Get Your Crystal Ball Out… What Will Michigan’s Municipal Finance Model Look Like in the Years to Come? 
Governmental Advisor, March 2007

Much has been written and presented in recent years regarding Michigan’s local government finance model. A commonly asked question by local government officials is: “Is Michigan’s Municipal Finance Model still functional?” In recent years, a number of factors have been identified as problematic with Michigan’s Municipal Finance Model, including:

• The interaction of the Headlee Amendment and Proposal A causing millage rate rollbacks.
• The elimination of millage rate rollups as allowed for by the Headlee Amendment prior to the enactment of Proposal A.
• Cuts to state-shared revenue.
• Limitations on fees and charges for services imposed by the Bolt case and revisions to the State Construction Code Act.
• Pressures on the cost side of the equation with rising health care costs and managing through binding arbitration or Act 312 (mandatory arbitration with police and fire bargaining units).

These are several of the more significant structural issues with Michigan’s Municipal Finance Model. In 2005, the governor commissioned a task force to further study Michigan’s Municipal Finance Model. The Commission completed their work and has released their report (available at http://www.migfoa.org/resource/docs/ 457/FINAL_Task_Force_Report_5_23_06.pdf). The report confirms these and other factors and their impact on the financial condition of local governments.

The realization that many local officials have come to in light of the above factors is that as long as your local unit has the ability to expand its tax base (i.e., your community is not fully developed), your community is much better equipped to deal with the limitations of the Municipal Finance Model. Current conditions have forced many local governments to make difficult decisions to maintain financially viable communities, including cuts to programs and services, staff reductions, deferring of capital and maintenance expenditures, requesting additional taxing authority, etc. For many communities, more tough choices remain.

That is the current state of affairs. What does the future hold for Michigan’s Municipal Finance Model? There are many issues pending that will play an important role in determining that future. We thought that it would be helpful to review some of these important financial issues on the horizon for local governments.

Revenue Sharing

Many local officials are tired of being reminded of the cuts to state-shared revenue over the last several years. Despite a greater level of sales tax collections today than five years ago, total revenue-sharing payments to cities, villages, townships, and counties (which are based on sales tax collections) are more than $442 million less annually today than they were five years ago. While distributions of “constitutional” state-shared revenue (i.e., that portion of revenue sharing protected by the state’s constitution) are greater than they were five years ago (by $65 million per year), payments of “statutory” revenue sharing (i.e., that portion of revenue sharing provided for in state statute and subject to an annual appropriation) are approximately $507 million less.

Recent state budgets have frozen revenue-sharing payments at reduced levels, as the state has opted to use monies from the revenue-sharing program to assist with its budget shortfalls. Cuts to state shared-revenue have come through the statutory payment. As a result, the majority of townships are no longer receiving any statutory revenue sharing. As many of you recall, the state terminated payment of statutory revenue sharing to counties in 2004 (which was approximately $182 million) and, in return, moved county tax levies’ operating millage from December to July. The counties were required to deposit the additional monies from the earlier levy into a “reserve fund” that was to be used by the counties to replace lost statutory revenue sharing in future years.

What Will Happen with Revenue Sharing Going Forward?

The state of Michigan continues to have a significant structural deficit in its budget. The magnitude of the deficit has become even more clear in the last few months. The state’s deficit is growing, which means statutory revenue sharing and other appropriations (like K–12 education funding) to stakeholders in the state’s budget are at great risk. The January 2007 revenue-estimating conference painted a grim picture. According to economists, Michigan’s budget is $3 billion short of the revenue needed to cover basic services this year and next.

With the statutory formula expiring in 2007, these dollars will receive considerable attention in the coming months. Will counties that were eliminated from the statutory revenue-sharing formula a few years ago be allowed back and to what extent? Will the size of the statutory pot grow or will there be a shift of the same monies from cities, villages, and townships to the counties? What impact will the new Business Tax have on the state’s budget? With the loss of $1.9 billion expected in 2008 as a result of the repeal of the Single Business Tax, how much revenue will the new tax structure generate for the state and will it be enough for the state to balance its otherwise teetering budget?

