As we prepare to begin a new year, I’m reminded by retiree friends that the Social Security cost of living increase for 2017 will be an uninspiring 0.3%. Many senior citizens are pointing out that this paltry increase does not cover the expected inflationary cost increase between 2016 and 2017, which is looking to be close to 2.0%. This gap between rising costs and stagnating income could put millions of senior citizens, especially those with limited other retirement income, in a difficult financial situation. It is times like this that retirees realize the value of income diversity; unfortunately, it is too late for many of them to change their income mix.
This got me thinking about local government budgets, and how they have suffered losses due to the economic recession of the mid-2000s. While inflation has been relatively low, many communities faced reductions, or at best stagnation, in revenues, which put significant strain on local service delivery.
Similar to retirees who rely heavily on Social Security for income, local governments are often heavily dependent on just one revenue source. In Michigan, this single source is property taxes. In other states it may be sales tax or income tax. During the Great Recession, a number of Michigan cities considered diversifying their revenues, through the adoption of a local income tax. There really are no other options available to local governments in the state, and only cities are authorized to implement a local income tax (with voter approval).
Municipal Analytics studied this option for five cities in the years 2008-2012. The reasons for exploring the income tax ranged from a new revenue source to pay for street improvements, to increasing revenues to help fund burdensome debt payments, to simply wanting to diversify the revenue streams coming in to the city to lessen the impact of real estate downturns. Through our analysis, we determined the revenue potential in each city varied considerably, based on the composition of income earners in the city. The estimated shift in tax burden among the various tax paying groups also varied, but in each case we estimated renters and non-residents of the cities would pay more.
In one case, we determined the revenue from an income tax could be equivalent to 7.5 mills of property tax. In another study, we found the city could reduce its general operating property taxes by 6.3 mills (35%) and maintain revenue neutrality. One city had considered the income tax at 4 separate points in time: 1990, 1994, 2000 and 2012. A comparison of the findings of the four studies revealed income tax revenue potential increased only modestly (24%) over a 22 year period. This was largely due to the shifting demographics of the city, as well as to the economic realities of the region, which was experiencing a shift in employment opportunities and payroll. The fact that revenue from an income tax was increasing each year the tax was studied supports the notion that an income tax can be stabilizing, even if property taxes decreased significantly, as they did between the 2000 and 2012 studies. However, the upside potential of the property tax outweighed the stabilizing effect of a local income tax, so the tax question was not put to voters.
What is important in each of the five cities studied is that the leaders understood the importance and value of undertaking a detailed analysis of the income tax option. The studies provided useful insight into the realities of a potential tax, gave policy makers real data to evaluate and deliberate, and informed the public of the impacts a new tax could have on their personal tax burden.
As a result of these feasibility studies, each of these cities now fully understands their options for diversifying tax revenues. They also have a better sense of the legal framework for requesting voter approval of an income tax. Any time a significant change is considered in revenue options, it is critical to first evaluate and compile the necessary information to make an informed decision.
Municipal Analytics is ready to assist with the analysis needed to understand complex issues in local government finance. Feel free to contact us to learn how we can help with your next big decision. And don’t forget to plan for diversified income in your retirement!