CHICAGO — Michigan's decade-long policy of repeatedly cutting local aid to help deal with its own fiscal problems has helped drive some of its local governments into fiscal crisis, the Chicago Fed says in a new report.

The Fed Letter examines the trend of state revenue sharing to local governments in Michigan over the past decade as part of a larger look at how local governments nationally have struggled with state aid cuts.

In Michigan, local governments have faced cuts since at least 2003, when the state's recession began, the report says.

The cuts have helped drive several local governments and school districts into fiscal crisis, the Fed said. Many of the state's local governments are under state-controlled emergency management, and its largest city, Detroit, filed for Chapter 9 bankruptcy.

Problems tied to state aid cuts are aggravated both by constraints on locals raising their own revenue as well as Michigan's method for funding local school districts, says Fed business economist Martin Lavelle, author of the letter, subtitled "Understanding trends in state revenue sharing with local governments in Michigan."

"While economic downturns clearly put pressure on state aid and local governments alike, in Michigan's case they have also added volatility and uncertainty into the revenue relationships between state and local governments," Lavelle wrote. "Local governments in Michigan may be forced to adjust what their services programs can deliver because of expected lower amounts of state aid over the medium term and possibility the long term."

Michigan's local governments are among the most dependent on state aid in the country, with 43.3% of their budgets funded by the state, according to the Fed.

That puts Michigan at the top in Midwest and in the top five in the country. Vermont tops the list, with 66.2% of local governments' budgets funded by the state.

Michigan's local governments have received less revenue from the state every year since 2003, the Fed report says. State revenue sharing as a percentage of state spending from state resources fell to 56.3% in 2013 from its peak of 64.3% in 2002, according to Lavelle. Michigan distributes state aid according to two formulas, one based on the state constitution and one based on state statute. While the constitutional aid has remained fairly flat since the early 2000s, the statutory aid has "fallen sharply," Lavelle wrote.

Partly that's because the funding formulas have changed at least three times in the last decade under two governors. A new formula called the City, Village, and Township Revenue Sharing program, will take effect in 2015. That program too is "likely to fall short of fully restoring statutory revenue sharing funds to levels before Michigan's one-state recession," Lavelle wrote.

Aggravating the problem is Michigan's formula for funding school districts. The state's school operating budgets are funded mostly from state sales tax revenue. When that revenue source drops or the state suffers a downturn, it means a drop in funding for local schools, the Fed said.

"While this program shifts the responsibility for funding education … to the state, it also exposes local education funding to any budget difficulties the state may experience," Lavelle said.

"After Michigan's recession began in 2003, state revenue sharing to local school districts decreased. And despite Michigan's economic rebound since mid-2009, local school districts remain fiscally challenged, in part because of recent spikes in teacher retirement costs," she wrote.

Michigan also places relatively severe constraints on local governments for raising their own revenue, the Fed said. Due to the 1978 Headlee constitutional Amendment, local governments in Michigan are among the only in the country that face limitations on revenue, levies, tax rates, and assessment limits, even when property taxes are declining.

"Local governments were hamstrung in raising new revenues themselves from their own communities," Lavelle said.

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