The Impact on Government of the Auto Crisis in Michigan

Hi, I’m Kathy Hoekstra of the Mackinac Center for Public Policy. On May 7, I spoke with Oakland County Deputy Executive Robert Daddow. He discussed the effect of the recent auto industry meltdown on Michigan’s state and local government finances. Daddow is a former director of the Oakland County Department of Management and Budget and a Mackinac Center adjunct scholar. He has studied distressed municipalities like the city of Ecorse and is a seasoned veteran of government finance. Daddow says even without the auto bankruptcies, Michigan government will soon be facing “a perfect storm.”

Daddow: "I’ve been doing a number of PowerPoint presentations in and around the state for the past two years on what I call a ‘perfect storm.’ A perfect storm is basically a whole series of fiscal issues that are occurring all at the same time, all heading downward and all adversely affecting governmental units — counties, cities, villages, townships, school districts and the state. All of [them] are coming in at the same time.

"Now what are some of those? [The] first one here is obviously the auto companies’ implosion. Just recently, Chrysler filed for bankruptcy. Unfortunately, that’s going to lead to additional layoffs; plants are now shut down. When you have a layoff, you have more unemployed individuals. When they’re unemployed, it’s more difficult for them to pay their property taxes, pay their mortgages. And the likelihood of their houses being seized by the mortgage companies increases substantially.

"When that happens, then you move over into the situation where you have more foreclosures. And Economics 101 — it’s quite simple — as inventory increases, and demand falls, prices fall. We calculate our property tax revenue on the basis of value. So as the value of the homes, as the value of the businesses, decline, so do the revenues for all of the governmental units: State, cities, villages, townships, schools and counties. So it’s kind of a feeding frenzy of when something happens, it has a tendency to impact unemployment; then it riffles through the revenue base of local governmental units."

Hoekstra: "Is the bankruptcy situation with Chrysler and the uncertainty with GM going to make that perfect storm worse?"

Daddow: "Oh my, my, my: It’s going to make it considerably worse. One of the first things Chrysler did was shut down the plants. People are now unemployed. They pay less income tax to the state, which is one of their three principal taxes. They’re not selling cars. They receive no sales taxes when you can’t sell a car. They don’t pay their Michigan business tax, because if you don’t sell a product or make a product, you don’t pay Michigan business tax (or MBT). So it has a tendency to ripple through the state, and people don’t generally know it, but 58 percent of all the tax revenues that flow up to the state flow down to local governmental units: schools, cities, villages and townships — "CVTs" — and the counties. And as a result, if the state gets less money, eventually it’s going to trickle down to the state not being able to distribute to the local levels, and that’s police on the street. That’s firemen on the street. That’s public health nurses. That’s jails. It’s court processes — court systems, if you will. I mean it will ripple through to the public quite quickly."

Hoekstra: "And we’ve got folks in Lansing right now, as we speak, trying to figure out exactly what you’re talking about, on the state level."

Daddow: "Yes."

Hoekstra: "So … will the situation with the automakers exacerbate their positions and what they have to do?"

Daddow: "They have three principal revenue sources. One is income taxes. People are not working because they have been laid off. Not only will they draw unemployment benefits; they aren’t going to be paying any income taxes. That’s one huge problem. And Chrysler has shut down plants, which means the parts suppliers to Chrysler are going to shut down. General Motors has announced anywhere from nine to 12 weeks worth of shutdowns sometime around June or so. That again will cause more problems for General Motors employees, but also all of the parts suppliers that go into the product relating to General Motors in this region. Oakland County, for example, has 362 ‘tier one’ parts suppliers to the automotives — in Oakland alone. We have 1,700 companies that provide services and goods to the auto companies in Oakland alone. That’s the Big Three. That’s pretty painful when they will be struggling as well.

"So there will be kind of like a cascading effect, you know, as Chrysler files for bankruptcy. A number of these other agencies here whose receivables are tied up in the bankruptcy won’t have the cash flowing in to pay their payroll, and as a result, they will either file for bankruptcy or also downsize as well. And this is just Chrysler. If General Motors goes in, General Motors is several times larger than Chrysler and would be ever so much more painful."

Hoekstra: "My goodness. Well, okay, with that foreboding forecast there, how long could we expect all of this to last? Or do you even see — is there even an end in sight to this?"

