1

May 19, 2004

Tom ClayDirector of State Affairs

Citizens Research Council of Michiganwww.crcmich.org

Michigan’s Chronic Budget Problem: Its Magnitude, Causes and Implications

Michigan’s Chronic Budget Problem: Its Magnitude, Causes and Implications

2

Citizens Research Council of MichiganCitizens 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

• 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

Five Years of Budget ProblemsFive Years of Budget Problems

• Declining General Fund Revenues• Slow Growth - School Aid Fund

Revenues

• Situation Cyclical or Structural?

• Prospects for Improvement?

• Declining General Fund Revenues• Slow Growth - School Aid Fund

Revenues

• Situation Cyclical or Structural?

• Prospects for Improvement?

4

The National SituationThe National Situation

• Worst State Budget Crisis Since World War II

• Revenue Structures Mismatched With Spending Responsibilities

• Spending Demands Outpacing Revenue Increases

• Medicaid a Nationwide Problem • Corrections Growing Rapidly in Michigan

and Some Other States

• Worst State Budget Crisis Since World War II

• Revenue Structures Mismatched With Spending Responsibilities

• Spending Demands Outpacing Revenue Increases

• Medicaid a Nationwide Problem • Corrections Growing Rapidly in Michigan

and Some Other States

5

• Total State Budget - $39.1 Billion• State’s Two Major Funds:

General Fund - $8.7 Billion School Aid Fund - $12.5 Billion

• Other State Funds Restricted for Other Purposes, e.g. Transportation, Federal Revenues

• Total State Budget - $39.1 Billion• State’s Two Major Funds:

General Fund - $8.7 Billion School Aid Fund - $12.5 Billion

• Other State Funds Restricted for Other Purposes, e.g. Transportation, Federal Revenues

The Michigan BudgetThe Michigan Budget

6

General Fund Budget General Fund Budget

83% of General Fund Spending in 4 Areas:• Higher Education ($1.8 B)• Community Health — Mental Health, Public

Health, Medicaid ($2.5 B)• Corrections ($1.7 B)• FIA — Family Services, Juvenile Justice,

Public Assistance ($1.1 B)

All Other General Fund Programs - $1.5 B

83% of General Fund Spending in 4 Areas:• Higher Education ($1.8 B)• Community Health — Mental Health, Public

Health, Medicaid ($2.5 B)• Corrections ($1.7 B)• FIA — Family Services, Juvenile Justice,

Public Assistance ($1.1 B)

All Other General Fund Programs - $1.5 B

7

School AidSchool Aid

• State Provides About 80% of Total State & Local Revenues to Local Districts & Charter Schools

• Almost All of the Revenue Base Earmarked Specifically for Schools

• Sales Tax is Principal Revenue Source (41%)

• State Provides About 80% of Total State & Local Revenues to Local Districts & Charter Schools

• Almost All of the Revenue Base Earmarked Specifically for Schools

• Sales Tax is Principal Revenue Source (41%)

8

External Causes of the Budget Problem

External Causes of the Budget Problem

• Weak Economy

• Stock Market Decline

• Michigan’s Deteriorating Share of Auto and Light Truck Market

• Weak Economy

• Stock Market Decline

• Michigan’s Deteriorating Share of Auto and Light Truck Market

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How Weak is the Economy?How Weak is the Economy?

Michigan’s Recent Statistics:

-46th in Personal Income Growth

-48th in Unemployment Rate

-49th in Employment Growth (Decline for Michigan)

-49th in Index of Economic Momentum (Population, Personal Income, Employment)

Michigan’s Recent Statistics:

-46th in Personal Income Growth

-48th in Unemployment Rate

-49th in Employment Growth (Decline for Michigan)

-49th in Index of Economic Momentum (Population, Personal Income, Employment)

10

Michigan Job LossesMichigan Job Losses

• 285,000 Jobs Lost in Three Years

• Manufacturing Employment Down 174,000

• 19% Fewer Manufacturing Jobs

• 61% of Job Losses in Manufacturing

• 285,000 Jobs Lost in Three Years

• Manufacturing Employment Down 174,000

• 19% Fewer Manufacturing Jobs

• 61% of Job Losses in Manufacturing

11

The Stock MarketThe Stock Market

• Michigan Income Tax Receipts From Non-Salary Income Dropped Over $500 Million in Three Years (Nearly 40 Percent)

• Affected General Fund and School Aid

• Hangover Will Remain For Several Years

• Michigan Income Tax Receipts From Non-Salary Income Dropped Over $500 Million in Three Years (Nearly 40 Percent)

• Affected General Fund and School Aid

• Hangover Will Remain For Several Years

12

Total U.S. Vehicle Sales & Big 3 Share 1992-2003

0

5,000,000

10,000,000

15,000,000

20,000,000

Sale

s Le

vel

52%54%56%58%60%62%64%66%68%70%72%

Total U.S. Sales Light Vehicles Big 3 Share of Total Sales

13

Internal Causes of the ProblemInternal Causes of the Problem

• Spending Growth Outpacing Revenue Increases-Medicaid –Double Digit Growth-Corrections-Some Programs Are Being Crowded Out of Budget

