Detroit: Who’s Next?

Dr. David Mielke, is the Retired Dean of the College of Business at Eastern Michigan University.

 

On Tuesday, December 3, 2013 at 9:00 AM,  U.S. Bankruptcy Judge Steven Rhodes will announce his opinion at 9:00 am as to whether or not the Detroit bankruptcy can proceed.  If he says it can, the next step in the process is to have Emergency Manager Kevin Orr, submit a plan to deal with $18 billion in debt.  If he says “no”, Kevin Orr will still have to wrestle with a payment plan for the debt.  Major portions of that debt are the legacy costs, that is pension and retiree health plan costs.  The unions contest the potential reduction in pension benefits as they say pension benefits are protected by the state constitution.  Mr. Orr contends that federal bankruptcy overrules the state law and as a result pensions can be part of the potential reduction in debt.  But whether or not pensions can or cannot be reduced, what about the retiree health care costs?  How significant are they in the state and what possible problems lie ahead for many municipalities in Michigan?  Is it time for our municipalities to reconsider retiree health benefits in order to head off “Who’s Next” in a municipal bankruptcy?  What is the “Right Thing to do?”  Let’s look at some issues:

1. A recent study has shown that the legacy debt in Michigan, excluding Detroit exceeded $10 billion in 2011 with nearly 80% tied to retiree health care.

2. As in Detroit, where debt is pegged at nearly $10 billion, rising legacy costs mean less money to spend on everything that makes a place livable: police and fire protection, upkeep on streets, lighting and parks and recreation.

3. Compounding the pain, communities have faced drops in property tax revenue, manufacturing jobs and population along with a $5 billion plunge in state revenue sharing over the past decade.

4. Cities are or will be facing the same tough choices, increase taxes, cut services or reduce pension and retiree health care benefits.

5.  As examples, legacy costs are equal to 30% of annual revenue for the city of Ann Arbor with a total of $227 million, 25% of revenue in Grand Rapids and a total of $325 million, 38% in Lansing, total $385 million and a staggering 85% in Saginaw with $312 million.

6. If you spread the debt out over 30 years, the owner of a $200,000 house in Ann Arbor would have to pay $491 a year more to fund legacy costs, $540 more a year in Grand Rapids and $1,731 in Lansing.  In Saginaw, where the median household income is about $28,000, that homeowner would pay $4,693 a year.

7. The real cost of retiree health care was not apparent until 2007, when new government accounting standards required communities to calculate it in annual budgets.

8. But the bill was accumulating before that as many communities applied a “pay-as-you-go” formula.  That was before health care costs began to spiral upward.  Adjusted for inflation, the yearly cost per person rose from just over $1,000 in 1960 to more than $8,000 in 2010.

9. In an analysis of 311 municipalities in Michigan that provided some kind of retirement health benefits at the end of fiscal year 2011, it was determined that the total liability was $13.5 billion.  Just 6% of that was funded.

10. As examples, Grand Rapids had health care retiree debt of $223 million, nothing was funded, Kalamazoo had $263 million and none funded.

11. In many cases retirees contribute nothing for their health care.

 

Are many municipalities in danger of a death spiral where taxes are raised and services cut which potentially drives away businesses and residents, causing property values to drop, requiring higher taxes, which drives away even more?  Who wants to pay more for less?  What is the “Right Thing to do?”  Stripping retirees of health care, or at least requiring them to contribute to coverage could be a template for financially strapped communities.  Or perhaps, changing the system to a defined contribution, that is give each retiree a set amount and have them use the contribution to buy their own insurance.  Or perhaps, drop the coverage for all those retirees who are Medicare eligible.  The UAW gave up health benefits for existing retirees in bargaining to save the auto industry.  Is it time to do the same to save our communities?

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