Michigan’s Budget Crisis and Options for the Future

1. Michigan’s Budget Crisis and Options for the Future February 21, 2007 Tom Clay Citizens Research Council of Michigan www.crcmich.org

2. Citizens Research Council of Michigan • Founded in 1916 • Statewide • Non-partisan • Private not-for-profit • Promotes sound policy for state and local governments through factual research • Relies on charitable contributions of Michigan businesses, foundations, and individuals

3. Michigan’s Budgetary Morass • Seven years of spending cuts • FY2007 General Fund revenues lower than in FY1996 • School Aid Fund annual growth since 2000-1.4% • Nearly $7 billion in one-time resources used • Reserves exhausted • Weakened connection between revenue structure and the economy • Spending pressures growing faster than revenues

4. The Central Message Is: • The State of Michigan has a structural deficit affecting: -Public K-12 education -General Fund financed programs • Its causes have both spending and revenue components • We will not grow out of it • Significant spending cuts and/or tax increases will be required

5. Deficits Defined Cyclical— Caused by Economic Downturn - Revenues worsen - Some spending pressures increase - Deficit erased when economy recovers Structural — Caused by cost increases to maintain current policies outpacing revenue growth, Even in Good Economic Times

6. The Michigan BudgetHow the Public’s Money is Spent • Total state budget - $41.7B • State’s two major funds: General Fund - $9.2B School Aid Fund - $13.1B • Other state funds restricted for other purposes, e.g. transportation, federal revenues • Over 80% of all revenuesspent locally—schools, hospitals, universities, roads

7. How Weak is the Economy? Michigan’s Recent Statistics: • 50th in Personal Income Growth • 50th in Unemployment Rate • 50th in Employment Growth (Only State with a Decline) • 50th in Index of Economic Momentum (Population, Personal Income, Employment) Economy in Early 1980s Much Worse

8. Michigan Manufacturing Employment Lost 1 in 4 Manufacturing Jobs Jul 1999 908,200 November 2006 638,900 Source: Bureau of Labor Statistics.

9. Big 3 Losing Market Share Source: Automotive News.

10. Economic Forecasts

11. Revenues • Self-inflicted changes in revenue structure -Tax rate cuts -Federal changes in tax law— failure to amend state law -Increased use of slow or no- growth revenue sources (e.g. tobacco taxes) • Weakening connection of economy with revenues -Sales Tax -Income Tax

13. Constitutional Revenue Limit • FY1995—State revenues at the limit (9.49% of Personal Income) • FY2007—State revenues 17% below the limit (7.91% of Personal Income) • Difference equals $5.2 billion

14. General Fund RevenuesLower Than 10 Years Ago($ in millions)

15. Summary of One-Time Resources FY2001-FY2006 (in Millions)

16. General Fund BudgetFY2007 • 86% of General Fund spending in 4 areas: -Higher Education ($1.9B)—21% -Community Health-Mental Health, Public Health, Medicaid ($2.9B)—32% -Corrections ($1.8B)—20% -Human Services-family services, juvenile justice, cash assistance ($1.2B)—13% -All other General Fund programs ($1.3B)—14%

17. Looking Back: Reshaping the General Fund Budget Reductions • Higher Education- $275M in 4 years (13%) • Human Services- $172M in 5 years (14%) • School Aid- $323M in 5 years (84%) • Revenue Sharing- $447M in 5 years (29%) • State employees- 7,400 in 4 years (12%)—smallest workforce since 1974

18. The Immediate SituationFY2007 • Michigan is still in a recession • Revenue performance continues to lag • General Fund revenue shortfall of $600 million in current fiscal year • School Aid Fund $377 million short • $1 billion overall problem • Governor’s proposed solution Feb. 8 • Cuts to cover whole problem would be devastating • Single Business Tax repeal looms

19. Single Business Tax Eliminated(Effective December 31, 2007) • Law change initiated by petition • Legislature enacted the law • Impervious to gubernatorial veto • SBT is gone and with it $1.9 billion of General Fund revenue (22%)

20. SBT: The Remaining Work Ahead • What will replace the revenues? • New taxes on business? • Individuals? • Full or partial replacement? • $500 Million revenue cut? • Where will budget cuts occur? • Nearly 30% of businesses pay no SBT (41,000)—45% below $1000 in liability • Potential for plenty of losers • Personal Property Tax relief?

