Detroit’s Revenue Structure: Part 2, Impact of Covid-19

In the five years following its bankruptcy, despite ongoing demographic and fiscal challenges, Detroit was able to stabilize its relatively diverse municipal revenue structure. In 2020, the Covid-19 pandemic presented a new and significant set of challenges.

On March 23, 2020, Michigan Governor Gretchen Whitmer issued a statewide order “directing all Michigan businesses and operations to temporarily suspend in-person operations that are not necessary to sustain or protect life,” and prohibiting “all businesses and operations from requiring workers to leave their homes, unless those workers are necessary to sustain or protect life or to conduct minimum basic operations.”

These restrictions, other state and local efforts to protect health and safety, and individual decisions to curtail activities impacted Detroit’s revenue streams. The chart below shows the composition of major revenue sources of Detroit’s general fund for fiscal years 2019 and 2020. As we discussed in a previous post, Detroit’s primary sources of revenue are municipal income tax, state shared revenue, wagering tax, property taxes, and utility users tax.

In this post, we explore the potential impact of Covid-19 on each of the primary sources of revenue for the City of Detroit’s general fund.

General Fund Primary Revenue Sources

City of Detroit

Municipal income taxes

According to research by Michael Pagano and Christiana McFarland, only about 10% of cities nationwide “rely most on income or wage taxes.” At 30% of the total, Detroit’s municipal income tax is its general fund’s biggest single source of revenue.

Detroit levies an income tax of 2.4% on residents and 1.2% on nonresident commuters who work in the city. Declines in labor force participation for residents and commuting patterns into the city for nonresidents have led to declines in this source of funds. It is not clear how quickly they will bounce back. For residents of the city, barriers remain to sustainable growth in wages and labor force participation. As of this writing, it is not yet clear to what extent pre-pandemic commuting patterns will resume.

Since March 2020, The University of Michigan’s Detroit Metro Area Communities Study (DMACS) has conducted three “rapid response” Covid-19 surveys of a representative sample of Detroit residents. The first of those surveys showed the immediate impact of Covid-related job changes. According to Lydia Wileden and Jeffrey Morenoff (2020), “Thirty-five percent of Detroiters employed full-time or part-time before March 1 lost their jobs as a result of the pandemic.” Further, Wileden and Morenoff note that job losses were much more prevalent among Black residents (37%) than White residents (17%) and that Black Detroiters had less flexibility to work remotely or adapt to the stay-at-home order by adjusting their work activities. Thus, not only were Black Americans more likely to experience work disruptions, but “those who continue working are less able to protect themselves from exposure while maintaining their livelihoods.”

A more recent survey’s results highlight the enduring impact of the pandemic on Detroit residents. As some restrictions are lifting and some businesses are reopening, Detroit’s unemployment has fallen from a peak of 48% to 28%. However, White workers have regained a lot more ground than Black workers. The unemployment rate for White workers has fallen to 4%, while the rate for Black workers remains at 29%. Further, according to Lauren Slagter (2020), as of the end of November, 2020, “About 25 percent of Detroiters say they are in financial trouble right now, a slight increase from the proportion who said they were in some or deep financial trouble in July (21 percent) according to the survey.”

The relief legislation passed by Congress in 2020 and 2021 created, expanded, and extended unemployment benefits for workers displaced by the pandemic. Unemployment benefits are generally taxable at the state level in Michigan, but they are not subject to the municipal income tax. A statewide reduction of $103 million in taxes for Michigan cities is expected, of which $64 million will be a reduction in Detroit’s revenue from income taxes.

Taxes on income earned by nonresident commuters who work in the city but live outside the city have been an important source of revenue for the city since the inception of its municipal income tax. However, according to Michigan’s Department of Treasury, “nonresidents of a city that imposes a city income tax under the City Income Tax Act are not subject to city income tax on compensation earned while telecommuting from a location that is physically outside of the city.” According to local media reports, it is anticipated that workers will seek refunds of withheld funds for workdays performed outside the city during the pandemic. The Detroit Budget Department, working with the Michigan Department of Treasury, has set aside a $30 million payable to offset the anticipated payout of refunds related to remote work.

With many employees now telecommuting, and not knowing what the future balance of on-site versus telecommuting will be longer term, a few states have announced temporary extensions of existing withholding regimes in response to the pandemic. In Ohio, for example, responding to concerns raised by the Ohio Chamber of Commerce, lawmakers passed legislation requiring Ohioans working from home because of the coronavirus crisis to continue to pay municipal income taxes as if they worked at the office.

Cleveland, like Detroit, derives a significant portion (85%) of its income tax revenue from nonresident commuters. So, without the state’s legislation, Cleveland was at risk of losing millions in anticipated revenues. As of this writing, however, neither the City of Detroit nor the State of Michigan has established new payroll tax withholding guidelines in response to the pandemic.

State shared revenue

State revenue sharing, Detroit’s second highest single source of revenue, is a sales tax collected by the state and distributed back to cities, villages, and towns (CVTs) under two different formulas: a fixed constitutional formula based on a CVT’s sales taxes collected and population; and a statutory formula that varies with the State’s annual appropriations processes.

Therefore, Covid-19 may have an impact on Detroit’s revenue sharing from the constitutional formula (through its impact on population trends and state sales tax receipts) and from the statutory formula (from the State’s own budget shortfalls as well as sales tax receipts).

Population loss—The constitutional payment from revenue sharing is based, in part, on population as determined by the most recent census. Detroit’s decades-long trend of population loss continued following its bankruptcy. The decennial census will show the extent to which that trend may have accelerated or decelerated.