Daddow: "Well, unfortunately, even if the economy starts rolling back and starts picking up, and let’s presume the real estate market starts picking up, the plants start coming back online in the next year or two, real estate starts selling at a more normal pace, there’s fewer foreclosures, if you will, and just the economy in general moves up. [What] I’ve predicted — and I have done this and proved it out time and time again in speeches and asked everyone in the audience to challenge me — is that the absolute dollar amount we received in property taxes in 2008, the absolute dollar amount, we won’t see that same level of dollars collected until probably 2020 or 2022, for governments. Governments are about to go through at least a decade of where two-thirds of their principal revenue source — two-thirds of revenue sources for most governmental units is property taxes, setting schools aside for a moment — that isn’t going to go up. In fact, it is going to go down because of constitutional limitations on how fast it can come back up, and as a result people are not thinking in terms of, for government, this is a decade problem. They won’t see the improvements until 2020 or 2022."

Hoekstra: "So for the folks in government and the policymakers and decision-makers who are trying to do what they can to weather this storm, what would you tell them?

Daddow: "Several things. First, you better start doing some long-range planning. You better be looking out for what your revenue base is going to be for the next three or four years. And that’s the first item. And start thinking in terms of how you will deal with considerably less revenue internally. That’s one item. That is — I can’t underestimate — that is critical that people start thinking longer-term to deal with the problem longer-term.

"Second issue here is be careful of your labor contracts. The traditional 3 percent raises are … going to be very difficult to provide because they sort of mirrored the increases in your property taxes and the CPI, your economic increases —"

Hoekstra: "General growth of the economy?"

Daddow: "— growth, yeah, covered your growth in the cost of living. Problem here is that it’s long since changed in the present environment. So, be careful of what you do with your labor agreements.

"Third item: You need to really get a handle on your retirees’ health care. Your retirees’ health care is far more costly than most people understand. ... Your other fringe benefits, like health care, you need to really — between health care in the active employees and health care in the retirees — you really need to start managing that activity. Whether it’s movement to additional co-pays, or whether it’s addressing of the, oh, I don’t know, vesting schedule, or the number of head count.

"And getting to head count: People need to start thinking about how they’re going to do business differently than they have in the past. Maybe government ought not to be in some businesses. Government’s going to drop back to a core set of services sometime in the next several years. They’re going to have to do that. But maybe government doesn’t necessarily have to perform those services. They could also … have those services performed by private entities, who often don’t pay the fringe benefit rates governments do. So there might be a savings there for local officials to look at as well. So take a look at your health care area, and challenge whether or not you can control [that] cost growth, and maybe one of the ways you in which you can deal with the health care issue is by head counts — by considering having a private vendor perform those services as well."

Hoekstra: "And then by having a private vendor perform a service, you are employing another business in the state of Michigan, which is sorely needed."

Daddow: "Well, and, of course, that business is going to pay Michigan business tax; it’s going to pay property taxes, and so forth. So there [are] some advantages to doing that. And people need to start taking a look at that approach as another alternative.

"I’m firmly convinced that at some point in the next couple years, as governmental units run into deficits and they start having cash flow problems, that they’re going to have to work together more cooperatively. Oakland County has, through [County Executive L.] Brooks Patterson, initiated a program called CCIRF [Capital and Cooperative Initiative Revolving Fund]. We provide … dollars for professional services to go out and make a feasibility case for two or more units [of government] combining a service. So we’ve had two units want to combine their police service, or their fire service, or their DPW (department of public works). … We pay for the professional study to be conducted on behalf of the local units. Unfortunately, we’ve been terribly unsuccessful. ... The projects have been decent work product; the problem here is that the local units have not yet seen the need to combine their services. I’ll submit that as the fiscal pressures continue and they start running up deficits and cash gets really tight (which will happen in the next couple of years), that those types of relationships are going to have to be formed to save the dollars and provide the service the public expects."

Hoekstra: "OK, so … well, kind of a different way of thinking, but it sounds like definitely a more responsible way of thinking."

Daddow: "It absolutely is. … It’s something that’s gotta happen. It can’t not happen. For example, … fire departments have horrendously costly equipment that is used once in a while. And when it’s used, it’s very much needed. The problem here is, How many communities can afford to purchase an $800,000 pumper, when the next person down the road — three miles down the road — has another $800,000 pumper? You really need to start thinking in terms of enclaves and start thinking in terms of cooperative services. This doesn’t mean the legal entity goes away in consolidation. It just means that the services can be more cooperatively shared to lower the cost and [address] what’s about to happen to the local units."

Hoekstra: "Headed for disaster, right?"

Daddow: "We’re heading for disaster right now, but if people start thinking about what they need to do longer term, and start thinking and looking at that nut three years out and how bad it’s going to be, it’ll force them today to start looking for these collaborative efforts or revising the way in which services are provided to the public."