What do all the actions in Lansing the last several months mean to local governments and related organizations?

These question are top of mind lately for many in Michigan — government officials, business leaders and citizens. The last several months have seen the following developments:

• A replacement for the Single Business Tax with the introduction of the new Michigan Business Tax
• A continuation budget for the beginning of the State’s 2007/2008 fiscal year
• An expansion of the sales tax to cover certain services — later repealed
• Modifications to health care — particularly for schools
• A final budget for the State’s 2007/2008 fiscal year
• Funding for revenue sharing

In addition to these changes, there have been many other legislative developments and state happenings. This issue will provide detail on these developments and discuss what they mean to governmental units.

New Business Tax Structure

Michigan Business Tax Basics — In June 2007, a replacement for the Single Business Tax (SBT), which was set to expire December 31, 2007, was finally announced. The new Michigan Business Tax (MBT) is intended to replace the $1.9 billion generated by the expiring SBT. The MBT for the SBT. But, what is the MBT and how does it affect local governments? Read on!

The MBT is a very lengthy and complicated new tax law, but let’s lay out the basics. The new MBT imposes two taxes — a modified gross receipts tax and a business income tax. The MBT allows for new investment, compensation and research and development credits to businesses. It also allows for entrepreneurial credits and has an alternative tax for small businesses. Many of the credits are geared towards businesses with payroll and property in Michigan.

According to the Senate Fiscal Agency, the tax will generate about the same level of revenue as the former single business tax, about $1.9 billion. Many think that the MBT in its current form could generate much more. A goal of the MBT tax rate structure is to make Michigan a more attractive place to own a business by putting the state tax rate on profits well below any other state’s corporate income tax rate, by allowing special provisions for small businesses and by adding incentives for businesses with operations located in Michigan. The MBT even provides more personal property tax relief for businesses.

Personal Property Tax Relief — That last sentence probably got your attention and left you asking: Does that mean more money out of the pockets of local government? The answer to that is a complicated one. As we now understand it, there are really two main areas at the local governmental level that will be most impacted by this new provision: tax administration fees and tax captures by special authorities, such as DDAs, TIFAs and Brownfields (particularly entities with eligible pre-Proposal A existing obligations and Brownfields with reimbursement agreements).

As the new law states, certain business property will be exempt from personal property tax on the State Education Tax (SET) and the local school operating mills. This is a direct mill reduction for industrial and commercial personal property. Industrial personal property taxes will receive exemptions from the 6 SET mills and the 18 schools operating mills (for a total 24 mill exemption). Commercial personal property will be exempt from 12 of the 18 school operating mills.

Many local governments collect, as allowed for by State law, a property tax administration fee (up to 1 percent of taxes levied). Because the MBT provides certain personal property tax relief in the form "exemptions" versus credits to the MBT tax, local governments will collect less "school related" taxes and some communities will see a decrease in the administration fees that have traditionally been collected. For certain communities with a higher percentage of its tax base composed of commercial and industrial property, this reduction in fees might be significant.

Because of the SET and school operating personal property tax exemptions in the new MBT, local governments utilizing a tax increment financing vehicle that is eligible to capture school taxes may have considerably less dollars captured for projects. As an outright exemption, beginning with the summer 2008 tax levy, these taxes will no longer be paid and thus will not be available for capture. However, the current language written into the law related to the passage of the MBT indicated the Legislature’s intent to address these revenue shortfalls and evaluate the impact of these exemptions in the future. Follow up legislation to formally address this matter is required.

Given the favorable tax treatment of industrial versus commercial personal property, companies will surely be re-reviewing their classifications. The assessors office at your local government will most likely receive more frequent inquiries and requests to change classification of personal property to take the most advantage of the tax break afforded to industrial property.

We will all learn more on the impact of the MBT as it becomes effective in January 2008.

Budget, Taxes, and More Budget

The enactment of the Michigan Business Tax basically resulted in replacement revenue for the expiring Single Business Tax. Even with revenue replacement secured in June 2007, the State still found itself looking at a budget shortfall of approximately $1.8 billion for fiscal year 2007/2008. Would the solution come through cuts, new revenue sources or a combination thereof?

That answer did not officially come until the early morning hours of October 1, 2007. With the State’s new fiscal year beginning that day and a State government shutdown looming, marathon budget negotiations yielded a continuation budget, tax increases, some "government reforms," and a promise for more cuts.

The continuation budget kept State government open for business during the month of October while the Legislature finalized details and the remaining cuts for the fiscal year 2007/2008 budget. The tax increases are projected to close approximately $1.45 billion of the $1.8 billion budget gap. Raising the individual income tax rate from 3.9 percent to 4.35 percent is expected to generate more than $750 million. The income tax rate will be rolled back from 2011 to 2015, ending back at 3.9 percent. Combined with the income tax rate increase, the Legislature also expanded the sales tax to cover certain services generating an estimated $750 million per year ($614 for fiscal year 2007/2008).

