Pension Debt Challenges Will Persist as East Lansing Income Tax Likely to Bring $1M/Year Less than Original Estimate

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Tuesday, January 7, 2020, 7:45 am
Alice Dreger

Revised estimates from the City of East Lansing’s financial staff indicate that the net revenues from the City’s new income tax will likely come to about two-thirds of what had been predicted before East Lansing voters approved the tax.

The net new revenue estimate for the new municipal income tax is down from a consultant’s estimate of $5 million per year in 2016 before the vote to a new estimate by City staff of $3.3 million.

For the City’s pension debt, that means payment of about $1 million less per year than had been hoped when the income tax passed.

What has changed since external consultant Plante Moran’s estimates in October 2016 of what an income tax could bring in new revenue?

For one thing, revenue to the City in the first year is now being projected to be about $9 million, about $1.4 million less than what was estimated before the vote.

Another significant change involves an estimate regarding property taxes. Why do property taxes matter in this calculation? Because before voting through the income tax, East Lansing voters approved a City Charter amendment that required an automatic drop in property taxes if an income tax took effect.

As property values are rising, so is the amount of revenue essentially lost to the City from the property tax reduction. To make up for that, a bigger chunk of the income tax revenue is being diverted to the General Fund than had been estimated in October 2016.

The amount of the income tax revenue diverted to cover the property tax reduction is now expected be more like $5.3 million, rather than the $5 million estimated by Plante Moran before the vote.

These new numbers come from East Lansing Finance Director Jill Feldpausch. Responding to emailed questions from ELi in mid-December, Feldpausch warned, “With this being the first year, the City has little experience with income tax collections or refunds, which makes it difficult to estimate the results.”

But given what’s known now, Feldpausch concluded in her email to ELi, “This would leave approximately $3.3 million” net new revenue for allocation on June 1, 2020.

Speaking to Council at its December 10 discussion-only meeting, Income Tax Administrator DaMar Boyd reiterated there are still some big unknowns.

He said this was particularly true with regard to the total gross revenue from the income tax and the amount that will be refunded after returns are filed.

Boyd said the administrative costs are also unknown because that will depend on the volume of returns received. The City is paying an external consultant, Innovative Software Services, to handle the returns on a per-return basis, so the higher the volume of returns, the higher the administrative cost.

Asked about whether businesses in East Lansing are complying with the income tax law, Boyd (pictured below) said he does not have a compliance rate determined yet and that that will become easier to figure out after the first year of returns comes in.

Sixty percent of net income tax revenue has been designated for the pension debt.

When East Lansing voters approved the 12-year City income tax in 2018, the ballot language they approved stipulated how the new net revenue from the income tax would be used. Sixty percent is designated to go to the City’s pension debt, 20 percent to police and fire services, and 20 percent to parks, roads, and other infrastructure. The City Council cannot change these percentage allocations.

The new estimates mean all of those areas will be obtaining about one-third less than previously expected from the new income tax. So, while the Plante Moran estimate put the extra funds available from the income tax for the pension debt at about $3 million per year, now it looks like it will be slightly under $2 million.

That’s going to create a challenge for the City’s plan to rein in the pension debt – debt significant enough to have triggered a new type of review by the State of Michigan required under Public Act (PA) 202, a law aimed at dealing with unfunded retirement-related obligations in Michigan municipalities.

State officials acknowledged the new municipal income tax as an important management strategy for East Lansing, approving East Lansing’s management plan. And the income tax will undoubtedly help the City’s financial situation compared to if it had not been passed.

But City leaders will have to address the need for additional funds to put toward the City’s regular annual pension payments, plus payments to cover the $94 million in East Lansing’s unfunded pension fund liability.

Several assumptions regarding the pensions are changing in the next few years – all of which have the effect of increasing the annual contribution amount needed to fully fund the pensions promised to East Lansing’s current and former employees.

The three most significant changes are: (1) adjusting the mortality table because people are living longer; (2) lowering the projected average rate of return on investment; and (3) shortening the “amortization period” set by the state (i.e., the number of years municipalities have to eliminate their unfunded liabilities and fully fund their pension systems).

Below: East Lansing Finance Director Jill Feldpausch presenting to City Council on Dec. 3, 2019.

The bottom line is that the City must make large annual contributions to cover both “normal” pension costs for the current year and to make progress in reducing the legacy of unfunded pension liability from past years.

Larger payments in the near-term can reduce the total payments needed in the future because putting money into the pension system sooner will make it possible for those funds to grow from investment earnings.

This is why City leaders advocated the allocation of 60 percent of the net income tax revenue to pension payments and why they also have been looking to other sources of income that could be steered toward retiree-related debt, including revenue from land sales and increased revenue-sharing coming to East Lansing from the State, including under PA 289, a law that helps reimburse East Lansing for the cost of providing MSU with fire and paramedic emergency services.

Even if the income tax had produced the net revenue estimated before the income tax vote, the City of East Lansing would have had to continue to struggle with its budget. It now looks likely that the struggle will be more difficult than anticipated before the vote.

Chris Root contributed reporting to this article.

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