According to Larry Gatlin of the legendary country group the Gatlin Brothers, the definition of bankruptcy is: “When your outgo exceeds your income, your upkeep will be your downfall.” And boy, does Detroit fit that definition.
But the origins of Detroit’s bankruptcy are far from unique or exclusively Detroit’s fault.
And while Detroit’s corruption-ridden city government and unfunded pension-fund liabilities are the proximate cause of the Michigan city’s bankruptcy, the root causes are far deeper.
Detroit is the first of a number of triple witching events.
First of all, Motown is part of the American economy, which is experiencing the slowest recovery from the second worst recession/depression in the past century.
The prolonged downturn and its depth are consequences of the massive expansion of stimulus spending during Bush’s second term and Obama’s first term.
Milton Friedman was quick to remind people that government stimulus spending is taxation and a prosperity killer. Governments don’t create resources; they redistribute resources.
While tax rates were raised during the Great Recession, they were raised a lot more during the Great Depression, which explains the difference in severity between the Great Depression of the 1930s and the modern Great Recession.
To push this point home, the highest marginal income-tax rate in 1931 was 25% and by 1938 it was 83%. Whoever heard of an economy being taxed into prosperity?
Obama Tax Hikes
President Obama raised the highest personal income-tax rate to 42%, raised the federal estate tax, upped the payroll tax — and now we have the prospects of greatly increased taxes as a result of ObamaCare.
The U.S. has the highest corporate tax rate in the OECD at 35%, which is the only corporate tax levied on global income, meaning that profits earned abroad by U.S. corporations have to pay the full U.S. tax upon repatriation after a credit for foreign taxes paid.
As a consequence, total employment as a share of the U.S. population has hovered in the 58.5% range for four years now with no sign of improvement, down from well over 63% in 2006.
Real GDP growth over the past four years since the economy troughed has averaged only 1.8%, well below the 2.5% rate needed for the economy to show improvement.
Steering The Motor City Wrong
The U.S. corporate tax structure is especially important for Detroit because the auto industry is global.
German, Japanese, Korean, Italian and French autos sold in countries other than the U.S. pay at most the highest corporate tax in those countries, while U.S. companies are always liable for their U.S. 35% corporate tax rate plus city and state corporate taxes, which in Detroit are serious.
No real solution for Detroit’s bankruptcy is possible without a solution to our nation’s stagnation.
Secondly, Detroit is part of Michigan, which over the past decade (2001 through 2011) has had the lowest growth, bar none, in population of all the 50 states: -1.2% vs. the U.S. average of 9.5%.
Michigan’s labor force growth, employment growth, productivity growth, gross state product growth, state and local tax revenue growth and income per capita growth are all the very lowest in the nation. Yikes!
In 1967, under Gov. George Romney’s leadership, Michigan initiated a state income tax, initially setting the highest rate at 2.6% using federal adjusted gross income (AGI) as its tax base. The state’s income tax rate peaked in 1983 at 6.35% and is now down to 4.25%.
Even though a 4.25% maximum tax rate is a lot better than a 6.35% tax rate, those towering tax rates have surely damaged today’s Michigan economy.
The state’s corporate tax rate stands at 6%.
These unwarranted burdensome taxes on business surely have added to Detroit and Michigan’s decline.
Again, there’s no real solution for Detroit that doesn’t include tax reform in Michigan.
High Labor Cost, Little Labor
If all of this weren’t enough to doom Detroit, add to it that Michigan and Detroit are highly unionized and have a minimum wage above the federal minimum wage. Gov. Rick Snyder and the state’s legislature recently passed right-to-work legislation, so there is progress.
Worst of all, hear this: Using full-time equivalent employees per 10,000 of population in state and local governments as a way to measure such public services as education, police protection, fire protection, public welfare, hospitals, corrections and highways, Michigan — and thereby Detroit — ranks third lowest in the nation and 12% below the national average.
In police protection personnel per 10,000 population alone, Michigan is dead last in the nation.
Is it any wonder that Detroit is No. 1 for violent crime among any U.S. city with over 200,000 people?
In spite of being right at the bottom of the public service ladder, Michigan pays its state and local government employees 5% above the U.S. pay average and has enormously generous retirement and health benefits.
It’s another double whammy: overpaid public servants and too few of them. In order to pay for poor service, by the end of 2013 Detroit will have closed 260, or over 80%, of its parks.
SOS For Positive Legislation
The high cost and lack of benefits of being located in Michigan, and especially in Detroit, incentivize people and businesses to locate elsewhere. Again, no Detroit cure is possible without total reform in state and local government spending.
Then we come to Detroit itself. In 1962, Motown adopted a 1% net income tax for residents and 0.5% for nonresident income earners. In 1964, the city initiated a 1% corporate tax as well.
Detroit’s income tax stands at 2.4% today, and the corporate tax is 2%.
Businesses that can locate outside Detroit do. In 1950, 1.85 million people lived in Detroit.
Today the population of Detroit would be lucky to top 700,000. You can’t balance a budget on people who leave or are unemployed.
Imagine a boiler’s heat is turned way up, its safety valves are shut off and you tap the boiler every five minutes with a little brass tap hammer.
By turning the boiler’s heat way up and shutting off the safety valves, you have guaranteed the boiler will explode.
By tapping the boiler every five minutes with a little brass tap hammer, you’re guaranteed you’ll be there when the explosion occurs. Such is the case with Detroit.
But let us assure you: While Detroit is the worst and the first, it won’t be the last or the biggest.
Laffer is chairman of Laffer Associates, an economic research firm, and was an adviser to President Reagan.
Drinkwater is a research analyst at Laffer Associates.