Very early in the pandemic, Wayne County was identified as a national hot spot for Covid-19 infections and mortality. Anecdotal evidence indicates that people may be choosing to move away from densely populated pandemic hot spots. A survey released in July 2020 by the Pew Research Center found that, “Overall, around one-in-five U.S. adults (22%) said they either changed their residence due to the pandemic or know someone who did. Among those who moved, 28% said the most important reason was to reduce their risk of contracting the virus, and 18% said their move was financial—either job loss or another money-related reason.”

If the pandemic accelerates Detroit’s population loss, the city will suffer reduced revenue from the constitutional portion of state shared revenue.

State budget shortfalls—The Michigan Municipal League has made note of the State’s history of diverting sales tax revenues from the statutory revenue sharing formula to solve its own budget shortfalls. Therefore, the uncertainty of the impact of the pandemic on the state’s budget has been cause of concern for affected municipalities. The impact of the Governor’s March 23 statewide order was reflected in the Senate Financial Agency’s (SFA) April 2020 Monthly Revenue Report, where tax collections were approximately $1 billion below expected levels. The report indicated that “for several revenue sources, the dynamics of federal stimulus checks, the timing of payments for withholding on unemployment compensation, and the impact of other temporary federal stimulus measures, such the Paycheck Protection Program and new liquidity facilities from the Federal Reserve, offset some of those impacts. …” State total tax revenues are currently ahead of projection. The SFA’s May 2021 Monthly Revenue Report indicated that total tax collections were $1 billion above expectations. While this may not be sustainable, the state’s current fiscal condition is very good.

Changes in sales tax revenue—The decline in total tax revenues seen in the Senate Fiscal Agency’s (SFA) April 2020 Monthly Revenue Report included a decrease in sales tax receipts—at $452 million, they were $239 million below forecasted levels. However, consumer spending, due in part to compensation received through the aforementioned federal programs, resulted in higher than expected consumer spending. The Monthly Revenue Report from the SFA for May 2021 indicated that sales tax collections totaled over $837 million, $115 million above the forecast. Though current revenues from sales tax are strong, it remains to be seen how consumer behavior will change emerging from the pandemic.

Wagering tax revenue

The Covid-19 pandemic’s restrictions and shutdowns led to Detroit’s three casinos being ordered to close between March 16 and August 5, 2020, and again between November 18 and December 23, 2020. Between August 5 and November 18, 2020, the casinos were allowed to reopen, but only to a maximum of 15% of capacity. As a result, Detroit’s revenue from the Total City Wagering Tax dropped from more than $180 million in 2019 to $74 million in 2020,¹ a 60% drop in the city’s third largest source of revenue. On January 22, 2021, the state officially launched online sports betting. It is hoped that the introduction of online sports betting will help compensate for reduced wagering tax revenues resulting from the pandemic. As of May 2021, Detroit’s wagering tax revenue from Internet sports betting at the city’s three casinos totaled nearly $700K.

Returning to pre-pandemic levels will require not only allowing 100% occupancy, but also ensuring that patrons once again feel safe gathering in enclosed spaces.

Property tax revenue

Property taxes are Detroit’s fourth largest revenue source. This is the revenue source that seems to have been least affected by the pandemic, falling only 2% in FY2020. This smaller impact in the short term is to be expected. As Pagano and McFarland explain, “Property tax revenue is less responsive, or ‘elastic,’ to economic downturns in the short term—but over time, property tax revenues may decline to the extent rising unemployment and other unfavorable economic conditions dampen real estate demand and thereby reduce some residential and commercial real estate values.”

Recent surveys of Detroit residents by the University of Michigan note the “enduring financial impacts of the pandemic on families,” and that, “Those who fell behind on rent, mortgage payments, and other bills while they were unemployed earlier in the pandemic may not be able to easily make up that deficit, even if they go back to work.” These are the types of economic conditions that could dampen real estate values and revenues over the longer term.

Conclusion

While Covid-19’s potential impact has yet to be fully measured, some of its impacts on Detroit’s major revenue streams are beginning to be better understood.

With the recent passage of the American Rescue Plan Act (ARPA), Michigan anticipates receiving more than $11 billion from the federal government, with $6.5 billion going to the state and $4.5 going to local governments. Detroit will receive $826 million, half in 2021 and half in 2022. All of these funds must be spent by 2024. The funding is designed to offset Covid-19 related financial problems and cannot be used for past debts, pension funds, or past legal obligations. The mayor has indicated that $400 million will be reserved to offset potential budget shortages through 2024, including deficit issues due to a drop in income taxes. The remaining funds will be used to aid households, nonprofits, and small businesses through programs targeted at fighting intergenerational poverty; restoring neighborhoods; improving public safety; improving parks and cultural facilities; reducing the digital divide; and aiding small businesses. More information about the plan may be found here.

Monitoring and researching how Detroit’s revenue structure responds in a post-pandemic economy will continue to be a focus of research and outreach efforts at the Detroit Branch of the Chicago Fed. Evaluating whether the city has sufficient revenues to support critical programs for city residents while regaining economic development momentum is important for understanding Detroit’s future.

Notes

¹ The discrepancy between the $74 million figure and the $132,404 figure shown in the chart above is that Michigan Gaming Control Board’s fiscal year runs through September and includes three more months of pandemic losses than the City’s fiscal year which runs through June and includes three more months of pre-pandemic revenue.

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.