The Challenge of Tax Subsidies in Municipal Fiscal Recovery

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eBlog, 6/16/16

In this morning’s eBlog, we consider the fiscal balancing challenges in Detroit as it emerges from the largest municipal bankruptcy in the nation’s history: how does it deal with the expiration of a key state tax break that has been successful in drawing higher income families and investment to its downtown? How does it balance equity in dealing with a state program that has been effective in revitalizing the city’s heart, but has provided benefits to those least in need—but not to those in greatest need?

Taxing Challenges to Detroit’s Future. At a time when Mayor Mike Duggan and the Detroit City Council have so far led a stirring physical and fiscal revival out of the largest municipal bankruptcy in American history—two issues challenge the ongoing recovery: 1) will the state bailout of the Detroit Public Schools inspire sufficient confidence in the city’s public schools (and charter schools) so that families not only do not leave, but also that there are incentives for other young families to move in, and, 2) how to deal with the expiring Neighborhood Enterprise Zone (NEZ) tax incentives program, which appears to have played a key role in drawing professionals to downtown and Midtown Detroit. Mike Wilkinson, writing for Bridge Magazine, noted that this state tax incentive, which appears to have been strikingly effective in filling high-rise downtown condos, is not permanent—raising two difficult questions: equity and the downtown’s future. The stakes are significant: yesterday, Realcomp Ltd reported that Metro Detroit experienced record median home sale prices in May: the number of sales reached a 10-year high, in the latest year-over-year figures; median home and condominium sales jumped 8 percent and sale prices increased 3.8 percent in Wayne, Oakland, Macomb, and Livingston counties. At the time Detroit filed for chapter 9 municipal bankruptcy, the city today was home to an estimated 40,000 abandoned lots and structures. Indeed, between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base.

Detroit, which had been hemorrhaging population for decades, but which has one of the broadest tax bases of any city in the U.S., has been using the NEZ program aggressively—and with impressive results: a renaissance of development and reinvestment downtown and other neighborhoods near the city’s core. Now, however, with hundreds of NEZ units set to expire this year and next, there is increased apprehension with regard to whether the lapse might reverse this tide of human and capital investment in the city core. That is: when condo tax bills that have been artificially reduced to as little as $500 annually revert to their assessed level of $12,000: what will happen? Mr. Wilkinson, writing about an interview he did with the author of a Michigan State graduate doctoral study on the issue, wrote said author told him: “If you start taxing them on what their (properties are) worth, they’re not going to stay,” leading him to wonder, however, if the city opts to further extend generous tax subsidies to new(er) Detroiters living in some of the city’s most expensive homes, “what message does that send to ordinary residents of more modest means, people taxed on the full value of their properties for decades? After all, the city’s high assessments, combined with the city’s high tax rate, are why so many longtime residents have been unable to pay their tax bills.”

Michigan’s NEZ program has been around for more than two decades. When it began, it targeted new construction and building rehabilitation. For new construction, the owner would receive up to 15 years of tax relief, paying half the statewide average millage rate. This year, that amounts to less than 17 mills, a startling 75 percent discount from the 69 mills that most Detroit homeowners without an abatement would pay.

The program is not unique to Detroit: more than 14,600 residential properties in 26 municipalities have been the beneficiaries of state-sanctioned NEZ tax subsidies since 1993, designed to encourage residential development in financially distressed communities; however, the vast bulk, close to 90 percent, have been issued in Detroit to incentivize new construction throughout the city and the rehabilitation of older buildings. Moreover, the City of Detroit and some other communities have also been innovative in finding ways to extend the program to existing homeowners, so that if a homeowner invests as little as $500 in improvements, she or he is eligible.

That raises taxing issues of equity, however: he notes that some 5,000-square-foot mansions in gated communities with personal boat docks along the Detroit River assessed at values in excess of $800,000 year pay less than $5,000 in taxes, even as less than a mile away Detroit homeowners with properties assessed at only $30,000 are paying more than $1,500 a year in taxes.

Gary Evanko, the Motor City’s chief assessor concurs that too many properties are assessed too low, even as many more are assessed too high, deeming the question about the future of the NEZ program as something which merits special attention. The challenge of expiring tax incentives is not unique to Detroit—as Mark Skidmore, an economics professor at Michigan State University put it: when a business which has been the beneficiary of tax subsidies watches the end nearing, it seeks to renegotiate, obtain an extension, or threaten to depart. So, as Mr. Wilkinson writes: “That same dynamic could play out with residential properties in struggling cities: The question is: what will the city of Detroit do? Will they…extend the abatements for fear of losing the people, or will it make them pay the full rate?”

In Detroit, as in every metropolitan area, the challenge of setting property tax rates is competitive: each jurisdiction watching its neighbors for bragging rights with regard to which has the lowest—even as there is recognition that families with children sometimes find the assessment of such a jurisdiction’s public schools a greater determinant in where the family would like to live. So it is in Detroit that, at 69 mills for owner-occupied homes and condos, the city’s tax rate can generate a bill of as much as $7,000 for homes worth $200,000—in contrast, in the Detroit suburb of Troy, a home assessed at the same $200,000 would mean a property tax bill of just over half: $3,700.

For owners of rehabilitated buildings, the NEZ program works differently: owners pay the full property tax rate; however the assessment is frozen at the share of the building’s value before renovations. So that, for instance, in downtown Motown at the Book Cadillac, which underwent extensive renovation and emerged as a mix of hotel rooms, condos and restaurants, that meant valuing refurbished condo units at their assessed value pre-chapter 9—meaning that today’s posh condo owners are the beneficiaries of assessments frozen for 15 years at $3,026, or roughly 1 percent of the $290,000 cost of purchase in 2008—or an annual property tax of less than $500—that is unless you are a lucky reader who happens to own one of Book Cadillac’s three-story penthouse units, then your assessment is frozen at $3,000—one of more than 3,000 municipal tax subsidies for rehabbed buildings and some nearly 3,900 for new construction. Because these tax breaks are time limited; however, and many of the NEZ tax subsidies offered to new and current homeowners are maturing, there are two issues: what will happen as these subsidies phase out: will higher income owners move out of the downtown? And, second, what is the equity in a city with such a disproportionate number of low-income families?

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