The Importance of Property Taxes in Municipal Bankrupcy Recovery

November 11, 2015. Share on Twitter

Does the Motor City Have to Change its Property Tax? Detroit has one of the broadest tax bases of any city in the U.S.: municipal income taxes constitute the city’s largest single source, contributing about 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the Great Recession. But the path to municipal bankruptcy also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents are under the poverty line and that the composition of businesses—unlike any other major city in the nation—are primarily made up of public organizations. The reduction also reflected state mandates. Only Chrysler and DTE Energy pay business taxes. Detroit’s revenues had been declining year-over-year. And, even while spending has declined, spending had exceeded revenues, on average, by more than $100 million every year since 2008. Moreover, state law prohibits cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Now, having emerged from the largest municipal bankruptcy in U.S. history, Detroit is still hindered in its recovery by structural flaws in its property tax system, according to a new report published by the prestigious Lincoln Institute of Land Policy, which has reported that Detroit’s high property tax rates, delinquency problem, inaccurate assessments, and overuse of tax breaks—together with limitations imposed by the Michigan constitution and state statutes, continue to expose the post-bankruptcy city to fiscal stress, with authors Gary Sands, a professor emeritus of urban planning at Wayne State University and co-author Mark Skidmore, a visiting fellow at the Lincoln Institute and a professor of economics at Michigan State University, writing: “Property tax reform is just one of several challenges facing Detroit and its residents, but tackling it could have a real impact on the city’s economy and quality of life, and could serve as an example for other cities struggling with population and job losses and a shrinking tax base….Detroit has an opportunity to restore the basic covenant that should exist between every city and its residents — fair and efficient taxes in exchange for good public services and reliable infrastructure.” In the post-bankrupt city, where Mayor Mike Duggan has secured Council approval to lower assessments 5 percent to 20 percent in some neighborhoods, the report recommends Detroit cut its tax rate, which is the highest of any major U.S. city and more than double the average rate for neighboring cities (The rate for homeowners is 69 mills, $69 for every $1,000 of assessed value).The report, Detroit and the Property Tax: Strategies to Improve Equity and Enhance Revenue, suggests key, post-bankruptcy reforms which could help, including: improving the city’s assessment system—a pre-bankruptcy system under which significantly over-assessed properties was a key contributor to the Motor City’s exceptional property tax delinquency rate—a rate which, the report notes, has improved, yet remains still about 30 percent, or ten times the median rate for major U.S. cities—adding the city also should reconsider its property abatement practices: Detroit has granted property tax breaks to over three percent of its 11,400 private properties; yet the report notes that research shows that the fiscal benefits of abatements are often outweighed by the costs. Significantly, the authors recommended the city should implement a land-based tax, a municipal tax based purely on the value or size of a piece of land, but with no additional tax for new development or improvements—an approach favored over the traditional property tax by many economists because it discourages holding property vacant or underutilizing land, and encourages development. The report also recommends eliminate Michigan’s “taxable-value cap,” a mechanism adopted by the state’s voters in 1994 which restricts the growth of the city’s tax base as the real estate market recovers, and which, the authors warn, also provides preferential treatment to longtime homeowners, locking in low effective tax rates at the expense of new buyers. The authors finally recommend reducing the city’s statutory tax rates, noting Detroit has the highest tax rate of any major U.S. city, more than double the average rate for neighboring cities. Lowering the rate could reduce delinquency and help increase property values, and could help offset increased tax burdens that may otherwise result from reducing abatements or eliminating the taxable-value cap.

Unschooled in Pensionary Math? While fixing Detroit’s revenue and tax systems is an ongoing issue, addressing its bankrupt public school system is key to the city’s fiscal future. Yet, now that the Detroit Public Schools (DPS) has to count its pension obligations, DPS’ balance sheet, in the first set of annual financial statements since Detroit emerged from municipal bankruptcy, the system has reported a $1.66 billion net deficit—or more than double that of a year ago—a change in significant part attributed to a new line on the balance sheet: $858 million of unfunded pension liabilities—a change reported in the wake of the implementation of a new accounting law which requires shortfalls to be counted against an entity’s assets on its annual balance sheet: DPS’s pension funded ratio as of last June 30th was 66.2%, according to the document. In contrast, other parts of DPS’s finances appear to be improving: its operating deficit was $42 million, a significant drop from the previous $70 million, and DPS appears to be modestly reducing its expenditures, where figures released demonstrated a modest reduction from $887 last year to $863 million. DPS state-appointed Emergency Manager stated: “Our team is working diligently every day to become a solvent school system which will allow local control to be restored.” Nevertheless, under strong pressure from Michigan Governor Rick Snyder, the state continues to seek a fiscal sustainable solution through a potential restructuring plan which would split DPS into two divisions: one responsible for the math: financial management, and other for the arithmetic: education. Indeed, DPS remedial math is an issue: In the first set of annual financial statements since Detroit emerged from bankruptcy, the system reported a $1.66 billion net deficit—equivalent to a 118 percent increase over last year, with the increase most adversely impacted by some $858 million of unfunded pension liabilities—liabilities which the system reports issued yesterday show DPS’s pension funded ratio as of June 30, 2015, was 66.2 percent.

