Philanthropic Plan ‘Certainly Could Change the Face of Government Funding’

KALAMAZOO, Mich. — An income tax was thought to be the only long-term solution to an annual, multi-million dollar budget deficit in this southwestern Michigan municipality, so last December City Manager Jim Ritsema went to the head of the regional chamber of commerce and two of the wealthiest people in town to convince them it was their least worst option.

"We knew [the business community was] going to oppose an income tax—and they've got deep pockets," Ritsema said.

It would be a risky public vote, expensive to win and, if voted down, the budget would still be in a perilous state, since Michigan has severely limited other local funding options, has skimped on implicit promises of late to share revenues with local governments, and bans cities from operating at a deficit.

"The question was literally: if not an income tax, then what?" Ritsema said in an interview. "How do we get something that has the same impact but not a tax?"

The proposed solution has become a philanthropic fund of $500 million or so, called the Foundation for Excellence, an economic development tool that also prioritizes property tax cuts and increased spending on poverty reduction.

This city of 75,000 to 100,000 residents, depending when Western Michigan University and Kalamazoo College are in session, and the seat of a quarter-million population county, had a 36 percent poverty rate in 2014, up from 24 percent in 2000, according to WMU’s Walker Institute for the Study of Race and Ethnic Relations. That’s some of the highest poverty rates in the country for cities with a population of at least 65,000 people. African Americans and youth—and especially African American youth—suffer a higher poverty rate.

The two rich Kalamazooans who Ritsema met with have pledged more than $70 million in immediate funding.

"It certainly could change the face of government funding in a new way," Ritsema said.

It’s a first-of-its kind social experiment, to plug a multimillion-dollar structural budget deficit and move more aggressively against systemic poverty—but profoundly change how the government is funded. It has also raised concerns.

City officials commonly praise its surplus of generosity and resiliency: the city made international headlines in 2005 when an anonymous gift, believed to be partly funded by Foundation for Excellence donors, began giving free college tuition to all public school graduates through the Kalamazoo Promise.

There is a deficit of trust, however, especially in the current political environment, and an excess of fear: that the state will continue its financial stranglehold on local governments while restricting ways it can raise revenues (there's no evidence this will not happen); that the city will be forced to cut services if it doesn't come up with the money; and that the "Foundation for Excellence" will risk vital budget expenses and inherently if not covertly hand partial control of the city to the wealthy patrons.

Two months after the groundbreaking project was made public, few details have been revealed, mostly because they are still being worked out.

“I suspect we'll be taking a huge leap of faith on this $70 million dollars,” said city commissioner Matt Milcarek who has been consistently detailed, and vocal, in his skepticism.

That information vacuum has been filled by both unduly optimistic and irrationally critical news articles, public comments at city commission hearings and via "trial by Facebook" as Mayor Bobby Hopewell refers to the democratic theater of social media commentary.

"A lot of mistrust in federal and state government spills onto us. The wealthy and who is in control and all that. I get that," Ritsema said.

A draft Memorandum of Understanding with the two initial donors of $70.3 million is still in the works—the donors are still reviewing the draft and Ritsema said he hopes to make it public at the Oct. 17 city commission meeting.

The timeframe is tight, however, if the city of Kalamazoo wants to see the tax breaks in the 2017 budget. At the same time, however, a lot rests on the MoU to be done right: it’s the document that will set the terms of the governance of the Foundation, and from it those fears will either be realized or put to rest.

State Fiscal Policies Cut Deep in Kalamazoo

From the late 1960s to the early 1990s, Michigan voters and politicians enacted restrictive measures and local funding algorithms that have been widely regressive for local government financing.

Progressive state-to-local revenue sharing overall has essentially devolved to leave each local government to tax on their own, while the state has restricted the amount and types of taxes local governments can utilize (cities are banned from enacting a sales tax, for example). This financing structure benefits wealthier areas, with a higher tax base and thus usually better services, while exponentially harming poorer areas with struggling tax base and services that had previously relied on a larger slice of the state revenue pool.

In the end, poorer communities or those with a lower per capita tax base have struggled more to both fund its budget and maintain the conditions to increase the tax base, which is increasingly relied upon by levying higher millage rates to fund its budget because state revenue sharing has been cut, according to a May 2016 report by the Michigan Municipal League and the Great Lakes Economic Consultants.

“A strong revenue sharing program, as Michigan used to have, allows communities with low tax bases to maintain a reasonable level of services without needing to levy uncompetitive tax rates,” the report concluded.

Between 2002 and 2012, states in the U.S. averaged a 48 percent increase in state-to-local revenue sharing; in Michigan, however, it declined by 57 percent. "There is little evidence of a rebound," the report said.

"Statutory revenue sharing to municipalities in FY 2016 is estimated to be $585 million below the full funding of the statutory dedication," the report estimated. That, it said, is on top of the more than $7.5 billion in accumulated cuts of state statutory revenue sharing to cities, villages, townships and counties since 1998.