21. Attributes of Potential SBT Replacements • Low rate • Broad base • Avoid pyramiding • Simple compliance • Revenues grow with the economy • Favor Michigan companies

22. Many Proposals • Chambers of Commerce: State, Detroit and Grand Rapids • Michigan Senate (BEST-Business & Economic Stimulus Tax) • Governor (MBT-Michigan Business Tax)

23. Common Elements • Tax gross receipts • Personal Property Tax relief • Filing threshold • Cuts business taxes (except Governor’s proposal)

24. Avoid Pyramiding With a Gross Receipts Tax and What do you Get? A Value–Added Tax

25. Fiscal Year 2008 • General Fund shortfall about $1 billion, even without net business tax cut • Shortfall over 10 percent • School Aid Fund $450 million short • Total problem about $1.5 billion • Failure to replace any SBT revenues would add $1.2 billion to FY2008 problem

26. Solutions for FY2007 and FY2008 4/5th Revenue-1/5th Spending • Total problem $3.651 billion (including $1.167 billion SBT loss) • Revenue increases—$3.015 billion • Spending reductions (net) $636 million

27. Revenue Proposal • Partially replace SBT ($1.924 billion) with: -Michigan Business Tax (MBT) —$1.990 billion -Insurance Tax increase—$92 million -Exempt Industrial and Commercial Personal Property from 24 mills of School Taxes—($614 million) -Net full-year revenue effect—$468 million cut • 2% Tax on services—$1.518 billion • Cut sales tax on new cars—($180 million) • Decouple from federal Estate Tax—$134M • Other—$193 million Net Revenue Increase—$1.158 billion

28. Michigan Business Tax (MBT) • Sales and assets taxed at .125% • Business income taxed at 1.875% • Insurance premiums 1.25% • 24 mill cut in commercial & industrial Personal Property Tax (46%) • Headquarters credit—$240 million • Raises $480 less than SBT • 111,000 “winners” • 33,000 “losers”

29. Business Taxes in Michigan • 35 states had greater business tax burden than Michigan in 2005 (Council on State Taxation—by Ernst and Young, LLP) • Business share of state and local taxes in Michigan dropped from 43% in 1990 to 37.9% in 2005—Senate Fiscal Agency) • Single Business Tax cuts since 1994 totaled $941 million in FY2006 (34%) • Without cuts SBT would have yielded $2.78 billion instead of $1.84 in FY2006

30. General Fund FY2008 Proposal • Program reductions total $310 million -Corrections -Tuition Grant program -Human Services—day care policy changes • Revenue increases total $2.06 billion (including SBT replacement)

31. School Aid FY2008 Proposal • $178 per pupil foundation increase net of enrollment declines—$190 million • Reduced retirement costs (relative to 17.74% rate)—$100 million • Other specific increases—Great Start, Declining Enrollment, Special Education, Cost Sharing, etc.—$287 million • Total revenue increases and cost reductions $577 million • Potentially the best School Aid budget since FY2000

32. What is Required for FY07 and FY08 Proposals to be Implemented? • Legislative approval of tax changes—increases and decreases • Majority vote of each house • Legislative approval of retirement change—value portfolio at 9/30/06 market value

33. What Happens if Legislature Does Not Approve Governor’s Proposal? General Fund Programs • Cuts exceeding 10 percent for remainder of FY2007 • Average cuts in FY2008 would have to exceed 10 percent • Higher Education, Revenue Sharing especially vulnerable • Health care and services for the poor at risk • Other areas include corrections, public safety, mental health, judiciary

