State and Local Public Finance Challenges in Michigan

1. State and Local Public Finance Challenges in Michigan Rochester Rotary Club Craig Thiel Citizens Research Council of Michigan October 5, 2010 www.crcmich.org / cthiel@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 – accurate, independent and objective • Relies on charitable contributions of Michigan foundations, businesses, and individuals • www.crcmich.org

3. The Last Decade Has Beenan Economic Disaster for Michigan *GDP growth is for 2000 through 2008. 3

4. Almost Every Sector in MichiganHas Lost Jobs Source: Bureau of Labor Statistics. CRC calculations.

5. State Forecast – No Job Growth for Michigan Yet Michigan Wage and Salary Employment Y-O-Y Change (In Thousands) Avg. Source: Bureau of Labor Statistics. 2010-2011 estimates are from the May 2010 Cons. Forecast.

6. Michigan Has Become PoorerRelative to Other States Michigan per Capita Income as a Percent of U.S. Per Capita Income Rank has fallen from 20th in 2001 to 37th in 2009 122% 93% 87% Source: CRC calculations from Bureau of Economic Analysis data. March 24, 2009 personal income release for years Prior to 1969. March 2010 release for years after 1969. Ranking excludes Washington D.C.

7. What is the Impact on Public Finances?

8. Revenue and Spending Effects • Revenue • All major state taxes affected • Property tax begins to show weakness • General tax increase in 2007 • “Rainy Day” funds depleted or at very low levels • Spending • Spending on “counter-cyclical” programs rises • “Required” personnel costs (pensions and retiree health) do not abate

9. The Michigan Budget Story Has Not Changed • The state budget has generally tracked economy, but other forces at work too • Since FY2001, budget faces structural budget problems • Prospectively, the State will have to confront dual structural deficits affecting: - Public K-12 education - General Fund-financed programs • Its causes have both spending and revenue components • We will not grow out of it – long-term problem • Conclusion: Significant spending cuts and/or tax increases will be required to align on-going spending and revenues

10. On-Going Discretionary RevenueGF/GP at FY1965 and one-half of FY2000 Billions of 2010$ FY2000 $14.4B FY1965 $6.9B FY2010 $6.9B Note: GF-GP figures are presented on a Consensus basis and adjusted for inflation to 2010 dollars using the state and local government price deflator. 2009 and 2010 are estimates.

11. On-Going Dual DeficitsFY08 Benefitted from Tax Increases Note: Operating deficits equal difference between on-going revenues and spending in GF/GP and SAF; revenues exclude temporary ARRA funding * FY10 is an estimate

12. State Spending From State SourcesDown Sharply in Real Terms • From FY2000 to FY2010 • Inflation up approx. 23% • Total state spending up 22.5% but increases in federal aid drove increase; state spending from state sources up only 2.3% • Spending changes from state sources: • K-12 +8.2% • Community Colleges +0.7% • Universities/financial aid -13.7% • Revenue sharing -34% • Corrections +27.2% • Medicaid +49.9% 12 Source: Senate Fiscal Agency.

13. Michigan’s GF/GP Budget Significant Changes Total: $9.9 Billion Total: $8.1 Billion Source: Senate Fiscal Agency

14. There is a New Chapter in Budget SagaFocus Shift to Short-Term Problems • Severe recession: all of 2008 and most of 2009 • Impacts on state budget were massive - primarily in FY2009 and FY2010, and lingering into FY2011 • Revenue declines unprecedented • Spending demands spiked • State budget unprepared to deal with current recession • Exhausted reserves earlier in decade • Few non-recurring resources available • General tax increases of 2007 • Challenge facing policymakers - Must correct for two problems simultaneously • Structural deficits • Cyclical deficits • Each problem requires specific set of tools

15. Revenues Crash in FY2009Recover in FY2011 but Slowly Annual Growth Rates Note: Projected totals are the May 2010 Consensus Revenue Estimates.

16. FY2009 and FY2010 BudgetsAttention to Short-Term Problem • Revenue decline in FY2009: -21% • Major taxes affected by economy • Tax policy changes contributed too • After 13% increase in FY2008 (income tax rate increase) • Overall: $2 billion hit to General Fund • Another 10% decline in FY2010 • Economy and tax policy factors continue • Another $700 million Two-year decline: $2.7 billion

17. FY2010 GF Cuts Were Severe Medicaid provider rates (cut 8% from original FY2009 level) Non-Medicaid CMH funding ($40M cut) Elimination of $238M from DHS budget Revenue Sharing to CVTs down 9.7% State employee concessions/layoffs (varied) Average of -8.4% cut (GF-GP) across all state departments Some larger than others Some areas protected from cuts per ARRA Scholarships to university students cut by two thirds (incl. elimination of Promise Grants) Budget also supported by $1.2 billion in stimulus funds

18. “Balanced” Budget AchievedHeavy Reliance on One-Timers • *Based on projected spending • Based on May 2010 Consensus Revenue Estimate • Fund balance = $458 million on 10/1//08

19. FY2010 School Funding CutsInitially Very Sizeable • On-going revenue $750 million below FY2008 • Budget enacted with sizeable cuts, including: • $165 per pupil ($263M) • ISD reduction ($16M) • “Hold Harmless” Districts veto ($52M) • Others ($35M) • Budget includes $450M in stimulus funding • Some funding later restored

