MuniLand

Where is Detroit’s sales tax?

I have read about 5,000 stories about the collapse of Detroit. I keep searching for some useful or novel idea for fixing the city, and what I haven’t seen is any discussion of raising taxes.

I wrote yesterday about Stockton, California putting a 3/4 cent sales tax increase on the ballot. The city intends to use the new revenue to put more police on the streets. I thought about how little of Detroit’s revenues came from sales tax, and I wondered why a tax couldn’t be implemented to lift the city out of bankruptcy.

According to the Detroit News, Detroit has the highest property tax rate in the country:

Detroit ranked first among the 50 largest U.S. cities in taxes and last among property values in a 2011 study by the Lincoln Institute of Land Policy in Cambridge, Mass. Detroit taxes on a $150,000 house were $4,885, twice the national average of $1,983.

Wayne County, Michigan, which collects these taxes for Detroit, has a terrible collection rate. The Detroit News concluded  that about half of property taxes go uncollected (an estimated $246 million last year). It will not be easy to correct this problem because so many property units are abandoned or foreclosed.

Stockton proposes sales tax hike to put police on the street

Stockton, California was a topic on Morgan Spurlock’s Inside Man program on CNN this week. The focus was on the increase in crime since the city slashed spending on police and fire in its bankruptcy proceeding. 70 percent of the city’s budget is spent on “safety” needs, and the city is broke.

After the housing crisis cut property tax collections, the ax in Stockton had to fall on the next-largest area of spending. City employee payrolls were cut 25-30 percent for public safety and 40 percent for non-safety positions. Now the city has a 3/4 cent sales tax increase on the ballot for November to add police to the streets. The proposed tax would raise an estimated $28 million dollars the first year. It’s an excellent idea, but not a panacea for the city’s deep fiscal problems.

Stockton pays very high salaries to city employees, especially to fire and police workers. As I wrote in March:

Europe’s privatization of public assets isn’t a model for the U.S.

Chart: Policy Dialogues

Some think that when it comes to privatizing U.S. public assets, our nation is a laggard and we really should be following the path of Europe in selling infrastructure into private hands. Here is attorney Kent Rowey, who is a leading infrastructure privatization attorney (and whom I’ve sparred with previously):

This should be a golden age of public-private partnerships — the need exists in cities across the country. And the capital is there, from private investors seeking long-term returns. American infrastructure has fallen behind countries like France, Italy, Spain, Portugal, Poland, Hungary and countries that have long embraced privatization of urban systems. Ironically, the United States has become an emerging economy when it comes to developing P3 projects — in which opportunity needs to be matched with political will and bold thinking to undertake.

Europe went through a massive privatization process starting under Margaret Thatcher in the 1980’s. But unlike the United States, U.K. and European countries had enormous state holdings that encompassed telecoms, utilities, banks, manufacturing and energy companies and many other industries. Few of these are under public control in America, which makes the pool for privatization much smaller.

Detroit’s emergency manager sure loves the media

#Detroit EM Orr was one of Miami's "most eligible men" in 1990, thank you @MaryellenTighe for the best fact of the day! #muniland

— Kate Smith (@laKateKate) August 8, 2013

I’ve closely watched five municipal bankruptcies, Jefferson County, Alabama, Central Falls, Rhode Island, Vallejo, Stockton and San Bernardino in California and two near bankruptcies in Mammoth Lakes, California and Harrisburg, Pennsylvania. Never have I seen the person managing a bankruptcy process seek media attention like Detroit’s Emergency Manager Kevyn Orr.

You can watch video interviews of Orr done with Detroit television stations and newspapers, national broadcast networks and national financial media like Reuters, the Wall Street Journal and the Financial Times. This media rush began before Orr dropped his Proposal to Creditors on June 14th. I was astonished at the time that Orr had pre-packaged and distributed how he wanted creditors treated. This step usually happens much later in a bankruptcy process. Although Orr claimed that he wanted to use his proposal as a template for negotiations with creditors he held no meetings with retirees, unions or bondholders other than marching these groups into city auditoriums and presenting Powerpoint presentations. Everyone of these groups say that Orr did not hold “good faith” negotiations; a requirement to be accepted into Chapter 9 bankruptcy.

The real history of public pensions in bankruptcy

There appears to be a frenzy of comments lately that public retirees receive excessive pensions in the current economy and that they need to be reduced. Many in the media have taken a brief look at Detroit and decided that costly pensions were the cause of the city’s bankruptcy. Nothing could be farther from the truth. Detroit pays a relatively modest median pension of $19,000 a year to general government retirees and $30,000 to police and fire retirees. Detroit’s pension system was funded at 82 percent in 2011 (and at 99 percent for its police and fire retirement system). That is higher than the national median of 74 percent. But public benefits make easy targets for critics. Let’s take a tour of pensions in bankruptcy through the years.