34. What Happens if Legislature Does Not Approve Governor’s Proposal? School Aid • Per pupil cuts this year—$118 per pupil • Not enough state funding in FY2008 to match FY2007 appropriations • Revenue increase proposed for FY2008 $453 million—$268 per pupil • Significant program cuts from current levels will be necessary

35. Beyond FY2008Does the Budget Proposal Fix the Structural Deficit? No, but………… • Revenue structure has stronger connection to the economy • Proposed changes in Corrections polices would slow down growth in spending pressures • Progress is made

36. Elements of Structural Deficit • Exploding health care costs • Prison costs outpacing revenue growth • Antiquated revenue structure • Slow economic growth

37. A Ten-Year Scenario • Spending and revenue trends extended • EITC factored into projections • Huge gaps between the cost of maintaining programs and revenues • Gap is $10 billion in General and School Aid Funds combined • Gap equates to 31% of projected revenues overall—General Fund 50%

38. Structural Revenue Issues • Revenue system reflects economy of the 50s, 60s, and 70s • Revenues grow more slowly than economy • Income tax growing slowly • Consumption taxes goods-oriented • Relatively few services are taxed • Services are over half of private sector economic activity

39. Health Care Health care everywhere in budget Growing faster than revenues Largest component in state budget -Medicaid -Health insurance for school and state employees -Health insurance for school and state retirees -Prisoners

40. Medicaid • Medical care for one in seven Michigan citizens • Future spending growth pressures 8 to 9 percent annually • Some state revenues dedicated to Medicaid do not grow—Tobacco Settlement revenues, Cigarette Tax • General Fund requirements grow faster than total Medicaid spending • General Fund spending pressures outpace revenue growth by 3 to 4 times

41. Corrections • Largest state-operated program • 30 percent of state employees • More than 50,000 prisoners • 58 prisons and camps • $30,000 per prisoner cost per year • $1.9 billion budget • Incarceration rate 40% higher than Great Lakes neighbors-the result: $500 million higher costs

42. States With More Than 500 Prisoners Per 100,000 Residents

43. Corrections Projections • Crime rates falling but prison population pressures continue to increase • Populations projected to increase 1,000/ year until 2010 (if current policies continue) • Annual cost increases about $80M • Annual increases about 7%—Twice as fast as revenues will grow

44. School Aid Outlook Beyond FY2008When Economy Finally Improves • Moderate Revenue growth ($340 Per Pupil) • Revenue growth rate below general economy • Annual State revenue increases about 3% • Not enough growth to match spending pressures • Will new revenues from services change the revenue growth significantly?

45. School Aid Structural DeficitSpending Pressures Outpace Revenue Growth • Retirement Contributions • Employee Health Insurance • General Pay Raises • Other—Fuel, Utilities, Supplies • Revenues Growing Slowly

46. School Retirement Funding • School Districts pay contributions for employees • Rate for FY2007 17.74% of Payrolls • Contribution rate composed of two parts -Regular Pension Benefit -Health Care Benefits • Health care contribution will continue to increase after FY2008

48. Financial Significance • School District contributions exceeded $1.35 billion in FY2005 • Costs will likely average $1000 per student in FY2007 • Incremental increases exceed $90 per pupil after FY2008 • Rising contribution rates will continue to claim significant share of future revenue increases

49. Employee Health Insurance • Double-digit premium increases recently • FY2007 increases moderated • Schools spend over $1200 per pupil on Health Insurance Premiums • Annual increases could exceed $100 per pupil

50. School Aid Numbers —Beyond FY2008 • Revenues grow about $340 per pupil per year • Spending Pressures and “Requirements” -Retirement- $90+ -Health Insurance- $100+ -Salaries and Wages (4%)- $240+ -Fuel, Utilities, Etc.- $50+ • Structural Deficit Nearly $150 per pupil (about 2%) • Recession Widens Gap to 4% or More