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

Soundbite conclusions, misleading comparisons, and poorly explained statistics.

Cities in Michigan face limitations for revenue (taxation).  As we’ve discussed in previous posts, the City of Ann Arbor relies mostly on the property tax. We are advocating that the voters should be allowed to consider substituting an income tax (collected from a broader base, namely all income earned in the city) for part of the property tax. This would mean that the general operating millage, which in 2010 was 6.1682 mills, would be eliminated.  Ann Arbor residents would still pay all other current property taxes.  This would mean a higher rate of revenue for the city and avoid some really nasty budget decisions.  (See the current discouraging article from the Ann Arbor Chronicle.)

AnnArbor.com has been publishing stories on this issue.  The most recent discussed the possibility of a local sales tax.  But as we have explained, that is contrary to current state law.  Anyone care to place a bet on the Michigan Legislature making that particular change this year or anytime soon?  So despite local legislators promising to put it on the table, Mayor Hieftje’s expressed preference for it is wishful thinking.  Council (or anyone else) should not allow themselves to be distracted by this fanciful possibility.  (As an aside, it is not clear how a local sales tax would interact with the Headlee restriction on total tax capture;  it might actually require a constitutional amendment.)

Misleading comparisons lead to overstated conclusions.

Earlier, AnnArbor.com had two companion stories based on a  “Memorandum” from the Citizens’ Research Council on local-option city income taxes in Michigan.   Much of that CRC report is a summary rather than an analysis.  It is an overview of cities in Michigan that have local income taxes.  (Ann Arbor itself is not mentioned in the report.) But AnnArbor.com’s main story appears to draw the conclusion from the study that income tax wouldn’t work for a city like Ann Arbor.  Again, Mayor Hieftje is quoted as saying that it “reaffirms his thinking that a city income tax may not be the right move for Ann Arbor”.  Yet that conclusion is not justified by the report or the facts.

Aside: Mayor Hieftje has now stated that he is hoping to “make it through the recession without a tax increase”.  What is his plan, exactly?

The main argument against an income tax is made in a story with a misleading headline, “City income tax revenues can be volatile, unreliable during recession, Grand Rapids shows“.

But the information in the graph that relates to Ann Arbor is misleading. Let us refer to the authoritative source of information about Ann Arbor City’s finances, the Comprehensive Annual Financial Report (CAFR).  The numbers used for Ann Arbor are difficult to reconcile with the figures in these reports, but it appears that in the last few years the numbers are Total Revenues, not property tax collections.  As the attached spreadsheet shows,  property tax collections for FY 2008, FY2009, and FY 2010 were flat, at about $70 million each year.  The higher number (about $80 million) includes Michigan state shared revenue.

Notes to the spreadsheet:

• Figures do not include other sources of revenue, like fees, interest on bank deposits, sale of property, etc.
• Figures are from Basic Financial Services section under “General Revenues” and include property tax for debt retirement purposes but do not include “Business-type Activities”, which are enterprise funds.  Instead, they are “Governmental Activities”.

The conclusions drawn also fail to consider implications of the time context.

The AnnArbor.com graph refers to “2010” as its last data point.  But assuming that the Grand Rapids figures are correct and that they and the Ann Arbor data are both referring to Fiscal Year 2010 (though the Grand Rapids CAFR for that year shows a slightly higher figure), we should remember that FY 2010 ended June 30, 2010.  The income tax figures thus would reflect tax collected on income made in 2009.  But Ann Arbor’s FY 2010 property tax collection is based on taxable value from 2008 assessments.

This time-frame shift is important in making this comparison.  First, the Grand Rapids numbers date from the most severe year of the recession, and before the voter-approved increase from 1.3% to 1.5% (which took place July 1, 2010).  But Ann Arbor’s property tax figures do not reflect either the worst of the bursting of the housing bubble or loss of the Pfizer property tax with the sale of that property to the UM.

Thus, the comparison is highly misleading and overstates the stability of Ann Arbor’s property tax vs. the Grand Rapids example.

The graph above shows the taxable property valuations and the property tax collected over most of the last decade, based on figures from the CAFR.  Note that while property tax is collected in a given Fiscal Year, it is based on valuation from a calendar year two years earlier.  (The dip in property tax collection early in the decade was because Council reduced the millage rate below what was allowed.)  This shows that the trend in valuation had dropped and tax collection had flattened even before loss of the Pfizer property (December 2010) is accounted for .