• Tax Cuts Eroding the Revenue Base• Failure to Implement Permanent Budget-

balancing Changes

• Spending Growth Outpacing Revenue Increases-Medicaid –Double Digit Growth-Corrections-Some Programs Are Being Crowded Out of Budget

• Tax Cuts Eroding the Revenue Base• Failure to Implement Permanent Budget-

balancing Changes

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The Tax Rate CutsThe Tax Rate Cuts

• Single Business Tax - 26% of General Fund Revenue

• Individual Income Tax Cut - 8% of General Fund Revenue

• Implication: State Could Afford to Finance Existing Programs w/1/3 Less Revenue

• Roughly 13 Percentage Points of 34 Percentage Points Gone ($1.3 B)

• Single Business Tax - 26% of General Fund Revenue

• Individual Income Tax Cut - 8% of General Fund Revenue

• Implication: State Could Afford to Finance Existing Programs w/1/3 Less Revenue

• Roughly 13 Percentage Points of 34 Percentage Points Gone ($1.3 B)

15

Summary of One-time Resources

(in Millions)

Summary of One-time Resources

(in Millions)

Rainy Day Fund $1,363

FY2000 School Aid Fund Surplus 984

FY2000 General Fund Surplus 212

Medicaid Benefits Trust Fund 561

Advance State Education Tax Collection Date 455

Tobacco Settlement/Merit Award Revenues 317

Temporary Federal Fiscal Assistance 655

Bond for Pay-as-you-go Capital Projects 211

Revenue Sharing Accounting Change 181

Refinance Bonds 209

Employee Wage Concessions 110

Other 759

$6,017

16

($1,200)

($1,000)

($800)

($600)

($400)

($200)

$0

$200

$400

$600

($ i

n M

illi

on

s)

FY00 FY01 FY02 FY03 FY04 FY05

School Aid Fund

General Fund

($1,200)

($1,000)

($800)

($600)

($400)

($200)

$0

$200

$400

$600

($ i

n M

illi

on

s)

FY00 FY01 FY02 FY03 FY04 FY05

School Aid Fund

General Fund

General Fund & School Aid Operating Deficits

General Fund & School Aid Operating Deficits

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Perspective On RevenuesPerspective On Revenues

• Actual General Fund Revenues in FY03, FY04, & FY05 Below FY1995

• 10 Years of Higher Costs & Increased Needs Go Unfunded

• Some Programs Crowding Out Others• School Aid Revenues Up $3.5 B Over

Same Period (45%)

• Actual General Fund Revenues in FY03, FY04, & FY05 Below FY1995

• 10 Years of Higher Costs & Increased Needs Go Unfunded

• Some Programs Crowding Out Others• School Aid Revenues Up $3.5 B Over

Same Period (45%)

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FY2004 Review—General FundFY2004 Review—General Fund

• Budgets Cut $1.7 Billion– General Fund - $1,335 Million– School Aid - $361 Million

• Onetime Resources & Savings - $807 M• Fees & Other Revenues - $453 M• Other Changes - $155 M• Tax Increases Off the Table• More Cuts Coming

• Budgets Cut $1.7 Billion– General Fund - $1,335 Million– School Aid - $361 Million

• Onetime Resources & Savings - $807 M• Fees & Other Revenues - $453 M• Other Changes - $155 M• Tax Increases Off the Table• More Cuts Coming

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FY2004 School Aid ReviewFY2004 School Aid Review

• School Aid Down Year to Year—

$128 Million

• First Decline Since Proposal A

• Retirement Percentage Held at 12.99%--Reserves Used to Postpone Increase

• Can More Cuts Be Avoided?

• School Aid Down Year to Year—

$128 Million

• First Decline Since Proposal A

• Retirement Percentage Held at 12.99%--Reserves Used to Postpone Increase

• Can More Cuts Be Avoided?

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Summary of Other Budget CutsSummary of Other Budget Cuts

• Higher Education Cut 14% in 2 Years - $297 M

• Revenue Sharing Cut 15% in 3 Years - $293 M

• State Workforce Down 8,500 in 3 Years (14%) - Smallest Workforce Since 1974

• Higher Education Cut 14% in 2 Years - $297 M

• Revenue Sharing Cut 15% in 3 Years - $293 M

• State Workforce Down 8,500 in 3 Years (14%) - Smallest Workforce Since 1974

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Revenue Sharing PaymentsFiscal Years ’93 through ‘04 Revenue Sharing PaymentsFiscal Years ’93 through ‘04

