Coronavirus threatens Detroit's independence from state oversight

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With its independence from state oversight at stake, Detroit Mayor Mike Duggan is proposing to manage a $348 million COVID-19-driven revenue hit by dipping into reserves and the city’s fund balance, along with layoffs and pay cuts.

While existing federal aid packages will help cover expenses and future federal aid may offset tax losses, Duggan said the city can’t wait as it grapples with losses tied to the economic shutdown.

An empty Woodward Avenue in Detroit. Closed businesses and a spike in unemployment because of virus-prevention measures threaten the city budget.

That’s because its exit from state oversight in April 2018 required that it maintain balanced budgets. One slip up and the city would return to oversight by the Financial Review Commission for three years under rules established when it exited its historic Chapter 9 bankruptcy in late 2014.

“While we have a health crisis, we have the biggest budget crisis this city has seen in seven years and we have to solve it at the same time,” Duggan said in a speech Tuesday where he laid out the bleak budget picture for the fiscal year that ends June 30 and fiscal 2021. “If we do not handle this deficit ourselves the state of Michigan is going to be running the city again.”

The city has been hit hard by the virus, accounting for 7,136 of Michigan’s 28,059 COVID-19 cases and 475 of the state’s 1,921 deaths.

“We can’t borrow money to cover deficits," Duggan said in his speech. "That’s what the city of Detroit did for years. The way Detroit got into bankruptcy is it took in a billion dollars a year in revenue it spent $1.1 billion and it borrowed the difference. We are not going to run into deficit. We can’t do it. We are going to live within our means.”

The city operates on a roughly $1.1 billion general fund budget that’s part of the $2.2 billion all-funds budget. About 30% of the general fund comes from income taxes; 19% comes from state revenue sharing which is based on a formula and tied to sales taxes; 17% comes from casino taxes; 10% comes from property taxes; and 24% comes from court fees, fines, and other revenues sources.

The city now projects double-digit losses to the income tax, revenue sharing, and casino streams with additional losses from property taxes, parking meters and court fines. Casinos have been shuttered since March 17.

The revisions will leave a $154 million hole in the current budget and projected gap of $194 million in next year's. Before the pandemic struck, the city was on pace to exceed estimates.

The revised estimates come from the city’s finance team with input from state and University of Michigan officials. Formal estimates are established in February and September.

Duggan’s fix draws $101 million from the city’s “savings” account or unassigned fund balance which heading into this year was at $123 million. Another $50 million would come from the city’s rainy day fund.

Another $72 million in funds set aside for blight removal in 2020 and 2021 would be tapped along with $33 million in capital funds. Another $6 million would come from project savings achieved by the chief financial officer, and $36 million from a federal grant for transit.

The remaining gap would be closed by a series of personnel cuts to the city’s 8,000-person workforce. Part-time and seasonal employees would be laid off. Several categories of employees would see a pay cut and work reduction. Those in top posts who earn $125,000 or more would see a 5% cut. Emergency, police and fire personnel would not see any cuts, but give up a July 1 pay hike.

The city’s unions need to sign off, and council approval is needed for some of the measures like use of the rainy day funds.

The plan leaves intact about $57 million in the rainy day fund meeting a threshold laid out in bankruptcy agreements that the city hold 5% of the general fund in reserves. The proposed 2021 budget had called for a $30 million deposit to move the city closer to a 15% goal.

The city is retaining funds needed for essential capital and emergency blight removal, said Chief Financial Officer David Massaron.

The plan leaves intact the special retiree trust fund established to help blunt the budget impact in 2024 when the city will again be required to make pension contributions. The city's 2014 plan of adjustment froze the city's legacy pension plans and provided an initial funding infusion from the so-called "grand bargain," funded with help from the state and private entities. The city received a funding holiday until 2024.

The city’s portion of the estimated 2024 payment is $166 million. To cover the 2024 pension contribution, the city would draw $79 million from the general fund and $87 million from the retiree trust fund. The general fund contribution rises by $10 million annually through 2032 when the trust is exhausted and the general fund must fully cover the $166 million payment.

The city is making a $45 million deposit into the retiree trust fund this year and will make the scheduled $50 million 2021 deposit and a $20 million supplemental payment. The fund is on track to reach $355 million by 2024 with scheduled deposits of $55 million in fiscal 2022 and $60 million in fiscal 2023.

“My hope is that what the market takes from this is that the city is taking decisive action to make sure we can meet our long-term obligations,” Massaron said. “The city is acting now because if we don’t then the problem becomes more acute and more difficult to deal with. We have the flexibility and we are trying to show that we can balance the budget without federal help.”

The city retains some wiggle room to make additional cuts should the revenue hole deepen, but the retiree protection fund would be touched only as a last resort as it’s in place to deal with long-term challenges, Massaron said.

“If we do not handle this deficit ourselves the state of Michigan is going to be running the city again,” said Detroit Mayor Mike Duggan.

Tax hikes are not on the table. “All of the work we have done over the last five years sets the stage for us to recover from this quickly,” he said.

The city has liquidity to fund expenses being accrued and no short-term borrowing is required, Massaron said. The city has received philanthropic support to cover some expenses such as virus testing sites and has spent $15 million of its own funds so far with another $10 million in expected costs. Massaron said the city expects federal funds will cover those costs. The last federal package provided direct aid to state and local governments with a population of more than 500,000. That includes Detroit, which has about 670,000 residents.

The city’s budgetary and economic recovery is tenuous and its ratings remain three notches away from investment grade. Moody’s Investors Service revised the outlook on its Ba3 rating to positive from stable Feb. 25.

“They were doing pretty well and that positive outlook was due in part to having a rainy fund and a pretty conservative budget,” said Howard Cure, director of municipal bond research at Evercore Wealth Management.

“Luckily they have the reserve but it’s going to halt their momentum. It’s going to halt everyone’s momentum but they are in better shape than they were a couple years ago,” he said.

“It’s going to hurt them from a credit point of view,” Cure added. “But the mayor deserves credit for being realistic, conservative, and transparent. There are no gimmicks or debt restructuring.”

The city accessed the bond market on its own credit in 2018 with a $135 million junk-rated deal. The new money unlimited tax general obligation bonds were part of $225 million in tax-exempt borrowing the city council authorized. The city has no near-term plans to tap the remainder.

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