A constant complaint elected officials hear about is taxes. Some constituents say they are too high. Some constituents argue taxes are too low. In this piece, I want to discuss Michigan’s taxation system as it relates to local government and suggest some systemic changes to address local government revenue for today’s needs.
But first, a little bit of education. Local governments (cities, villages, townships, counties) receive funding from a variety of resources. In general, though there are four types of resources:
- State funding which includes a variety of sources including, but not limited to: Constitutional and Statutory Revenue Sharing; Local Stabilization Funding (i.e. Personal Property Tax replacement); Liquor Taxes; Fuel Taxes for Road Repairs; and General Fund/General Purpose (GFGP).
- Local Property Taxes which are governed by state law.
- Local Income Taxes which are governed by state law and been passed by voters in certain cities.
- Fees that governments charge for things like recreation programs, permits, and health services to name a few. Often these service fees are subsidized through tax revenues.
State funding usually comes with significant restrictions on how a local government can spend it. The funds themselves are determined by the tax rates set by the Legislature and Governor. And how much a local government receives is determined either the legislative process (revenue sharing as an example) or formula (fuel taxes as an example).
Local governments can spend property and income taxes on needs determined by the local elected body. (One major exception is a dedicated property tax millage. Common examples include: transit, parks, trails, veteran services, and/or senior service millage). However, the amount of revenue that property taxes generate is limited by the State Constitution through the Headlee Amendment and Proposal A.
Headlee & Proposal A
In the late 1970s, inflation was rampant causing all kinds of problems including rapidly increasing property taxes. In response, voters approved the Headlee Amendment in 1978 which includes principles such as:
- Requires a vote of the people for any local tax increase or new tax established after the Headlee Amendment was approved.
- Requires a local unit of government to reduce its millage rate when annual growth on existing property tax value is greater than the rate of inflation. This, in essence, limits the total property tax revenue collected across a taxing district.
- Requires the State Legislature to fund programs and services it creates or expands rather than passing them on to local governments via unfunded mandates.
In the early 1990s, school funding in the State of Michigan was paid for by local property taxes, and the amount of school funding available across Michigan varied widely based on a community’s property value, and how much it was willing to tax itself. Proposal A was approved in 1994 in response to this, and did the following:
- Shifted the primary responsibility for school funding from local property taxes to the State by increasing the State Sales Tax from 4% to 6%. This increase created a statewide minimum per pupil funding amount (i.e. a floor) that every school district would receive, thereby narrowing funding differences between the ‘have’ and ‘have not’ districts.
- Limits local property tax increases to the amount of inflation up to a maximum of 5% per year.
- Created a two-part property tax system: The State Equalized Value (SEV) and State Taxable Value (STV). The SEV assesses what the property is worth in the marketplace (i.e. – SEV amount x 2 = property value). The STV sets the amount the property owner is taxed upon in a given year based upon the previous year’s STV (i.e. the amount of inflation up to 5%).
- Allowed that when a property is sold, the difference between the taxable value (STV) and equalized value (SEV) would ‘pop up’ to the SEV amount, which then serves as the new base for future property taxation (i.e. the SEV and STV are equal).
For the most part, the changes dictated by the Headlee Amendment and Proposal A worked well. Property taxes were lowered and held relatively stable. School funding across Michigan became more equitable. Taxation was predictable for local governments and taxpayers. But then, came the Great Recession of 2008.
Great Recession Issues
It was during the Great Recession of 2008 that a situation arose which was not envisioned in 1978 or 1994: Property values started decreasing significantly. In many cases, decades of property value growth were lost within two and three years. Housing values crashed, and when the properties sold, often due to foreclosure or a short-sale, the anticipated ‘pop up’ actually became a ‘drop’ which created a lower base. This reduced property tax receipts for local government. Likewise, development curtailed during the Great Recession and, in many places, stopped altogether. This limited or eliminated the ‘new growth’ property tax revenue for local governments.