The introduction of the governor’s fiscal year 2007/2008 budget in early February 2007 provided a first look at the administration’s answer to these questions. In summary, the governor’s fiscal year 2007/2008 budget preserves local government funding (with a potential increase) by replacing a majority of the repealed Single Business Tax revenue with the Michigan Business Tax and the enactment of a new excise tax on service providers. More details of the governor’s plan are as follows:

• The governor is re-proposing the Michigan Business Tax (MBT) that was originally introduced in November 2006 as a replacement for the Single Business Tax. The MBT has been revised from November 2006 and projects to generate approximately $480 million less annually in revenue than currently generated by the Single Business Tax.
• A new 2 percent excise tax is proposed on most services. Although technically not an expansion of the sales or use tax, the service excise tax has the same effect of a sales and use tax by taxing users and consumers on the price paid for services. As introduced, government purchases of services are exempt from the excise tax. The effective date of the excise tax is June 1, 2007, and it is projected (if effective on June 1, 2007) to raise about $576 million in the remainder of the fiscal 2006/2007 to help with the state’s budget deficit for that year. The new excise tax is projected to raise $1.47 billion in the state’s fiscal year 2007/2008.
• In addition to the new Michigan Business Tax and the excise tax described above, the governor’s plan also includes a federally decoupled estate tax, an increase in tax on tobacco and cigarettes, an increase in the liquor markup, and the elimination of certain tax loopholes.
• Specifically related to revenue sharing, the governor’s budget, as introduced for fiscal year 2007/2008, includes a $27 million increase in revenue sharing along with an additional $14.5 million for public safety funding. According to the governor’s plan, the additional $27 million increase will be distributed using the three-part formula currently contained in the revenue-sharing act (taxable value per capita, population/unit type, and yield equalization). While specific details have not been announced yet, communities would only be eligible for the increase if they could demonstrate service sharing with other local governments.

At the same time, the governor also announced an Executive Order to remedy the deficit in the state’s fiscal year 2006/2007 budget. Subsequently, the Executive Order was rejected by the Senate Appropriations Committee, sending the administration back to the drawing board. This is likely a preview of things to come in Lansing as the budget negotiations for fiscal years 2006/2007 and 2007/2008 play out. The stakes are considerably higher given the state’s worsening financial condition. There are a multitude of factors that will ultimately determine the fate of local government funding including:

• What new state-level tax(es) will be enacted to replace the Single Business Tax and how much revenue will it (they) generate?
• How much of the state’s fiscal year 2006/2007 shortfall will be solved by the new excise tax?
• If significant budget shortfalls remain, where will the needs of local government fit in the hierarchy of special interest groups in Lansing, including K–12 education, higher education, health and welfare organizations, etc.?

There still remain considerably more questions than answers, and we continue to strongly encourage local governments to consider this as annual budgets and long-term financial plans are prepared.

Revenue sharing is not the only revenue source with uncertainty…

Personal Property Tax

Over the last six years, the state’s personal property tax has changed substantially. Beginning in 2000, the State Tax Commission updated the general business depreciation tables that are used to calculate personal property taxes, resulting in an approximate 10 percent drop in property tax revenue. In addition, the State Tax Commission also approved new personal property tax tables for utilities. The new tables made drastic changes to transmission and distribution property of utilities, resulting in approximately 30 percent revenue loss to local units of government.

As you recall, Proposal A changed the definitions of “addition” and “loss” under the General Property Tax Act to provide for an increase or decrease in value attributable to a property’s occupancy rate. In WPW Acquisition Co. versus City of Troy, the Michigan Supreme Court ruled that the Proposal A cap prevents assessors from increasing the taxable value of commercial rental property above the rate of inflation using the occupancy methodology. As a result of the court’s ruling, a property’s taxable value can be reduced because of a decrease in occupancy rate, but does not increase when the occupancy rate subsequently increases.

The governor’s tax plan as introduced proposes to exclude commercial rental property from the General Property Tax Act and impose a new property tax on commercial rental property to mitigate the impact of the WPW case.

