Rock Bottom: Detroit’s Financial Turmoil


In the shadow of the federal sequester, another even more intractable challenge to sustainable public finance reached a breaking point last week on a smaller stage.

Detroit, the cradle of the global automobile industry and once the nation’s fourth-largest city, is poised to cede its local sovereignty.

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chandan silo for webMichigan Gov. Rick Snyder, citing the city’s deteriorating fiscal health, will appoint a new emergency financial manager, effectively wresting control of the city from its mayor and city council.

The numbers are staggering. Apart from a current budget shortfall exceeding $300 million, the city’s unfunded pension and health care liabilities are on the order of $14 billion. Higher automobile sales and a Strategic Framework Plan for Detroit Future City have not been enough to reverse the outflow of residents fleeing higher crime, poorly delivered city services and a relatively burdensome local tax structure.

The loss of taxpayers makes it increasingly unlikely that Detroit will be able to avoid bankruptcy. If that does happen, it will be the largest failure of a city government, surpassing Jefferson County, Alabama, more than three times over in terms of its debt obligations.

It is unlikely that an emergency financial manager will steer clear of sacred cows. Pontiac, Mich., has been under emergency control since 2009 and may put its City Hall on the auction block. There was no debate or voice of dissent at a public hearing in late December. Save for the emergency manager, Pontiac’s beleaguered mayor, his assistant and one reporter, not one of Pontiac’s citizens attended the meeting.

Detroit’s economy is diversified into health care, education and other fields. But at its heart, it is a manufacturing center. Between 1910 and 1920, the rise of the automobile saw the city’s population nearly double. During World War II, Detroit was a linchpin of the Arsenal of Democracy. The city’s infrastructure was built to support 1.5 million people.

As of last year, its population had fallen by more than half, though the infrastructure obligations have not diminished.
How badly are things going for the Motor City? In early December, the State Senate passed legislation creating a public lighting authority to assume control of the city’s streetlights. All told, there are just under 90,000 streetlights in Detroit. Only about half of them work.

Holding on to its residents, and one day attracting new ones in significant numbers, requires that public services improve dramatically from their current levels. That runs the gamut from the streetlights to policing. The city also must reduce the tax burden it places on its residents. For high wage earners, Detroit’s agglomeration is simply too weak to support local taxation. That presents a major problem, given the city’s obligations.

With the need for public dollars clearly observable, the State Senate passed a bill eliminating a previous requirement that the city draw down its local income tax, levied on residents and on nonresidents at a reduced rate. That is probably an error in policy, since the overall tax base is shrinking.w

There’s an important technicality in the details of Detroit’s takeover. The law that affords the governor the power to co-opt the local government will be replaced later this month. In its place, a new law comes into force under which the emergency manager—minus the financial qualifier—will have the authority to abrogate labor contracts. That’s not just by chance.

Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.