As an example, between 2008 and 2012, one of Michigan’s most prosperous counties, Kent County (home of Grand Rapids and its suburbs), saw its population increase by just over 25,000 while its SEV decreased annually, losing $3.349 billion in value during this same time. And at its low point, Kent County’s STV lost $1.299 billion from its 2009 high. (Chart 4-A identifies year by year between 2008 and 2013 the increases/decreases in population, SEV, STV, and General Fund Property Taxes. For complete information, see https://www.accesskent.com/Departments/Equalization/pdfs/EqualizationReports/2020.pdf)
|Kent County Population||599,234||601,437||602,975||608,501||615,798||624,303|
|SEV Increase/ (Decrease)||(0.17%)||(2.00%)||(5.18%)||(3.73%)||(3.43%)||0.02%|
|STV Increase/ (Decrease)||2.01%||0.34%||(3.76%)||(2.39%)||(2.28%)||(0.07%)|
|General Fund Property Tax Revenue||$85,793,376||$86,601,152||$84,499,582||$84,842,765||$83,037,168||$83,152,405|
|General Fund Increase/ (Decrease) from 2008 Base||–||$807,776||($1,293,794)||($950,611)||($2,756,208)||($2,640,971)|
Kent County’s lost SEV and STV did not fully recover its lost value until 2017. Because of the natural development occurring to meet the growing population in Kent County, along with a low inflation rate, there was a required Headlee Amendment maximum tax rate rollback beginning in 2017. In 2019, the maximum allowable tax rate for Kent County is 4.2571 mills instead of the historic rate of 4.3200 (See Chart 4-B). All in all, it means limited property tax revenue with a growing population, aging infrastructure, and a need for more services (like additional judges and judicial staff, environmental health staff, animal control, law enforcement, et cetera).
|Authorized General Fund Tax Rate||4.2803||4.2803||4.2803||4.2803||4.2803||4.2571|
|Maximum General Fund Allowable Rate||4.3200||4.3200||4.3200||4.3014||4.2846||4.2571|
During the Great Recession, certain government services remained in demand, infrastructure continued to age, and health care costs grew at a rate that outpaced inflation. Additionally, many local governments faced large increases in pension contributions due to mismanaged pension programs and stock markets drops during 2008. Last, the Accounting Boards correctly required that governments start placing their ‘Other Post-Employment Benefits’ (OPEB) liability on their financial statements. And imagine this…that caused governments to either fund these OPEB benefits or acknowledge that they had not been funding their OPEB liabilities for years…a very needed reform.
Counties were uniquely disadvantaged during the Great Recession when the Michigan Legislature and Governor eliminated state revenue sharing for counties by requiring the collection of three years of property taxes in two calendar years. This created a local Revenue Reserve Sharing Fund (RRSF) where counties could draw down their revenue sharing amounts until the RRSF zeroed out, and then ask the State to receive revenue sharing checks again. A classic case of Paying Peter while Robbing Paul. (Fortunately, the State provided reintroduced revenue sharing to counties, but at a rate that did not include inflation and/or population growth.)
This Great Recession crazy cocktail caused significant problems for local government budgets. Property tax revenue stagnated and dropped while costs increased, and more services were needed. Revenue sharing became unpredictable. Ultimately, many local governments responded with significant personnel reductions via layoffs and/or not replacing staff, closing pension programs, and reducing capital investment in aging infrastructure.
So what is the problem almost a decade later?
For the past 10 years, these moves – reducing personnel, closing pension programs for 401k type programs, and delaying capital investment – worked. Budgets stabilized, and the cost of government decreased. Further, the economy started to grow again until COVID-19. So what is the problem? Let me try to explain.
If government were a business (and I would argue it is not….a bias I recognize, but stay with me for a minute), a decade of stagnant revenue would cause the owners to evaluate the business model. Questions they may ask include: Is our profit margin holding firm? Can we increase our rates? Do we need to invest money in technology to lower costs? Do we have the right talent? Can we reduce long-term costs by purchasing new equipment? Is our organizational structure correct?