Attorneys Kenneth E. Noble and Kevin M. Baum describe Prichard, Alabama:

Prichard, Alabama, which experienced a population decline of approximately 50 percent over the past 50 years, filed for bankruptcy in 1999 after it was unable to pay approximately $3.9 million in delinquent bills. In addition to the unpaid bills, Prichard also admitted to not making payments to its employees’ pension funds and, even though the city had withheld taxes from employees’ paychecks, the city failed to submit such withholdings to the state and federal governments.

While in bankruptcy, the city successfully revised its budget so that it no longer operated at a deficit. However, Prichard was still unable to meet its pension obligations. In 2009, Prichard filed for bankruptcy for the second time in order to stay a pending suit brought by its pensioners after it failed to make pension payments for six months. In its chapter 9 petition, the city claimed that during the previous year it had operated a $600,000 deficit on its $10.7 million budget. Further, Prichard had failed to make a $16.5 million payment to its pension fund under its previous plan of adjustment.

The looming battle between Chicago and Illinois

 

The bankruptcy filing of Detroit has thrust the fiscal health of America’s cities into the spotlight. This is a good thing, because a number of U.S. cities are facing similar problems: Declining populations, rising costs, heavy pension burdens and thin budgets.

Detroit’s pension troubles are not a major contributor to the city’s insolvency, in my opinion, but many are going on to question Chicago’s large pension challenges.

Chicago is in a unique situation where, burdened with enormous pension costs, it is unable to adjust current pension commitments. This is because the State of Illinois has control of the law that applies to Chicago’s pensions. This may sound odd, but it is how muniland works. In addition to state capitols passing revenue to local governments, they often have significant control over the disposition of local finances.

The deafening roar has subsided

The recent sell-off in fixed income markets, led by the decline in U.S. Treasuries, was big by historical standards. Here the Federal Reserve Bank of New York compares past Treasury bond sell-offs with the most recent one. The recent rout was much deeper and more sustained than most in history.

If we drill down a little deeper into muniland, we see some interesting patterns. Using index data from Standard & Poor’s and Morningstar we can see how July and year-to-date losses compare for various classes and maturities of bonds:

Treasury bonds were hardest hit this year-to-date. Long-dated Treasury bonds had a loss of over 7 percent for the year. Short muni bonds squeaked out a small gain, while long munis suffered. Long corporate bonds fared slightly better.

The return of the bond vigilantes?

On Thursday, a small municipal bond deal for a Michigan county was postponed due to “lack of investor interest.” This is unusual, given the yield premium offered on the bonds. The Wall Street Journal has the story:

In the most tangible sign of fallout from Detroit’s bankruptcy filing, a Michigan municipality postponed a $53 million bond sale as investors blanched at the offered terms.

The Genesee offering didn’t attract enough buyers at a yield of 5.34 percent on a 29-year bond, the longest in the deal, according to people familiar with the offering. The average yield on a comparable 29-year municipal bond is 4.91 percent as of Thursday, according to Thomson Reuters Municipal Market Data.

How much federal money already goes to Detroit?

 

Members of the House of Representatives are trying to gather support from other members of Congress to hold hearings on a federal fund to help Detroit through its bankruptcy.

As I have been saying for months, the likelihood of a federal bailout for Detroit is miniscule. Federal spending, excluding transfer payments like Social Security, Medicare and Medicaid, has been shrinking as a percentage of the U.S. GDP. The federal government’s discretionary spending is contracting. Moreover, it is difficult to find the political will to rebuild Detroit. Federal money is spent on sudden, massive disasters like Hurricane Sandy, not on a slow crash like Detroit.

The likelihood of a federal bailout for Detroit is small to none, but there is a discussion about the funds that the federal government sends to Detroit on an annual basis. This has been a form of life support for the city. The question is how much Detroit already receives from the federal government.

How ratings agencies will approach pension liabilities

The New York Times recently ran a piece discussing how new pension valuation methods, put in place by the Government Accounting Standards Board, were far superior to the historical methods of valuing unfunded pension liabilities. They were even endorsed by some academic commentators. I have not heard of any state or local plan using these new methods to increase the funding of their pensions. Governments are not forced to use them, rather only to do the calculations and show the results on their balance sheets. Despite the revisions, governments will likely continue to use the averages of their historical rates of return on their pension investments to make decisions about the size of their annual contributions to their pension funds.

Here is the rationale that pension funds have used for decades, according to the Times:

Much of the theoretical argument for retaining current methods is based on the belief that states and cities, unlike companies, cannot go out of business. That means public pension systems have an infinite investment horizon and can pull out of down markets if given enough time.

  • # Editors & Key Contributors