The economic development tools for Michigan’s local governments are typical of those used by just about any government in the country. They basically fall into two methodologies: using tax abatements to retain or expand the local employment base, and using tax-capture programs to provide or enhance infrastructure and services to a specific area. The question. Do these economic development tools yield the same results in Michigan as they do in other states?
One common tool used in economic development is Michigan’s PA 198 abatements, the Industrial Facilities Tax. PA 198 allows local governments to exempt up to one-half of property taxes on a new manufacturing facility or all of the new property taxes on expansion or renovation of an existing facility. The abatements can be granted for up to 12 years. Tax abatements are often viewed in the same ways retailers look at “loss leaders” to get you into their store. You may lose the revenue from the property taxes, but you will make up for it in other ways. In the case of the retailer, it is additional sales; in the case of government, it is the secondary impacts of having more jobs in the area.
The use of tax-capture programs is also a very common economic development tool. Most cities have created Downtown Development Authorities, or DDAs. The simple concept of a DDA is that by investing in the public amenities within the downtown area, it will make the area more vibrant and desirable, which will draw additional activity. This investment in public infrastructure and services is paid for by the capture of the growth in property taxes paid by the property owners within the service area that occurs because of the improvements to public amenities. Typically, we talk about creating a sense of place as a significant means of enhancing economic development, especially in downtown areas. Tax-capture programs, like DDAs, are a vital financing mechanism to implement this economic development strategy.
So what happens when these programs are working as they should?
In a typical scenario, a PA 198 abatement is approved, which brings a major new manufacturer to town. This means new high paying jobs. Some of the jobs go to existing residents; in other cases it brings new residents to the area. Those new employees go looking for homes which drive up housing values. In some cases, especially in the outer suburbs, it will spur construction of new homes. If the person is looking for a home in an area that is already fully developed, it is more likely going to mean the purchase of an existing home and a potential renovation.
New jobs and more income in an area also have an impact on commercial establishments such as those found in the downtown. Restaurants and new retailers start filling the vacant store fronts. That means more jobs in the downtown. This activity feeds more money into the DDA which, in turn, is invested in making the downtown the great space that everyone wants. The new vibrancy in the downtown area brings in people who want to be within walking distance of that activity. Housing values in the downtown area skyrocket. The “Property Brothers” and the “Rehab Addict” come to town to show us how we can make older areas great places to live. Tradesmen are so busy they can’t take a day off. Life is great! This is just what we want to happen in our communities.
So who benefits?
The new manufacturer benefits from the reduced cost of property taxes. The shop owners benefit from having more money in the community, which means more sales and more meals being eaten out in area restaurants. Everyone who got a new job definitely benefits, whether it was in the factory, in a retail shop, or that independent tradesman. Homeowners see increased housing values. Commercial property owners also see a benefit in additional property value and increasing rents. The rising tide floats all boats.
On the public side of the coin, the state also sees significant benefits financially to economic development. More jobs and more income mean more income taxes. More money and more spending means more sales taxes being paid, even corporate income taxes go up.
But what about local government revenues?
This is where typical economic development scenarios found across the nation don’t work the same in Michigan as they do in other states. As noted earlier, local governments forego or capture certain property taxes in order to prime the economic pump. In many cases, states allow local option sales taxes or income taxes which can offset lost property taxes. Michigan has 22 cities that have local option income taxes. These cities can balance the loss of property taxes against the increases that they will see in income taxes. Of course this doesn’t offer any solace to the other levels of local government, like counties, that depend solely on property tax revenues for their general operations. In Michigan, this form of secondary impact has limited application.
In other states, economic growth impacts overall property values in the community, which will in turn generate additional revenue for local governments. Revitalizing downtowns creates a hot overall property market. Stimulating the housing market results in homes being rehabilitated and significantly increases their value. All of this activity generates more revenues for local governments: But not in Michigan.
Michigan local governments are extremely dependent on property taxes, but because of constitutional limitations, economic development often does not equate to additional revenues. When the Headlee amendment was adopted in 1978, it created a de facto definition of economic growth for local governments. Unlike the state, which measures economic growth by the change in total personal income, local governments must measure economic growth by how many buildings are constructed. This definition can be extremely problematic.
Headlee limits any growth in revenues from existing property to the rate of inflation, which was only 0.3% last year and will be 0.9% for the coming year. In other states, increased economic activity that also results in higher property values translates into additional funding for local governments. In Michigan, it results in reduced tax rates.
This issue is becoming more pronounced in the era of rehabbing homes. Television is saturated with shows that focus on turning tired old homes into sparkling new gems. The renovations are substantially increasing property values. Under Michigan law, most home renovations are not considered “additions,” and not even taxed until the home changes ownership. So if you purchase a home and replace the roof, siding, flooring, wiring, plumbing, move walls, and replaster the whole house, then flip the house for twice the price, the taxes will go up for the new homeowner, but Headlee will require the city and county to reduce the overall tax rate to the entire area so that no additional revenue will accrue to the local government, after inflation is taken into account.
In other states, if local government officials are successful in creating an environment that nurtures economic growth, they will see additional revenues for their operations, which can then be reinvested into the community to move economic growth even further ahead. This is the central concept of DDAs. Public investment in infrastructure and services creates desirable areas that spur private investment, which creates higher property values, which pay for public infrastructure and services. Other states use this economic development practice under all situations. It is the basis for economic development models at the state and federal level. But in Michigan, it can only be applied in very limited circumstances at the local level of government.
Why?
In our state, local governments will only see revenue growth if a building is constructed and the property taxes are not abated or captured on that new building. This has left us with a significantly flatter revenue growth trajectory for local government operations than other states.
What may be even more problematic is that Headlee has an uneven impact on communities here in our state. Those communities that have open areas where new homes and commercial buildings can be constructed are impacted to a lesser degree by our unique constitutional provisions than the well established urban areas of the state. In areas that were developed in the past, most new construction is either a renovation, abated, or not of great enough scope to significantly impact overall revenue growth.
Every local government official, elected or appointed, is focused on creating the best possible environment to support economic vitality in their community. That vitality enhances property values, draws jobs, and increases overall wealth. The state fully supports and depends on local government efforts in economic development because they also benefit financially from a thriving economy. In fact, the state legislature is always willing to allow local governments to abate their own tax revenue when it will likely mean an increase in state government revenues.
Unfortunately, one of the nasty side effects of the Headlee amendment is that local governments in other states see greater financial benefits for their operations from their economic development efforts. The Headlee amendment eliminates much of the financial gain to local governments from the secondary impacts of our economic development programs, which is the cornerstone of a loss leader approach to economic development. Michigan local governments have been working just as hard on economic development efforts as other communities across the country for the last 40 years, but have seen fewer rewards for their efforts. Going forward, this means that we will have fewer resources to compete with the rest of the nation.
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