The Michigan Court of Appeals’ recent ruling in a Mackinaw City tax case turned on the distinction between a tax and a fee for service, but it raises a bigger question for Michigan residents. Should cities that provide public services be able to call what they do government actions in some cases and business actions in others, depending on which is more advantageous at the time?

The judges of the Michigan Court of Appeals ruled two to one that Mackinaw City was justified in imposing a hike in water fees that had many of the earmarks of a hidden tax. The Village of Mackinaw City operates a water and sewer system. The local government decided to raise fees to finance infrastructure improvements, including construction of new facilities. The Mackinaw City tourism bureau and area hotels sued, calling the fee increase a tax hike that should have gone before voters. The Michigan Constitution’s Headlee Amendment prohibits governments from levying or increasing taxes without voter approval. A trial judge ruled in favor of the plaintiffs, deciding that the fee hike met the criteria of a tax increase.

But the appeals court judges were divided on whether the fee increase is more like a price increase by a business or a tax increase by a government. Two of the appeals court judges said that it was a fee payment exchanged for goods or services, making it much like a business transaction. The third judge, agreeing with the lower court, said that this was a government taxation decision. The majority opinion effectively treats the water and sewer rate increases as business decisions and not tax increases by a government.

The dissenting appellate judge found the structure of the rate increase troubling for two reasons. First, Mackinaw City planned to use revenues from the higher rates to build new infrastructure, which usually is financed by local governments through millages that are voted upon by residents. She concluded that this use of the funds “violated the admonition that a fee may not be used to raise revenue to finance a public works project.” Second, she noted that the rate structure was very progressive, with high-volume water users paying proportionately much more. “The rates were not proportionate in that there was no justification for why high-volume users needed to pay 50% more, and why they needed to do so even after the new water tower was constructed,” the judge wrote, concluding that the rate increase was more like a tax. The case may still go before the Michigan Supreme Court.

Local governments own a variety of business operations that could instead be provided by private companies. In Michigan these include electricity, water, sewers, internet services, trash collection, parking decks, fitness facilities and golf courses. All of these government-owned business operations may run into legal troubles like the one at issue in the Village of Mackinaw City.

More important, any of these services could instead be provided by private companies. The national trend is toward governments getting out of these kinds of businesses. Florida and 12 other states recently passed legislation to create incentives for municipalities to privatize their water and sewer systems. At the federal level, the President’s National Infrastructure Advisory Council recently endorsed more privatization of water and sewer systems in the United States as part of its recommendation that governments “remove barriers to new ways of funding water projects.”

Michigan has a mix of water and sewer systems owned by municipalities and by private businesses. The government-owned water and sewer system in Mackinaw City is far from unusual, but it is not necessary for a municipality to own or operate the local water and sewer system. Nationally, government-owned water and sewer systems are more common, but private systems currently serve about 72 million U.S. residents, a number that has doubled in less than a decade. This trend toward local governments getting out of the sewer and water business is an idea Mackinac Center scholar Gary Wolfram has advocated in Michigan.

Municipalities in Michigan operate a variety of other business operations that could instead be run by private companies. About 8% of electricity in Michigan is provided by city-owned utilities like Lansing’s Board of Water and Light, with the rest by private providers like Consumers Energy and DTE. Some Michigan cities like Ann Arbor operate trash collection services for their residents, while others, including Detroit in 2014, have turned to private trash collection companies. Some cities also operate parking decks, water parks, gyms and golf courses. These government-operated businesses are prone to the same entanglements with the Headlee Amendment that was at issue in the Mackinaw City case.

Many of these government-owned business operations have monopoly power, particularly with water, sewer and electricity services. The majority opinion in the Village of Mackinaw City case appears to have endorsed a loophole in the Headlee Amendment that invites abuse. The monopoly municipalities hold over these services gives them leverage to raise rates or protect their own interests, leverage private companies don’t have. Suppose voters reject a millage proposed by the local government. Could the local government simply raise its monopoly water and sewer fees to generate the funds? If that happens, what recourse do the municipal utility customers have?

The ruling in the Mackinaw City case does not explicitly allow the municipality to do this, but its deference to the village’s plan appears to make it a possibility. The appeals court ruling recalls a line from the 1979 football movie North Dallas Forty, in which a frustrated offensive lineman played by hulking former NFL star John Matuszak complains to a coach, “Every time I call it a game, you call it a business, and every time I call it business, you call it a game.” Michigan residents need more clarity about whether the services they pay for are provided by a government or a business.

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