If we were to do that with government in Michigan, I would argue that our current government business model does not meet the reality of the 21st Century. Examples include:
- Our taxation system is primarily based on sales (6%), individual income (4.25%), and property value while we leave out the fastest growing part of the economy: services.
- We do not have the revenue needed to pay for decaying, aging infrastructure like roads, dams, water/sewer systems and closed dumps/landfills. (Just look at what happened this year in Midland when a dam failed. Michiganders know roads need attention. Lead pipes across the state need replacement. PFAS remediation is necessary throughout the state. We could continue about the needed investment in wastewater systems, landfills, recycling, et cetera.)
- We have structurally limited property tax revenue increases when we are required to pay for legacy personnel costs promised by previously elected officials.
- We cannot create operating efficiencies due to the historic creation of township, city, and village governments. Therefore, we duplicate functions often and rarely able to optimize staffing levels or expertise.
- Our Information Technology (IT) programs are outdated and limp along because we do not have the capital necessary to replace them. And when we do replace them, somehow, they do not deliver the value promised and/or cost more than they should due to lack of qualified personnel.
- We struggle to recruit executive talent due to wage restrictions combined with heightened public scrutiny.
During the next year, I intend to write a bit about each of these subjects. But my Idea to Consider for today is taxation rates as they relate to Sales, Income and Services.
The Michigan House Fiscal Agency (HFA) published a wonderful infographic based on the 2018 budget that shows where Michigan raises its revenue, and how it is spent or appropriated. (See https://www.msbo.org/sites/default/files/Budget_Poster_FY19.pdf.)
As you can imagine, the infographic is incredibly complex. Interestingly though, Income Taxes at 4.25% provided $10,143 million in revenue with most of that dedicated to GFGP. State Sales Taxes at 6% provided $8,309 million in revenue with most of that dedicated to the School Aid Fund (SAF). But nowhere in the infographic is there revenue related to a ‘Service Tax’ because we do not have one.
What is a service tax? In my mind, it is a tax on a service and/or entertainment to the end user, not businesses to businesses. It would tax services like skiing, golfing, bowling, tax preparation, lawn care, dry cleaning, hiring a plumber, an electrician, a home builder, etc. Think about it for a second. Why do we tax the purchase of a bike or car at 6%, but we do not pay a tax on when we choose to hire a lawn service? We don’t need to hire a lawn service, we can do it ourselves if we buy a lawn mower (and pay 6% for the privilege of owning it), but we need transportation for the economy to function. A family needs to buy their children shoes (6% tax please), but we do not need to golf (no tax for the privilege of that activity).
Our tax code picks winners and losers all the time, and I am positive that service-related businesses do not want to be taxed. Who would?! Previously, Governor Granholm proposed a service tax at 2%, but she included business to business taxes in her proposal as well (i.e. a Value Added Tax or VAT like in Europe) My hunch is that the State could lower tax rates across the board and raise more revenue for education and local governments if we thoughtfully considered a rewrite of the State Constitution as it relates to the Headlee Amendment, Proposal A/Sales Tax Rates, Income Tax Rates, and creating a new Service Tax.
There are real demands on Michigan’s local governments that need to be addressed. Most will take courageous leaders to find real solutions that demand systemic changes to how we function now. Taxes need to be part of that conversation.
One thought on “Idea to Consider #4…New Revenue for Local Government”
Matthew: Glad you mentioned the reduction in property taxes when SEV went down. As I’ve talked to former legislators who worked on Prop A, none ever envisioned a reduction in property values and did not intend for the 5% to be applied when taxes went down. I has caused a significant challenge for local governments.
As we look at what COVID is doing to our spending choices, I wonder what that will mean for the future of the service industry. Will it continue to be as robust as in the past?