20. Schools Face Revenue “Cliff” in FY2012

21. FY2011 Budget – More of the SameSolution Includes $1 Billion in One-Time Fixes • Non-recurring resources ($945M) • Federal Medicaid match increase ($620M) • Unclaimed property changes ($166M) • Tax amnesty program ($62M) • Some structural reforms, but not as much as exec. budget • Retirement system changes ($80M) • Spending reductions – ($256M) • Debt refinancing ($77M) • Higher Education ($43M) • Human Services ($66M) • Corrections ($42M) Many of the reductions deemed “aggressive” by Governor

22. FY2011 School Aid BudgetCompleted “Early” • Original revenue picture: add’l $250 per-pupil reduction ($400M shortfall) in FY2011 • Sales tax restructuring and MBT phase-out • Add’l net revenue in FY2011 to solve problem, but revenue neutral in out-years • Mid-year cut for FY2010 ($127 per pupil) • May revenue estimate: major improvement for FY2010 and FY2011 • Add’l rev. $292M in FY2010 and $352M in FY2011 • Eliminate projected shortfalls and possible cuts • Portion of fund balance ($208M) used in GF • Budget deal: completed on July 1 - 3 months earlier • FY2010 cuts retained ($11 per-pupil cut restored) • $318M of fed. Edu Jobs will help restore FY2010 cuts

23. Problem Only Gets Bigger in FY2012General and School Aid Fund Budgets Face Min. $1.6B Shortfall • Use of nearly $1.5B in non-recurring resources in FY2011 will be added to: • First year of income tax rate reduction: $150M • Other tax changes • Spending pressures related to caseloads and employee economics • Some relief provided by: • Revenue growth coming out of the recession • Early retirement plan and pension reforms • Fed. Medicaid match still high because of economy • Upcoming employee contract negotiations

24. State Revenues Make the Turn, butLocal Revenues Fall • To date, local property tax has provided stability to local government revenue picture ~ 5% growth/yr (‘00 – ‘07) and flat in ’08 and ‘09 • In short-term and fairly short order, this picture changes dramatically • Taxable values fall in 2010 and 2011 • State revenues will not be positioned to help • Coming out of the downturn, tax value growth capped (Prop. A) – restrains revenue growth • Local cuts are coming and will be much more visible than many state cuts

25. TV Growth Stable But Taxable Value Now Falling % Change in Total Taxable Value Average Source: State Tax Commission and May 2010 Consensus Conference.

26. Previously Above the U.S. Ave, Not the Case Any Longer Source: US Census

27. Long Term Fiscal ChallengesCombination of Revenue and Spending • One-time resources eventually run dry (ARRA, Edujobs) • State taxes reduced, but underlying relationship between taxes and economy unaffected • Constitutional tax limitation (Headlee) will control growth in property tax receipts at unit level • Constitutional tax limitation (Prop. A) will control growth of property value at parcel level • Local governments more limited tax base and they are constrained in tax choices (no sales tax) • Spending pressures facing state and localities similar – health care and retirement, long-term obligations

28. State Revenue Growth Does NotKeep Pace with Economy • Increasing senior citizen population—retirement income not taxed and spend less on goods • Consumption taxes goods oriented—economic growth is in service sector • Slow or no growth revenues drag down overall growth (e.g. tobacco, gambling, alcohol) • Flat rate income tax • Tax Policy – reduce “natural” growth • Earned Income Tax Credit • Phase-out of Income Tax increase

29. Structural DeficitSpending Pressures Outpace Revenue Growth • Over 85% of GF/GP budget concentrated in four areas: • Community Health ($2.4B) • Corrections ($1.9 B) • Higher Education ($1.8 B) • Human Services ($0.9 B) • Most significant spending pressures: • Health care • Corrections – personnel costs • Employee compensation – pay and fringes • Caseload and “inflationary” increases drive spending

30. Without Structural Reforms Problem Compounds Source: CRC, Michigan’s Fiscal Future

31. Structural Spending ReformsActions Taken To Date • Corrections – focus on decreasing prison population through reducing the length of stay • Administrative actions to date – 6,300 prisoner reduction since 2006 peak • Gov. proposal to restore “good time credits” to reduce 10,000 prisoners – not adopted by legislature • Public employee compensation – focus on benefits • New employees: 20% premium sharing • State pension plans – require employees to pick up cost of retiree health care (cost shift from employer) • Recent changes require 3% contribution; however, some savings offset by “early out” plan

32. Other Potential Areas of ReformTopics Under Consideration Tax Structure – Potential goals include: faster growth; more favorable to economic development; increased progressivity; additional revenues; property tax limitations (Headlee and Prop. A) Local Government Service Consolidation or Service Collaboration – Increased service sharing among local governments, or outsourcing of service provision in an attempt to achieve cost savings Investments in Areas Deemed Key for Economic Development – Potential areas include infrastructure, higher education, targeted tax credits for key industries (e.g. film credits, battery credits) 32

33. Challenge Looking Forward • Michigan has to come to grips with new reality – sooner the better • No shortage of solutions - problem fairly well defined • Generating consensus around a reform agenda – very sharp philosophical differences exist • Long-term problem - will require a long-term solution (no “silver bullet”) • For those dependent on public dollars and absent reforms – likely to get worse before it gets better

34. Citizens Research Council of Michigan CRC Publications available at www.crcmich.org Providing Independent, Nonpartisan Public Policy Research Since 1916