Ann Arbor’s Budget: The Case for a City Income Tax II

The debate about an Ann Arbor city income swung into full cry January 30 with a story on AnnArbor.com.  The companion story purports to show that a city income tax is a less dependable source of revenue than property tax.

We’ll get to the arguments about those two stories shortly.  But meanwhile, let’s define the issue.  First of all, the city is facing a budget crisis.  Thanks to the Neighborhood Alliance for reproducing the handout from the January 8 Council budget retreat that helps to show the deficits.  Although our city has done relatively well through the recent economic downturn compared to other cities, especially in Michigan, to use CM Rapundalo’s frequent metaphor, it doesn’t make it okay to lose your toes and one arm up to the elbow just because someone else lost both their legs.  As we’ve reported before, some unpleasant choices loom if we don’t do something soon.

As stated in the first post of this series, I believe that a city income tax is the best solution for the budget problems confronting the city, and I’m advocating that City Council should put the issue on the ballot for the voters to decide.  Here is one of the reasons:

There are structural (i.e., problems unrelated to current trends, but inherent in the way our tax system is set up) reasons for this current crisis.  Here is a brief review.  (In order to keep this discussion moving along, details of Michigan tax policy are kept to a minimum here. See the excellent summary by the Citizens’ Research Council for details.)

1. No local sales or use taxes:  Michigan law imposes major limitations on the taxing power of municipalities (that includes cities, townships, counties and villages).  Michigan cities are not able to tax any activity.  Whenever the subject of Ann Arbor’s problems come up, someone is sure to suggest a fee on UM football tickets, for example.  But we can’t do that,  or any local sales tax.  There is a surcharge on hotel rents, but that goes to the Convention and Visitors’ Bureau and the county, under a special provision.  So although Ann Arbor’s economy is increasingly as a tourist destination, we can’t take advantage of that to offset our expenses.

2. No help from the State of Michigan either. The lack of such local taxes were supposed to be offset by state “revenue sharing”. But as explained in a recent story on Michigan Radio, the loss of revenue sharing dollars over the last decade has put stress on cities.  The state legislature has found these dollars a good source to plug budget holes at the state level.  So cities are stuck – with neither the power to tax on their own behalf nor a share of those revenues.

3. Property tax is left standing alone. What this means is that the City of Ann Arbor must derive all its revenue from property tax or fees for service.  We’ll look at the question of fees at a future time, but for the moment we’ll assume that they are only applied to users of certain very specific services and cannot be used to support most governmental functions.

But Michigan state law has also restricted the way property tax is levied.

a. The Headlee amendment to the Michigan Constitution (passed in 1978) has several provisions intended to restrain the growth of taxation.    Two are especially important to cities:

  • Headlee requires that any new taxes (like special millages) instituted after 1978 are approved by a vote of the people.
  • It also requires taxation based on current valuation to increase no more than inflation.  So (excluding new construction) if the assessed valuation increases more than inflation, the rate at which property is taxed (millage rate) must be reduced.  This is the well-known and much despised “Headleeization” that brings previously approved millages down, down, down.  That is why the General Operating Millage of the City of Ann Arbor, originally approved at 7.5 mills, is now 6.1682 mills.

b. Proposal A, passed by popular vote in 1994,  limits the increase in taxable value for an individual property to 5% or inflation (the consumer price index), whichever is less.  Since the CPI has been very low (note that this measure specifically excludes housing) over the last decade, taxable values have been very stable for long-term owners.

  • Cities were depending on transfers of property during the housing boom to keep their taxable values up.  When a property is sold, it reverts to an assessment based on the current market value – the so-called “pop-up tax”.
  • During the housing boom, the prices of houses and other property were going up yearly.  This also increased taxable value.
  • BUT – in the last half decade, fewer houses were sold, and the market price sank.

Here is a summary from the city’s Comprehensive Annual Financial Report (CAFR) for Fiscal Year 2010 (remember, that ended June 30, 2010).  It shows the effect of Headlee and Proposal A on property tax revenues.