At the time this document was written, the governor has not released all the details on the new Michigan Business Tax, but the version introduced in November 2006 provided an exemption from personal property tax for certain industrial and commercial properties. Personal property taxes are a significant revenue source to many local governments. If the Michigan Business Tax provides similar personal property tax relief, the question is: Will local governments be held harmless by the state and to what extent?

Cable Franchise Fees

Governor Granholm signed cable franchise legislation (House Bill 6456) into law effective January 1, 2007. The new law (Public Act 480 of 2006) creates the “Uniform Video Services Local Franchise Act” that provides a statewide framework for franchising agreements instead of individual community agreements. This Act requires video service providers to obtain a local franchise, good for 10 years, from the franchising entity (the local unit of government). As part of the local franchise, the provider is required to pay an annual video service provider fee, not to exceed 5 percent of gross revenue, as well as an annual fee for the costs of the PEG access facilities, not to exceed 2 percent of gross revenue. The Act allows providers to terminate the current franchise contracts before their expiration date in order to enter into this new local franchise agreement under the statewide framework. Effective January 1, 2007, all current provisions in existing local cable franchise agreements that differ from this uniform Act are considered unenforceable. No existing franchise agreement can be renewed or extended.

Local units of government will be impacted in the following ways:

• Under the Act, no additional fees or charges, other than those stipulated under the Act, may be written into the local franchise agreements. The Act does provide for franchise fees up to 5 percent of gross revenue and the same rate must apply to all providers in a community. PEG fees (public, educational, and governmental fees) are allowed up to 2 percent of gross revenue with a needs assessment.
• To the extent existing cable franchise agreements provided more funding than provided for under the new Act, municipalities will see reduced fees from these new local franchise agreements.
• A credit, based on annual maintenance fees paid for use of public rights of way, to video service providers is allowed under the Act. This credit could eliminate or significantly reduce any revenue the local unit might receive under the bill’s franchise fee. For example, if AT&T begins offering cable services in your community, they can offset their 5 percent franchise fee payment by the amount of Metro Act fees they have paid to the state.
• Audits of the video service providers’ calculations of gross revenue are limited to once every two years.

It is expected that local governments will receive their first payment under the new Act beginning in May 2007. We strongly encourage you to review this payment compared to payments previously received and follow up with your provider, if necessary.

Ballot Issues and Their Impact on Municipal Finance

Although the November 2006 ballot proposal to guarantee increases in education funding failed, it will probably come back around. In addition, although the Michigan Board of Canvassers elected to remove the proposed constitutional amendment that has been labeled “Stop Over Spending” from the November 2006 ballot, it is also likely that this proposal will be back for voter consideration in the future. This proposal would have created new restrictions on local government and state finances and would have substantially limited the ability to even increase user fees and charges for services without voter approval.

Increase in Service-Sharing Discussions

Given the limited revenue outlook, local governments are examining expenditure reduction. Increasingly, local governments are exploring collaborative efforts as a way to find fundamentally lower cost methods to continue to deliver services. Long recognized as an effective means to share the costs of significant capital projects (such as solid waste facilities, utilities, etc.), regionalized service delivery is now being put to the test in other venues. Specifically, communities are taking a serious look at police, fire, and other service consolidations.

With encouragement from the federal and state government (and even counties), local officials appear to be in a race to find different and better ways to consolidate expenses. Some appear to be getting close. There are numerous examples of consolidated emergency 911 dispatch services with more examples coming online each year. Now there are several examples of local communities testing the idea of full-scale police and fire consolidation. Some of these include the Downriver Community Conference Fire and EMS Consolidation Study and Oakland County’s two fire regionalization projects. There are already existing examples across the state of these types of activities. What’s new is that the current efforts also include urban communities with well-established and effective departments that are struggling to maintain service levels.

Early results are encouraging, with some studies indicating significant savings opportunities of 25 percent. While all of these efforts face significant challenges and hurdles, several are getting close to implementation. The next year should be interesting.