave us the Headlee Amendment. It basically provided a limit to which your taxable value could increase.  We doubled down on that with Proposal A in 1994, which, in addition to changing the way schools were funded, added new wrinkles to property value increases.

This helped keep taxes more stable for the property owner. But these tweaks were made with the assumption that property value would never decrease.

Hello, fall 2008. Property values fell by as much as 40 to 50 percent in many municipalities. So did property tax revenue, with an interesting twist: while property market values can recover quickly (and have, in many places), their taxable values are tied to inflation or five percent, whichever is less. So those taxable values – and the revenue they generate – can only go up by three to five percent a year.

The disincentive?  Improve your property – an addition, a swimming pool, even a new bathroom – and your taxable value jumps.

The best way to minimize both of these problems is to get away from a “current value” approach and use an actuarial tool: a 10- or 20-year rolling average or moving mean of property value. This means that if you add a guest room that increases your home’s value by 25 percent, you won’t see a the 25-percent increase in your next tax bill, but spread out over 10 or 20 years. By the same token, another implosion in the real estate market offers a similar buffer to municipal government.

3. If your basket sucks, get rid of it. Or have a backup or three.

Most of local governments’ eggs are in one pretty leaky basket right now. Either replace it with a few new ones, or at the very least, add a few sound ones to the mix.

A. Allow Local Sales Taxes

Allowing municipalities to enact their own sales taxes would allow the state to roll back the Michigan sales tax by at least one or two percent. It would also eliminates the pass-through bureaucracy required by the current revenue sharing – not to mention preventing the state legislature from looking at it, as it has for the past 12 years, as Lansing’s piggy bank.

Again, 35 states allow local units to establish their own sales taxes. Most of them are economically outperforming Michigan. Well, right now, according to the American Legislative Exchange Council, all of them – since Michigan is at no. 50 on its ranking of 2014 economic performance. Of ALEC’s top 10 economic performers, Montana is the only state that doesn’t allow local sales taxes. Oklahoma (no. 9 on the ALEC rankings) has the highest local rates, averaging 4.16 percent, along with a 4.5-percent state rate. Texas, ALEC’s top economic performer, has an average 1.89 percent local rate on top of the state’s 6.25 percent.

I’m certainly not saying that the cause of these states’ success is their local units’ ability to levy sales tax. But I am saying that having that ability doesn’t seem to be hurting them.

B. Expand Local Income Tax

Take the hobble off local income taxes, currently capped at 1.5 percent for residents and ¾ of one percent for non-residents who work in the municipality.

Michigan currently has 22 municipal governments who levy local income tax. State statute limits how much that can be, as noted earlier. Eighteen of them tax at 1.0 percent for residents and 0.5 percent for non-residents. Saginaw and Grand Rapids each levy 1.5 and 0.75 percent, respectively, for residents and non-residents, while Detroit (again!) and Highland Park have special rates set by legislative exception (2.5 and 1.25 percent for Detroit, 2.0 and 1.0 percent for Highland Park).

At the other end of the spectrum, 2,492 of Pennsylvania’s 2,562 municipalities and 469 of Pennsylvania’s 500 school districts impose a local income tax or local services tax. In large cities, that rate usually works out to anywhere from one percent (what Bethlehem, Harrisburg and York charge both residents and non-residents, with residents paying an additional flat $35) to Philly’s 3.9 percent. This all in addition to Pennsylvania’s 3.07-percent state income tax.

Two hundred ninety-seven Iowa school districts charge an income tax surcharge ranging from one to 20 percent of state income tax owed (under a bracketed state income tax system with a top rate of 8.98 percent). In Kansas, 535 counties, cities and townships have local income taxes ranging from 0.75 percent to 2.25 percent (bracketed state income tax with a maximum rate of 4.9 percent). In Ohio, 774 municipalities and school districts levy between 2.0 and 2.75 percent (bracketed state income tax with a maximum rate of 7.185 percent). In Indiana, 91 counties levy anywhere from 0.1 to 3.13 percent (with a 3.4 percent state income tax).

In most of the states that have local income taxes, residents and non-residents pay the same rate.

Lincoln Park is a warning.

However we do it, it’s not going to be easy. But what we have been doing since 1893 isn’t serving us well. Particularly in the last 30 or 40 years – as state legislatures have offered new ways for municipalities to raise revenue, then either put new restrictions on those ways, or simply reneged on them.

Unless we effect some kind of systemic change, more Michigan cities will fail. This week we saw an emergency financial manager appointed to Lincoln Park. While it lags slightly behind the state median household income, home value and educational achievement, it’s certainly a far cry from the profiles of Detroit, Flint, Lansing, Benton Harbor and other distressed cities. Lincoln Park is a message Lansing must heed.

*”Discussion” is putting it kindly. Eventually I got into full rant mode.
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