Blog: Conan Smith

Post No. 3

Building, Money and Power

Let’s take a tour through a prototypical first-tier suburb.  

About twenty thousand people live here. They’re among the most socially active people in the state; they lead nonprofits, donate to political candidates and volunteer for community events.  They own and work in the downtown businesses and they shop locally, intentionally.  Community is essential to them, and the neighborhood is more than just a safe place to park the car at night.

Their city is an orderly reflection of the design dreams of its founders.  Two or three commercial corridors stand out as major transportation arteries – wide roads of three to nine lanes. On one side the community is bounded by a highway; the others blend somewhat seamlessly into the neighboring city. Neighborhoods are defined by streets too. Square blocks of residential streets, mostly obscured by mature hardwoods, are hemmed in by wider two and three lane roads. Here and there a clear space of parkland or school yard breaks up a comfortably dense aggregation of houses. Main Street comprises an eclectic collection of shops and restaurants, government buildings and second story offices.  Sidewalks are ubiquitous although generous percentages of land are given up to parking. 

All but hidden from view is the enormous stress that this community is under. The people who live here are generally ready to tax themselves to maintain a high quality of life and sustain the character of their city, but the legacies of a shifting economy and investments in urban sprawl infrastructure and policy engines are taking their toll. The streets aren’t as smooth as they might be. Vacated industrial buildings await transformation to modern uses. Subtle reductions in services (city parks get mowed every other week now and there are a few less firefighters on the job) are starting to show through the veneer of a once-prized and fought over community.

This scenario is common throughout metro Detroit, from Warren to Roseville, Hazel Park to Farmington Hills, Inkster to Taylor to Dearborn Heights. These communities encompass the variety of southeast Michigan. They are growing and shrinking, racially mixed and monochromatic, well-to-do and economically struggling. The crisis they face is unique and structural... just like the solutions we need to adopt to overcome it.

Michigan’s cities are slowly dying, starving for resources to deliver high quality services and maintain existing infrastructure. At some level, it’s all about money. To understand the difficulty of the fiscal challenge cities face, you have to understand the interaction between two complex finance policies that are part of the state Constitution: 1978’s Headlee Amendment and 1994’s Proposal A.  

Headlee essentially limits the growth in local property taxes to the rate of inflation. Two things are at play here:  the tax rate (i.e., the percent of a property’s value that an owner must pay each year) and the tax base (i.e., the value of the property itself). If market forces increase the tax base higher than the rate of inflation, then Headlee forces cities to reduce the tax rate appropriately. The example below shows how an increase in the market value of property greater than the rate of inflation forces the city to reduce its tax rate.

  Taxable Value Tax Rate (Mills) Tax Collections
Base Year $1,000,000,000 10.000 $   10,000,000
3% Inflation $1,030,000,000 10.000 $   10,300,000
5% Market Increase $1,070,000,000 10.000 $   10,700,000
Headlee Rollback $1,070,000,000 9.626 $   10,300,000

Proposal A provides a similar tax shelter for individual property owners. It limits the increase in taxable value on each individual parcel to the rate of inflation (or five percent, whichever is less). When property is sold or transferred, its taxable value is adjusted to its current value. The example below shows how the taxable value “pops-up” when a property is sold. Notice that the new owners are paying taxes on more than $5,000 of additional value that the previous owners avoided.

  Market Value Taxable Value Inflation Rate Market Increase
Base Year $  100,000 $  50,000 2.50% 5%
Year 2 $  105,000 $  51,250 2.50% 5%
Year 3 $  110,250 $  52,531 2.50% 5%
Year 4 (Sale) $  115,763 $  57,881 2.50% 5%

Each of these policies serves to balance growth and taxation, and each has its benefits. Proposal A, for example, provides a buffer against the effects of gentrification in cities by protecting existing homeowners from being forced out of their neighborhoods by rampant tax increases due to growth in market value. A significant problem arises, however, from the interaction of these two policies.

Did you notice that the Proposal A “pop-up” resulted in an increase of taxable value of 10 percent on the one property? If this happens across many properties in one year – or if the pop-ups are even higher (imagine a property that changed hands after 15 years) – it can force an even more significant Headlee rollback. This is somewhat artificial because the full effect of the pop-up is felt in one year, rather than averaged out across the years that growth was held in check by Proposal A.  

The end result is that the Headlee rollback caused by Proposal A pop-ups reduces the overall tax rate in a city so much that tax collections grow slower than the rate of inflation. With health care costs increasing at seven percent annually, retirement obligations growing and public safety costs eating up around half of a city’s budget, revenue growth this slow is a recipe for financial ruin. In fact, some estimate that as many as 70 Michigan cities sit on the brink of bankruptcy because of this policy problem.

Under Michigan’s current systems of municipal finance and urban investment, there are only a handful of strategies local leaders can use to combat this phenomenon. They can promote redevelopment, which doesn’t count in the Headlee calculation. They can collaborate with neighboring communities to provide services, which shares the cost burden (sometimes) and can result in more effective delivery (sometimes). And, they can beg for structural reforms from the State.

As wonderful as it is to see old buildings rejuvenated, redevelopment cannot save any city from this fiscal predicament, no matter how vibrant the market. Our hypothetical city above would have to generate $40-$80 million in new development every year to keep up with costs. In communities like Michigan’s inner-ring suburbs, which are 90 to 100 percent built out, this is an unlikely proposition.  

Since we can’t build our way out of this problem, it is up to the Legislature to make the fix. The Michigan Municipal League articulated the Headlee/Prop A dilemma nearly four years ago, but lawmakers have continuously failed to acknowledge the ravaging impacts it has on our cities. In fact, a proposal passed this month by the Democrat-controlled Michigan House of Representatives would place a moratorium on the pop-up, further depressing revenue and shunting urban interests just as their Republican predecessors have done.  

Michigan’s cities will not dig their way out of this hole without structural reforms to the state’s local government finance system. It will be tragic if one of them has to fall into bankruptcy to convince our lawmakers of the seriousness of this issue.