Betting on the Garden State? In the wake of his conditional vetoes of the New Jersey legislature’s Atlantic City relief package, Gov. and Republican Presidential contender Chris Christie yesterday vowed he would meet with state Senate President Steve Sweeney (D-Gloucester) in an effort to agree on an alternate relief package for Atlantic City—a relief package the legislature sent to him last June—with the pair rolling the dice in issuing a joint statement that they intend to “construct a final and fast (sic) resolution path for Atlantic City.” Given that his veto was not issued until the very last possible moment, it is unclear what the Governor’s concept of “fast” means, but the clock began yesterday, with the legislature’s session scheduled to end in early January. In their joint statement, they said: “We remain jointly committed to Atlantic City’s long term viability as a great resort destination for entertainment, gaming and sports…Additionally, we both now understand more clearly how challenging this revitalization will be as a result of all the hard work that ensued this past year.” The timing with regard to Gov. Christie’s commitment is further complicated by the looming $11 million debt service payment due in December—a payment which Atlantic City Revenue Director Michael Stinson said would be made even if the redirected casino funds from the conditionally vetoed bills is not approved. Atlantic City Mayor Donald Guardian, who apparently was not consulted about the Governor’s last minute vetoes, is seeking better explanations and understanding from the New Jersey Office of Community Affairs with regard to the state’s concerns—especially as the clock is ticking. Or, as Garden State Assemblyman Vince Mazzeo (D-Northfield) put it: “Since June, we’ve been hopeful that Gov. Christie would do the right thing and sign these bills without delay…These bills were designed to bring real long term sustainable reforms to Atlantic City, help stabilize the tax base and generate new investments and business opportunities in the region.”

Windy City Pension Instability. Credit rating agency Moody reports, gloomily, in a special credit report, that Chicago’s unfunded pension obligations could continue to grow for at least the next decade, notwithstanding the record property tax that Mayor Rahm Emanuel secured from the City Council for the city’s public safety pension funds—and even assuming Chicago is successful in its pending legal challenges. The city’s general obligation bond ratings have steadily dropped in large part due to its accumulation of some $20 billion in unfunded liabilities, with the steep path down accelerating last spring when the rating agency dropped Chicago’s investment grade rating and issued a negative outlook. Moody analyst Matthew Butler noted: “The analysis indicates that, despite significantly increasing its contributions to its pension plans, Chicago’s unfunded pension liabilities could grow, at a minimum, for another ten years…Chicago’s statutory pension contributions will remain insufficient to arrest growth in unfunded pension liabilities for many years under each scenario,” adding that growth in the city’s unfunded liabilities and pension costs will continue “for some time regardless of the outcomes of the state’s and court’s decisions.” The credit report setback comes despite the record tax hike—a hike committed to the city’s proposed re-amortization of the schedule to implement increases in public safety pension contributions under a 2010 Illinois state mandate to fund them on an actuarial basis. Moreover, while the state legislature has passed and sent that re-amortization proposal to the Governor—a proposal which would delay the Chicago’s shift to an actuarially required contribution payment, that bill has become part of the accumulating morass caught up in Illinois’ dysfunctional ability to adopt its FY2016 budget—an inaction which is only driving up Chicago’s liabilities more, even as it prepares for a showdown before the Illinois Supreme Court next week over pension reforms approved for its municipal and laborers’ funds in Public Act 98-0641 to preserve and protect the funds’ solvency—a showdown which is an effort to overturn the lower court’s decision that the reforms violated Illinois’ constitution. A lower court judge in July voided the reforms, finding benefit cuts violated the state constitution. Yet even a win with the Supremes, Moody testily noted, despite being a “credit positive,” would still fail to address what the rating agency termed its “expectation of future growth in unfunded liabilities and the associated credit risk.” In response to the report, the city said: “Mayor Emanuel is committed to ensuring that city employees and retirees have a pension to turn to. Both SB777 and SB1922 were passed after successful discussions with the impacted unions, securing the retirements of our employees and retirees without burdening taxpayers with unsustainable pension contributions…These pension reform plans are sensible and represent a shared path forward in addressing the pension challenges that threaten Chicago’s future, while reducing the impact on taxpayers, and as Moody’s accurately states, the passage of SB777 and upholding of SB1922 are credit positives for the city.”

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