03/16/2012 11:39 am ET Updated May 16, 2012

State Government Bears Responsibility for Local Governments' Fiscal Distress

Michigan has over 1800 units of local government and over 500 school districts. It's well known that local governments and schools have been in fiscal distress for a number of years. While there are notable exceptions, for the most part both local units of government and schools have done whatever was necessary to remain fiscally sound under very difficult circumstances. 

What is poorly understood by the public and by a term-limited legislature is how previous state government decisions, and decisions that will be made later this year, contributed to that fiscal distress and contributed to the need for the EM law.

As a rule of thumb, local governments receive on average about 75 percent of their funding from local property tax collections and about 25 percent from state revenue sharing. Both sources have declined as costs and the demand for services have increased.

There are two parts of state revenue sharing: a constitutional distribution to cities, villages, and townships (CVTs) based on population; and a statutory distribution that goes to CVTs and counties. Unlike many states, local governments do not have the ability to levy local option taxes, such as a local sales tax. About 20 have the ability to levy a city income tax that is limited as to the rate at which they may levy it.

Decisions made by three administrations (including the current one) and during many legislative sessions since 1998 to not fully fund statutory revenue sharing have contributed to the fiscal distress faced by local government.

Prior to 1996, statutory revenue sharing was funded through various earmarks. Previous funding sources were eliminated and replaced by sales tax by Public Act 342 of 1996. Public Act 532 of 1998 earmarked an amount equal to 21.3% of sales tax revenue at the 4% rate to statutory revenue sharing. Of that amount, counties were to receive 25.06% and CVTs would receive 74.94%.

The statute currently states:

"Subject to section 13d, for the 1998-1999 through 2006-2007 state fiscal years, the department of treasury shall cause distributions determined under subsections (6) to (13) to be paid to each city, village, and township from an amount equal to 74.94% of 21.3% of the sales tax collections at a rate of 4% in the 12-month period ending June 30 of the state fiscal year in which the payments are made. After September 30, 2007, 74.94% of 21.3% of sales tax collections at a rate of 4% shall be distributed to cities, villages, and townships as provided by law." (MCL 141.913(5))

However, in Michigan, statute can't mandate an appropriation, and statutory revenue sharing has only been fully funded once since 1998. The first couple of years the reductions were fairly small, but reductions to full funding increased to $58.6 million in 1999-2000, $506.3 million in 2004-05, and $629.6 million in 2010-11.

The cumulative reductions to statutory revenue sharing since 1998 exceeded $4.4 billion by 2010-11.

This year statutory revenue sharing was renamed, revamped to include a number of specific criteria that most CVTs must meet to receive statutory funding, and available funding was reduced by about $100 million. The recommendation for next year includes no increase for CVTs.

Counties receive no constitutional revenue sharing distribution. As a way to temporarily offset state budget shortfalls, counties collected local property taxes early in 2005 and deposited the revenue in reserve accounts. They were allowed to draw down money from their reserve accounts to replace statutory revenue sharing payments which were temporarily eliminated.

The plan was, as counties used up their reserve accounts they would come back into the revenue-sharing formula. Currently about 60 counties will have exhausted their reserve account by the end of the year. The current proposal is to reduce that distribution by 25 percent.

More pressure for local government finances is coming. The administration has announced that within the next couple of weeks they will propose that most taxes businesses pay on personal property be eliminated. Depending on the actual language of the bill, it would be a business tax cut of $600 million to $700 million. The problem is that personal property taxes are part of local government's tax base and no local government official I know believes that the lost revenue will be replaced.

We need to look at this in the context of what just happened. State government was facing a shortfall this year that exceeded $1.4 billion. We solved the problem by cutting the budget almost $1.6 billion. Then we reduced business taxes about $1.7 billion (83 percent) and increased taxes on individuals about $1.34 billion to pay for it. As a result of the tax changes about 95,000 businesses no longer pay a state business tax. The proposed tax cuts of $600 million to $700 million would be in addition to what happened as of January 1st.

As part of the budget cuts, funding for K-12 was reduced about $529 million, which included cuts to the per pupil foundation allowance of $470 per pupil. As part of business tax reform, School Aid Fund revenue was reduced by about $690 million. In addition, for the first time $1.0 billion of School Aid Fund revenue was used to fund higher education and community colleges.

The current budget proposal would freeze per pupil foundation allowances at the reduced level for two more years. Total funding for schools would increase 0.2 percent from year-to-date appropriations. All of that increase is due to a $47 million increase in federal funds. State funding actually declines about $20 million. The governor has proposed a supplemental appropriation that has not yet been enacted, but when it is, the change will be slightly negative.

So what does it all mean? In some circles, the entire blame for the fiscal distress faced by local governments and schools, and the potential need for an emergency manager, is placed almost entirely upon employee costs, unions, and an unwillingness to look for efficiencies. And platitudes such as "We all have to live within our means" solemnly spoken are the norm. These same individuals also seem to think the solution to every problem is a tax cut for business and right-to-work legislation.

What they fail to understand or do not want to admit, that there is plenty of blame to go around, and part of the problems faced by local governments and schools are the result of fiscal and tax policy initiated in Lansing. They also don't seem to remember how much money was diverted to the state budget in order to reduce the need to make even tougher decisions.