Improper comparisons with other Michigan cities

The headline for the other story was, “New report says city income taxes work best in smaller cities, are less reliable than property taxes.”  But this is not an accurate summary of the report.  What the report did was to lump a number of Michigan cities into categories and compare the performance of income taxes for cities within each category against statewide figures for property tax and state income tax.  Notably, the period considered was from 1996 to 2009. (AnnArbor.com reproduced both a graph and a table comparing cities from the report.)

• Over this period, city property tax collection over the entire state increased steadily.  But is this a surprise?  We knew that the housing bubble and the real estate bubble in general lifted all boats through most of the last decade.  (Note, as we have explained, there is a two-year delay in translation of property values to tax collected, hence the 2009 figures in the report likely reflect a 2007 property valuation, before the big crash.)
• Over the same period,  the total income tax collected for all Michigan cities that impose them sank steadily.  Again, no surprise.  Michigan has been losing jobs for most of the last decade.  But this result was partly because it largely reflected Detroit’s tax collection. As the report says, “Detroit income tax revenues have constituted about 60 percent of all city income tax revenues over the past decade”.  And Detroit has, of course, been bleeding residents as well as manufacturing jobs.  So the statewide city income tax collection looks very poor because it is actually a statement about Detroit’s economy, not about smaller cities.
• There were three categories of cities shown separately: “Larger Core” cities such as Grand Rapids, Battle Creek, and Lansing; “Smaller Core” cities like Albion, Hudson, and Port Huron; and “Suburban” cities like Hamtramck, Highland Park and Pontiac, which were actually near large manufacturing core cities, especially Detroit.   Both Larger Core and Smaller Core cities actually did pretty well with their income taxes over the decade; the tax collected remained essentially level for that period, and well above the 1996 baseline.  Only the Suburban cities declined. But Ann Arbor does not match any of those cities in important ways, and is not at all like the Suburban cities.

How does Ann Arbor differ from the cities studied and how does that matter?

• Ann Arbor is comparable in population to some of the cities (like Lansing) described in the “Large Core” group, though it is  larger than some (like Jackson).  But it is much smaller (at about 110,000) than Grand Rapids (187,695 according to a 2008 estimate). Yet it is also the core city for a larger metropolitan area.
• Most of those cities (which include Flint, Saginaw, and Battle Creek) were dependent on the auto industry and other heavy manufacturing, much of which has been lost.  Ann Arbor is not.
• It is clearly not at all like the “Suburban” cities, which are dependent on large manufacturing centers in nearby cities. Again, Ann Arbor is insulated from the loss of heavy manufacturing.
• It has a high quality of life and attractiveness that encourage election both as a place of residence (retired people and others for whom this is an option) and upscale business ventures.
• It has the University of Michigan, with a physical plant that looks pretty well rooted in place.  The UM also raises the income level of the region.  While the median household income is shown for most cities in the CRC report as between roughly $27,000 and $40,000, the Ann Arbor area has held steady in the $60,000 range for many years.  (Current HUD figures used for housing estimates are $67,400 for a household of 2.)
• It is “landlocked” (mostly finished with annexation), and the UM has steadily acquired property within the city borders. Thus the property base for taxation is decreasing permanently.

In summary, Ann Arbor has a higher-income population, plus higher-income jobs that draw workers from adjacent communities; it is unlikely to lose its major industry, the University of Michigan; it is also likely to remain attractive to residents and businesses because of its quality of life and cachet, despite any change in method of tax collection; and its ability to continue increasing property tax collections (or to remain at the same level) is doubtful.

As the report states, much of the problem with income tax collection in some of the larger cities has been directly related to the problems with the (Michigan manufacturing-based) economy. “…the city income tax revenues also reflect the out migration and loss of income in the state’s largest core cities.”

Of course,  part of this discussion depends on your view of the future.  The belief in “business cycles” has become almost religious in some circles, but does it really apply to cities like Ann Arbor? Are the factors affecting future revenue collection from property tax vs. income tax really cyclical (and therefore stability is the key factor) or have circumstances changed for real?  I believe that it is a dynamically changing scenario and parts can be predicted.  More on that later.

The stories in AnnArbor.com are certainly timely and it is good to have the discussion happening.  But I hope that there is not a lot of prejudgment going on in advance of placing the question on the ballot. In spite of the negative tone and misleading comparison of Ann Arbor with Grand Rapids in the companion story,  a slim majority of those polled at the end of the story still supported putting the income tax on the ballot.