"We are supposed to get a portion of the sales tax," Ritsema said. "One component is constitutionally protected. The other is, statutorily, but the State, to fix its problems, they fix it on the back of local governments."

With such a structurally shrinking budget, tackling acute problems – such as pockets of poverty, violence, educational underperformance, and all of the individual and community setbacks such problems can then create – are, thus, more difficult to prioritize.

“The state has left struggling cities on their own, continually reducing state shared revenue and cutting programs. The federal government has not stepped in nearly enough,” said city commissioner Don Cooney. “Cities have to do it themselves—without anywhere near adequate resources.”

Even the city of Kalamazoo, which has survived and grown by economically and philanthropically punching above its weight, is now facing an unsustainable budget for the foreseeable future.

“Statutory Revenue Sharing to the City was over $7 million in 2001, and was less than $3 million in 2015,” the city’s chief financial officer, Thomas C. Skrobola, said in an email.

The Michigan Municipal League estimates that Kalamazoo city lost a total of more than $38 million from statutory payment reductions between 2003 and 2015.

Then, eight years ago, the Great Recession took its toll, especially on the property tax base.

The Michigan Municipal League report found that between 2008 and 2012 city taxable values dropped 18.1 percent and corresponding property tax revenues dropped 9.1 percent. This study by the W.E. Upjohn Institute for Employment Research estimates Kalamazoo city property tax values won’t reach pre-great recession rates until 2023.

"The pace of recovery is so slow that it will never keep pace with expenditures going up," Ritsema said. "That's the big issue for Kalamazoo in particular."

Meanwhile, the city's attempt to tackle poverty remains an expensive, uphill battle.

Youth poverty and education, for example, are top targets for programs in dire need of funding, and should be a focus of the Foundation for Excellence, Cooney said.

The youth poverty level has grown from 27 percent in 2000 to 39 percent in 2014, according to the Walker Institute’s data. For African-American youth, that’s 57 percent in 2014, the most recent year data is available. Kalamazoo youth have a higher juvenile arrest rate than the rest of the state as well, the data showed.

Despite the now 11-year-old Kalamazoo Promise free higher education tuition program for all students who graduate from public schools, graduation rates are below what city officials had hoped for and are worse off when the data is separated by poverty and race, which Walker Institute director Tim Ready said are inextricably linked.

When it studied the graduation rates of Kalamazoo high school classes of 2006 through 2008, the Walker Institute found high school graduation rates for white students was 82 percent, African American students was 63 percent and Latino students was 57 percent. Post-secondary graduation rates for those classes showed 42 percent for white students, 13 percent for African American students and 14 percent for Latino students.

This, local experts who have studied or worked on the issue have said, is because the problem is both systemic and long-term, thus the solution has a long-lead time for results.

"The Promise provides college education for those who graduate from Kalamazoo Public Schools. That's a financial hurdle. There are a whole lot of other hurdles that prevent kids from being successful and going to college and graduating," Ritsema said, adding that youth and poverty are to be top funding priorities with the new Foundation money.

For example, according to the Walker Institute study, “economically disadvantaged” third graders in Kalamazoo are less proficient in reading than similar third graders statewide, and far less proficient than non-economically disadvantaged third graders statewide, which are outperformed by similar Kalamazoo third graders. The Walker Institute classifies children as economically disadvantaged if they qualify for free or reduced cost lunch. According to its data, in the 2013-2014 school year, 51 percent of Michigan’s third graders were economically disadvantaged but 74 percent for Kalamazoo third graders.

“Disadvantages associated with poverty, especially concentrated poverty, and race are the primary factors explaining educational disparities. Addressing the cost of college through the promise scholarship addresses one barrier, but the larger barriers related to poverty remain unaddressed—despite an infrastructure of nonprofits in the city that is much more substantial than in most cities,” said Tim Ready, the director of the Walker Institute.

“The outcomes of the Promise thus are not surprising to me. The Promise helps, but much more needs to be done to approximate equality of opportunity for kids based on family income and race—from early childhood, onward. While school quality and resources matter a lot, decades of sociological research suggest that the social and economic circumstances of families matters more in predicting school success and many other quality of life indicators.”

In Search of a Budget Solution

In early 2015, the city commission authorized a multi-stakeholder Blue Ribbon Revenue Panel to assess both the extent of the fiscal problem and potential solutions.

"Due to Michigan’s restrictions on the rate at which property tax revenue is permitted to grow, the budget shortfall will continue to widen each year beyond the four-year projection" the panel said in its final report last December. It estimated a total $19.125 million budget deficit from 2017 through 2021. (The city estimates an even larger deficit.) Ritsema said, if nothing changes, and despite annual cuts, starting in 2018 the city estimates a $3.8 million a year deficit.

