Mercatus Scholars on the Detroit Bankruptcy

EXPERT COMMENTARY

Mercatus Scholars on the Detroit Bankruptcy

By Eileen Norcross, Matthew Mitchell, |
Jul 19, 2013

Detroit became the largest city in U.S. history to declare bankruptcy when it filed for Chapter 9 protection on Thursday. Mercatus experts weigh in:

Senior Research Fellow Eileen Norcross on why it was only a matter of time:

"Detroit's Chapter 9 filing is no surprise. Mayor David Bing sounded the alarm in 2011 when the city's deficit reached $45 million. Two years later, it's hit $380 million. Rising employee costs, a shrinking population and falling property values created the perfect storm for a city with several decades of bad economic fortune. 

"In fiscal 2013, employee wages, benefits and pensions took up 41 percent of city revenues, and over the years the city has met its budget by skipping pension payments and issuing bonds. Detroit reports an unfunded pension liability of $634 million, but using more accurate accounting methods it's closer to $3.5 billion. Factor in health care benefits and this shortfall rises to $9.2 billion

"Last week, the City's emergency manager Kevyn Orr proposed cutting pension payouts in a controversial move certain to be at the center of bankruptcy discussions. The bottom line: Pension accounting reform is crucial to ensuring other municipal governments don't suddenly find themselves in the same unenviable place.

"Detroit has run out of money and it has run out of time. The city's misfortune is a lesson to all governments that offer their workers a pension. Government accounting seriously underestimates how much employers must contribute to sustain pension payouts. Flawed pension accounting is the ticking time bomb in municipal and state budgets, and government workers stand to lose as much as anyone.”

Senior Research Fellow Matthew Mitchell on the long-term effects of cronyism in Detroit:

“Detroit's experience should give pause to policymakers thinking about promoting particular firms or industries through targeted assistance like bailouts, subsidies or trade protection. For decades, the city's automakers benefited from these types of government-granted privileges. All of this targeted assistance encouraged labor and capital to accumulate in Detroit, but the accumulation wasn’t sustainable. A large portion of that wealth was built on the favors of politicians, rather than the desires of actual customers. So Detroit stopped making cars that customers wanted, and customers turned to auto makers elsewhere. As they did, the city saw a mass exodus of workers and capital.

"Sustainable economic growth needs to be built around customer desires, not political desires.”

Senior Scholar Anthony Sanders on what must happen next:

Detroit is near the statutory limits of its ability to tax. That power has been dragged down by a drop in the city’s population, down 60 per cent from almost 2 million at the peak in the 1950s to just under 700,000. This led to a 40 per cent drop in tax revenues since 2000. The city has had to borrow money to meet its operating budget which has been slashed. With the City retiree pool currently outnumbering active employees by an over-2 to 1 margin and growing, the City must address pension and retiree healthcare liabilities as part of any comprehensive restructuring.

See also: Policy Research Manager Emily Washington on the implications of Detroit's emergency fiscal manager and the controversy over selling city-owned art to raise revenue.

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