Illustration by Bryan Walker

What Michigan and Suburbanites Owe Detroit

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Dec. 4 (Bloomberg) -- In his decision finding Detroit eligible for municipal bankruptcy this week, U.S. Bankruptcy Judge Steven Rhodes wrote: “The city no longer has the resources to provide its citizens with basic services. Was Detroit’s bankruptcy a foregone conclusion? Of course it was.”

But absent from the decision was any discussion of the role of Detroit’s revenue or of how critical it would be to any sustainable post-bankruptcy comeback -- or of how the state should and could contribute to a meaningful recovery.

Rhodes’ ruling gives permission for the city’s emergency manager, Kevyn Orr, and a newly elected mayor to take on the unspooling of the largest municipal bankruptcy in U.S. history, and achieving consensus on a blueprint for recovery.

Negotiating such a plan with 100,000 plus creditors would be, under any circumstances, an exceptional test. In this case, the goal isn’t only to find a solution that can gain the support of a majority of the city’s creditors. More important, it is to fashion a plan that will provide a viable economic future for Detroit. That is a far more complex and taxing undertaking than simply achieving a balanced budget or patching over a broken fiscal process.

On Tuesday, Michigan Municipal League President Jacqueline Noonan said the ruling was a reminder that any solution required a re-examination of the state’s municipal finance system, which allowed the legislature and governor to balance Michigan’s budget “on the backs of local governments” and take “about $6 billion in funds that, by state law, were supposed to go to local governments as statutory revenue sharing, including to the city of Detroit.”

Tax Base

Detroit has one of the broadest tax bases of any U.S. city. Municipal-income taxes constitute its largest single source, contributing about 21 percent of total revenue last year. Yet since the city last realized a general fund surplus in 2002, receipts have declined each year, reflecting both a rate reduction mandated by the state and the recession.

The declining revenue also reflects not just the significant population decline, but also the makeup of the decline: The census reports that one-third of current city residents are living under the poverty line and that its businesses -- unlike those in any other major U.S. city -- are primarily public organizations.

The reduction also reflects state mandates. Only Chrysler Group LLC and DTE Energy Co. pay business taxes. As a result, even though spending has been declining, outlays have exceeded revenue, on average, by more than $100 million every year since 2008. Moreover, state law prohibits cities from increasing revenue by adding a sales tax or raising residential property tax rates more than inflation.

Detroit’s debts also suffer from noncollection. A city-commissioned study by McKinsey and Co. reported last year that an estimated $6.6 million of municipal-income taxes on commuters who work in Detroit, $21.8 million in corporate taxes and $155 million of income taxes on residents weren’t collected in 2009. That amounts to almost 50 percent of the taxes owed from people living in or working in the city.

The report also determined that 54 percent of city residents who worked outside the city didn’t pay; in Michigan, employers aren’t required to withhold city taxes, creating an estimated shortfall of about $142.3 million.

Clearly, any meaningful recovery plan to achieve a long-term balanced budget must address this state-abetted drain on Detroit’s revenue.

Collection Shortfall

Property taxes accounted for just 13.3 percent of Detroit’s income last year. Perhaps, more than any other city, Detroit’s property-tax collections were devastated by the recession, with assessed valuations declining almost 46 percent from 2007 to 2012.

But Detroit’s property-tax shortfall is also adversely affected by state limitations as well as a city tax administration system described by the Detroit News as “riddled with errors and waste, and is overseen by a pair of double-dipping officials who work just two days a week.” The Detroit News reported that 47 percent of property owners were delinquent on their property taxes and fees in 2012 -- with some delinquencies “so pervasive that 77 blocks had only one owner who paid taxes last year.”

The newspaper pointed to yet another problem: high taxes and low values. In a 2011 50-state property tax comparison study, Detroit ranked first among the 50 largest cities in taxes -- and last among property values. Detroit taxes on a $150,000 house were $4,885, twice the national average of $1,983. The city’s average house price, $16,800, was almost 10 times lower than the average of the next lowest city, Mesa, Arizona.

Rhodes was correct to note the city’s need for resources. Now what is required is for the state to play a constructive role.

To do that, the state should help collect the taxes already owed to Detroit -- especially assisting in enforcing collection of the income and corporate taxes. It should also remove the tax limitations on the city, so that revenue, just like pension benefits, is on the table as Detroit cobbles together its plan of adjustment. Michigan has to rethink its entire policy of disinvesting in its cities’ futures.

Any plan of adjustment that omits the critical state role in securing revenue would amount to putting Detroit on life support instead of ensuring its economic future.

(Frank H. Shafroth is director of the Center for State and Local Government Leadership at George Mason University.)

To contact the writer of this article: Frank H. Shafroth at

To contact the editor responsible for this article: Katy Roberts at