Each July 1st the City property tax is levied and becomes a lien on the related property, the value of which is equalized by the State of Michigan and limited by Act 415 of 1994. The City’s operating tax rate levied July 1, 2009, as controlled by the Headlee Amendment, Act 415 and City Charter, is 6.1682 mills. Other tax rates are as follows: Employee Benefits (2.0560), Refuse Collection (2.4670), Ann Arbor Transportation Authority (2.0560), Street Repair (1.9944),Parks Maintenance & Repair (1.0969), Open Space and Parkland Preservation Millage (0.4779), and Debt Service (0.4806). Real and personal property located in the City as of December 31, 2008 were assessed and equalized at $5,787,470,424, representing 50% of estimated current value. Act 415 of 1994 limits annual increases in taxable value to 5% or the Consumer Price Index, whichever is less. The 2009 taxable value on March 18, 2010, was $4,730,622,646. Property taxes are due July 31st of each year and any delin- quent real property taxes are turned over to Washtenaw County for collection the following March 1st.

Note:

  1. The “estimated value” was about $5.787 billion.  This was based on current assessments, which are then “equalized” by the state (this process is to keep overly favorable assessments from being delivered in some localities) to give a State Equalized Value (SEV).  As it states, this is 50% of current market value.
  2. After Proposal A limits were taken into effect, the Taxable Value (TV), on which taxes are actually levied, was only about $4.73 billion, a reduction of nearly 20%.
  3. The millage numbers are all strange fractions.  For example, the Open Space and Parkland Millage (aka the Greenbelt Millage) was approved by voters at 0.5 mills in 2003, but is now down to 0.4779 mills.  This is the “Headleeization” effect.
  4. The taxes that Ann Arbor property owners paid in July 2010 were the result of an assessment conducted in 2008.  That is because taxes are paid after the year in which they are incurred.  So the tax collection for 2010 really reflects the value of property in 2008.

We said at the beginning that the City is facing a “structural” problem with regard to the taxes it collects.  Part of that problem is the almost complete reliance on property tax to fund the city.  The other part is the heavy presence of the University of Michigan as the main property owner in Ann Arbor – but which is exempt from paying taxes.

In future posts we will look at the impact of the UM and the reason that this makes a city income tax the solution to the budget problem that is most reasonable, feasible, and most stable over the long term.  We’ll also analyze the recently published arguments that seem contrary to that conclusion.

Explore posts in the same categories: Business, civic finance

3 Comments on “Ann Arbor’s Budget: The Case for a City Income Tax II”

  1. Tom Whitaker Says:

    Even if you are correct that there are structural budget problems, I can’t see an income tax being approved by voters. Council has been on a spending spree with the underground parking garage, Municipal Center (and its $1 million fountain), Fuller Parking Garage (and associated train dreams), and coming soon, a hotel and conference center on top of the underground garage. As you have reported, there will be City costs to operate this facility but payments to the City by the developer will be subordinated to their own profits and private debts. Meanwhile, another developer is being given discounted review fees even though he owes four times the fee amount in back taxes.

    I know and understand all the counter-arguments about buckets and the like, but elections and ballot initiatives are not won on details. They are won on impressions. The public’s impression is that Mayor and Council are spending us into this crisis with pet projects and inside developer deals, then building up drama over fire-fighters, parks and garbage collection in order to scare us into higher taxes.

    I predict we will see an income tax on the ballot soon and it will be soundly defeated. Then, as the economy improves and tax revenue increases again, the structural budget issue can will be kicked down the road. After all, population always increases and property values never go down, right?

    • varmentrout Says:

      Yes, you are mirroring some thoughts that I woke up with this morning. There are indeed many irresponsible projects being contemplated and this council and mayor have not created confidence in their judgment on so many things. It does create a “do you trust these people with this money” feeling.

      However, I return to my argument in the first post in this series. Even if we grant that there might be savings to be found that are not being discussed (as in, for example, administration, or the city attorney’s office); and even if we grant that money is already being spent badly, the bald fact is that we residents of Ann Arbor will be the ones to suffer when the money pot runs out. These bad decisions will be made in any event at our expense.

      The nature of those sitting on council is a political problem, and one that must be addressed through political means (i.e., replacing them). This has not been very successful lately, but it is the correct solution. The correct solution is not to cut our collective nose off to spite our city-wide face.

      I am currently trying to make a case for putting the issue on the ballot. Then we can have this discussion as a populace and we can decide what the merits of the arguments on both sides are.


  2. […] Fraser, I wrote three posts proposing that Ann Arbor should adopt a city income tax. (Post I   Post II  Post III)  These are still worth reading if you would like to dig really deep into taxation as a […]


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