The panel, however, decided not to endorse an income tax option—1 percent for city residents and .5 percent for those who work but do not live in the city, which would have more than plugged the structural budget gap—and instead suggested cost-savings via regional cooperation on water, law enforcement and emergency services and city asset sales.

Those long-lead time and one-time actions would not save city programs or reverse the decline in the number of police officers, potential actions, if necessary, to balance the budget by the end of January 2017, when a budget must be approved for the year. Anti-poverty programs, too, would struggle for necessary funding, if funded at all.

So Ritsema last December presented the city's dilemma—and an idea of a philanthropic fund—to Ron Kitchens, CEO of economic development group Southwest Michigan First; William D. Johnston, owner of a wealth management and properties firm and husband to local billionaire Ronda Stryker; and business executive William Parfet, heir to local pharmaceutical firm Upjohn, which is now part of Pfizer.

Parfet and Johnston did not respond to Route Fifty’s requests for an interview.

"This wasn't thrown by them onto the city like 'take it or leave it,’ " Ritsema said. "Some seem to think this is some form of extortion. That was never the case. We knew they would oppose the income tax, which the business community has in the past. . . . This is an alternative."

Parfet and Johnston offered up $70.3 million to give them and the city the financial breathing room to embark on a monumental task:

Over three years, that money would plug the existing hole in the city budget and additional losses as the city cuts its property taxes from 19.2705 mills to 12 mills and eventually to 10 mills (Kalamazoo is currently taxing between 4.3205 mills and 9.0705 mills more than Michigan cities with similar or larger tax bases, according to Skrobola, which inhibits attracting businesses and homeowners).

The remaining funds would fund programs including those aimed at vulnerable youth and generational poverty.

“I do not have an amount for the Foundation guarantee but for the first three years, $30 million will be for aspirational investments,” Ritsema said.

During those three years, Parfet and Johnston would lead the fundraising for the capital for the sustainable fund, which would be used to sustain budget measures aimed at improving the quality of living, working and having a business in Kalamazoo. The tax cut is intended to contribute too, by bringing more businesses in and increasing the tax base albeit at—and because of—a lower tax rate.

There remains a concern by many, including those who are in favor of this project, that the donors will have undue influence on the direction the city takes, how the money is spent and/or the city staff and elected officials. The only protection against this would be in the language of the laws passed by the city commission, and that language has not yet been made public, let alone debated and analyzed, just as the details of the inner workings of this Foundation for Excellence plan have not yet seen the light of day.

"We are going to put protections in place to prevent that from happening," Ritsema said.

The Memorandum of Understanding will be a legal document setting key terms into motion: the donors hand over $70.3 million, the city cuts property taxes and the actual foundation will be established by the end of the year, Ritsema hopes.

Will the entire $70 million be transferred up front? Will the Foundation rely on the “ups” of the stock market to return high enough financial commitment each year or will the budget suffer from the “downs”? Will additional donors be anonymous? Will the donors have any say in how their donation is used after it’s given to the Foundation? Will the governors of the Foundation have any of the city’s financing decision-making power that is currently held by the elected city commission? These are among the oft-repeated and unanswered questions that keep both citizens and commissioners leary of this project.

"That Foundation, how it is established, set up and how it runs, that's going to contain all of the protections, the firewall between donors and city, and how those funds get used," Ritsema said. "We have to set it up for the long run so the intent remains there and guard against" changes by future city leaders.

The critiques have been "absolutely" helpful, he said. "There are blind spots. Some of things pointed out, it is good to hear and protect against. The more we hear about that the more we build that into our thinking of how that is set up."

Still, the true risk or reward is in the details, and the Memorandum of Understanding won’t be made public until next month, ultimately reducing the amount of time for public comment and number crunching in order for it to be put in place for the 2017 budget.

One unknown is exactly how much money will be available for the "aspirational programs" aimed at reducing "generational poverty," once budget gaps are filled.

"Assuming the yet to be created and funded Foundation is funded to the tune of half a billion, and earns a steady return of 4 percent, we'd still be at roughly $3.3 million less a year under the Foundation than we'll be at for the next three years under the $70 million donation, so I suspect that much of this aspirational stuff highlighted above will be lessened in future years," said city commissioner Matt Milcarek.

If investor confidence is crucial to long-term economic gains on the back of this project, potential homeowners and business-owners may wait until the Foundation is fully capitalized—and property tax cuts are permanent—before making a move to or starting up in Kalamazoo.

There also remains the worst-case scenario: that the Foundation isn't fully funded in time. The income tax, a property tax reversal and other urgent budget gap options will have to be considered.

"If we don't get that done in three years, we'll either raise taxes back up to the max and still have a larger budget shortfall than today, in addition to needing to re-shrink the size of government, or pass an income tax," Milcarek said.  

That's exactly right, Ritsema said.

Parfet and Johnston "have agreed to support [an income tax] as option of last resort in that event. That's the protection. The general fund wouldn't be out that money. That's why there is every intent to get it fully endowed."