The continuation budget expired with relatively minor fanfare at the end of October as the Legislature came to agreement on the roughly $300 million of cuts remaining to bring the fiscal year 2007/2008 budget into balance.

The implications of all this to revenue sharing and other aspects of local government are described later in this communication. On the whole, most observers would agree that the financial consequences to local government could have been much worse during this very unpredictable journey through the State’s budget odyssey that began in February 2007 with the Governor’s introduced budget and wrapped up 30 days into the State’s next fiscal year.

Subsequent to the adoption of the final budget for fiscal year 2007/2008, discussions in Lansing turned immediately to whether the newly enacted services tax — scheduled to go into effect December 1 — would stay or go. The Michigan Legislature passed a bill to repeal the services tax and replace the revenue from the services tax with a surcharge on the Michigan Business Tax on December 1. Repeal of the services tax without replacement revenue would have opened up the 2007/2008 budget for discussion again.

Even with the replacement of the SBT with the MBT, the increase in the income tax rate, the surcharge to the MBT as a result of the enactment and then the repeal of the services tax and cuts made to the State’s budget, more budget shortfalls are likely. Citizens Research Council predicts that moderate increases in government spending will push the State back into a billion dollar budget deficit looking forward. The State is "…not there yet…" in terms of completely stabilizing its budget and dealing with structural issues with Michigan’s Municipal Finance model. Diligent financial planning remains a critical part of keeping a local government solvent in this environment because of the continued unpredictability of the State’s budget.

Revenue Sharing

All the ongoing dialogue about Michigan’s tax structure coupled with uncertainty as to how the State budget would ultimately be balanced continued to cast a shadow over state shared revenue for most of the year. With some finality to the debate on Michigan’s tax structure and a solution — for now — to the State’s budget, what about state shared revenue? There are a number of long-term issues involving revenue sharing including the level of funding, the expiration of the statutory formula, and the return of the Counties to the statutory formula that remain unanswered.

Fiscal year 2007/2008 — Short term, there are some answers. The final adopted budget for fiscal year 2007/2008 held revenue sharing "flat" at fiscal year 2006/2007 levels. The budget does include language stating that the Legislature would like local governments to actually receive in fiscal year 2007/2008 what they received in fiscal year 2006/2007. Therefore, if actual sales tax collections result in reduced constitutional payments, the Legislature intends to increase statutory payments to make up the difference. In that event, an extra payment would have to be appropriated by the Legislature. Also, in the final budget agreement, there was no funding provided for special census revenue sharing payments for certain communities with significant population growth since the 2000 census.

Additionally, many local governments observed a sizable shortfall in their October 2007 revenue sharing payment. The shortfall is a direct result of the 30-day continuation budget passed by the State. During the period of the continuation budget, the State reduced the October revenue sharing payments because of the limited availability of funds. The Michigan Department of Treasury has indicated that its intention, now that a final budget has been passed, is to distribute the October shortfall to local governments as part of the December payment or in an extra payment from Treasury prior to the December payment.

Expiration of the Statutory Formula — Also, many are wondering about the expiration of the statutory portion of revenue sharing (which technically expired at September 30, 2007). As indicated above, the State’s fiscal year 2007/2008 budget appropriated revenue sharing at fiscal year 2006/2007 levels. While no formal action has been taken yet to extend the revenue sharing act one year, it is the generally understood intent of the Legislature to do so (based on the budget that was adopted). Another legislative action will still be required, though, to formally extend the Act. After the dust finally settles from tax policy and budget negotiations, the Legislature will have to begin looking at and determining what the revenue sharing formula of the future will look like.

County Participation in Revenue Sharing — Going forward, the status of county participation in revenue sharing also has to be formally resolved. In 2004, the State terminated payment of statutory revenue sharing to counties (which was approximately $182 million) but allowed counties to move their operating tax levy to July from December. Counties are required to deposit the additional monies from the earlier levy into a "reserve fund" which is to be used by the counties to replace lost statutory revenue sharing in future years. The question that remains is when the reserve funds established by counties are depleted, will counties come back into the "revenue sharing formula" and to what extent? While certain smaller counties have already been allowed to return to the statutory revenue sharing program, the test will be with larger counties. At that time, the question that awaits an answer is will the size of the statutory pot grow to accommodate counties or will there be a shift of the same monies from cities, villages and townships to the counties?

In summary, the State’s fiscal year 2007/2008 budget process provided some answers to questions on revenue sharing. More answers remain and some continue to depend on the stability of the State’s budget and the State’s financial condition. Local governments need to consider all these factors when preparing their annual budgets and long-term financial plans. Revenue sharing is still at risk.