Chicago Fed Insights

Detroit’s Fiscal Challenges and Opportunities Now and Post-Pandemic

July 20, 2021

The Chicago Fed’s virtual event, “Charting Detroit’s Fiscal Future: Challenges and Opportunities,” held on July 14, 2021, is the latest in a series of Project Hometown events aimed at identifying obstacles facing communities in the Seventh District during the pandemic. The event examined Detroit’s city government financing to understand how its unique revenue structure has fared during the Covid-19 pandemic, how it will respond post-pandemic, and how federal funding under the American Rescue Plan Act can best be put to use to meet the needs of its residents and promote inclusive economic growth.

Overviewing Detroit’s economy, panelist Evan Cunningham, senior economist in the Office of the Chief Financial Officer of the City of Detroit, reported that Detroit’s unemployment rate was down significantly from January through May 2021 (9.8%) compared with 2020 (20%), although it is still well above pre-pandemic levels. Despite the encouraging unemployment figures, Cunningham explained that these data should be interpreted with caution because the unemployment rate is relative to the size of the labor force, and the number of Detroiters who are working or actively seeking work has shrunk since the pandemic started due to a variety of factors, such as childcare responsibilities, illness, or choice. Cunningham also highlighted the “stark difference” in annual salaries between residents of Detroit and nonresidents working in the city. While data limitations make direct comparisons difficult, Anika Goss, CEO of Detroit Future City, roughly estimates the wage differential at $35,000 lower for Detroit residents than nonresidents who work in Detroit. To address the inequity, Goss recommended investing not only in skills training in the city but also higher education so more residents can qualify for higher-level jobs. Currently only 14% of Detroit residents have an associate degree or higher. Goss also recommended requiring firms that operate in Detroit to pay residents higher wages ($18 per hour), versus the existing wage of $12 per hour on average.

Detroit has been under substantial fiscal pressure as a result of the pandemic, while at the same time the demand for many local government services has spiked, especially health services, said Rick Mattoon, vice president and regional executive of the Chicago Fed’s Detroit branch and moderator of the event. Detroit has a diversified revenue structure to meet the needs of Detroiters, explained Taylor Griffin, research analyst with the Chicago Fed in the Community Development and Policy Studies area. Yet Detroit relies heavily on two sources of finance that have been heavily impacted by the Covid-19 crisis—the municipal income tax, with losses driven by nonresidents working remotely, and the wagering tax on casinos, which have experienced intermittent closures. Steve Watson, Detroit’s Deputy Chief Financial Officer, added that out of a general fund budget of only about $1 billion per year, Detroit lost about $400 million in revenues during the pandemic (fiscal year 2020–21).

Detroit’s unique revenue structure poses particular challenges in meeting its fiscal responsibilities, said Griffin. Both residents and nonresidents pay a municipal income tax (2.4% and 1.2%, respectively), yet nonresidents only pay income tax on the earnings from the time they spend physically working in the city. Griffin explained that income tax revenues from nonresidents fell sharply during the height of the pandemic and continue to be strained as people continue to work from home and engage in hybrid work, stressing that “Detroit’s income tax laws clash with the lingering Covid-19 reality of remote work.” While the overall city budget has been strained by lost revenues from closed casinos, among other reasons, nonresidents working remotely represent the largest source of revenue lost during the pandemic, Watson reported.

Nathan Anderson, senior economist with the Federal Reserve Bank of Chicago, said that it is hard to forecast how many employees will work from home in the future, and “this remains a serious threat to Detroit tax revenues.” Michigan’s Department of Treasury says that Detroit cannot tax people’s income when working from home, and it cannot raise its municipal tax rates on residents or nonresidents because it has set those rates at the maximum level state law allows, he explained. To address the city’s revenue shortfall, he suggested exploring whether the state legislature can change the law so that it states explicitly that Detroit can tax part or all of the income nonresidents earn when they work from home for city employers. Anderson also recommended investigating whether the Treasury Department can interpret the law differently as has been done in other cities. For instance, Pennsylvania law is similar to Michigan law, but Pennsylvania has interpreted it differently to allow a city, such as Philadelphia, to tax the income of a nonresident who works from home when they work there for their own convenience rather than as a requirement for employment.

Despite these challenges, a tremendous revenue boost for Detroit is on the horizon as a result of the federal government’s American Rescue Plan (ARP), whereby Detroit city government is set to receive $826 million in revenue, Watson explained. Separately, the Detroit school district will receive over $800 million. Also, federal funding for Detroit transit and other infrastructure is in the works but is not yet confirmed, he said. While the ARP funds are substantial, it is just one time money, he noted, and therefore it cannot be used for recurring costs after a few years.

How should those ARP funds be used most effectively? According to Watson, the Detroit city council approved an overall spending plan for the $826 million on June 29, which broadly includes $400 million to stabilize the municipal budget and the remaining $426 million to be used for a Detroit Future Fund. The city council is “casting a wide net” in the use of this fund, Watson said, with projects ranging from neighborhood and park improvements and investments in community health, to funding for skills training, small business development, and homeownership assistance. Not only will these projects help the community, but they will also help to grow the future tax base, he said.

Detroiters, the majority of whom are African American, face tremendous challenges with respect to access to funds for small business development, skills training and education, employment opportunities, and housing, Goss said. With the APR funds, “we have this one shot to really think about how we can make these investments to improve conditions for Detroiters,” she remarked. To address racial inequality in Detroit and historically poor investment decisions, she recommended targeting new investments in traditionally low-income neighborhoods. High-priority areas for these investments include housing and small business development as well as reforms in lending practices, she said.

Looking to the future, Watson noted a huge amount of uncertainty around what the future of work in the city will look like and the tax base derived from it. Forecasting is challenging because “all previous trends are broken,” said Cunningham, with Mattoon adding, it is “a time for humility for economists.” Reworking or reinterpreting the law is one way to regain some certainty, as Anderson pointed out. Despite the uncertain future with respect to revenue generation, Goss emphasized that the Detroit community currently has an extraordinary opportunity to use ARP funds to reverse long standing inequities—notably to reduce the earnings gap and improve Detroit’s neighborhoods.

The views expressed in this post are our own and do not reflect those of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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