$800.0

$1,000.0

$1,200.0

$1,400.0

$1,600.0

$1,800.0

Fiscal Year

In M

illio

ns

Statutory/Constitutional

Actual/Proposed$800.0

$1,000.0

$1,200.0

$1,400.0

$1,600.0

$1,800.0

Fiscal Year

In M

illio

ns

Statutory/Constitutional

Actual/Proposed

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MedicaidMedicaid

• Spending Up 40 Percent in 4 Years - Nearly Double Digit Increases

• Caseload Up 27% During Same Period• Program Now Covers 1.35 Million

Michigan Citizens• Pressures on Rates Paid Providers -

Could Add Significantly to Growth in Future

• Spending Up 40 Percent in 4 Years - Nearly Double Digit Increases

• Caseload Up 27% During Same Period• Program Now Covers 1.35 Million

Michigan Citizens• Pressures on Rates Paid Providers -

Could Add Significantly to Growth in Future

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CorrectionsCorrections

• Largest State-Operated Program• Most State Revenue Goes to Other

Organizations - Universities, Schools, Hospitals, Local Government, etc.

• 50,000 Prisoners• Over 30 % of State Workers• Share of Budget Has Increased 4

Percentage Points Since FY2000

• Spending Up $253 Million (17%)

• Largest State-Operated Program• Most State Revenue Goes to Other

Organizations - Universities, Schools, Hospitals, Local Government, etc.

• 50,000 Prisoners• Over 30 % of State Workers• Share of Budget Has Increased 4

Percentage Points Since FY2000

• Spending Up $253 Million (17%)

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States With More Than 500 Prisoners Per 100,000 Residents

States With More Than 500 Prisoners Per 100,000 Residents

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Shares of the General Fund Budget

0.05.0

10.015.020.025.0

Fiscal Year

Per

cen

t of T

ota

l

Corrections

Higher Education

School Aid

Shares of the General Fund Budget

0.05.0

10.015.020.025.0

Fiscal Year

Per

cen

t of T

ota

l

Corrections

Higher Education

School Aid

26

State Government Employment TrendsState Government

Employment Trends

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

1980

1985

1990

1995

2000

2002

2003

Fiscal Year

Em

plo

ym

en

t

Corrections

All OtherDepartments

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

1980

1985

1990

1995

2000

2002

2003

Fiscal Year

Em

plo

ym

en

t

Corrections

All OtherDepartments

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State Employee CompensationState Employee Compensation

• Increases in Employee Compensation Costs Not Funded In FY2004 Appropriations

• Pay Raises Negotiated in 2001—Three Year Contract—2%(‘03), 3%(’04), 4%(’05)

• Other Increases—Group Insurance & Retirement Contribution Rate

• General Fund Costs---$140 Million• Concessions Prevented Loss of 3,000 Jobs in

Place

• Increases in Employee Compensation Costs Not Funded In FY2004 Appropriations

• Pay Raises Negotiated in 2001—Three Year Contract—2%(‘03), 3%(’04), 4%(’05)

• Other Increases—Group Insurance & Retirement Contribution Rate

• General Fund Costs---$140 Million• Concessions Prevented Loss of 3,000 Jobs in

Place

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Areas of Continuing RiskAreas of Continuing Risk

• Economic and Revenue Outlook

-Traditional Michigan Recovery not Likely

-Auto and Light Truck Sales Already Strong

-Incentives, Rebates and Low Interest Loans Borrowed Sales From Future

-Big Three Losing Sales Share

• Spending Problems—Particularly Medicaid

• Economic and Revenue Outlook

-Traditional Michigan Recovery not Likely

-Auto and Light Truck Sales Already Strong

-Incentives, Rebates and Low Interest Loans Borrowed Sales From Future

-Big Three Losing Sales Share

• Spending Problems—Particularly Medicaid

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Revenue Forecasts for FY2005 May Consensus Agreement

Revenue Forecasts for FY2005 May Consensus Agreement

• New Forecast Approved Yesterday-May 18

• Recovery and Steady Growth Projected for Economy

• Economic Forecast Produces About 4% Revenue Growth

• Little Change From January Forecast

• New Forecast Approved Yesterday-May 18

• Recovery and Steady Growth Projected for Economy

• Economic Forecast Produces About 4% Revenue Growth

• Little Change From January Forecast

30

Updated FY2005 General Fund Budget Challenge

Updated FY2005 General Fund Budget Challenge

• Projected Deficit of Nearly $1.3 Billion• Projected Revenues $200 Million Below FY2004

Appropriations• Additional Requirements---$916 Million

– Medicaid---$447 Million– Additional Medicaid Requirements--$100+Million – Employee Compensation-Existing Contract and

Expiring Concessions---$246 Million– Corrections---$44 Million – Family Independence Agency---$25 Million– Higher Education Tuition Restraint---$52 Million– Other---$102 Million

• Projected Deficit of Nearly $1.3 Billion• Projected Revenues $200 Million Below FY2004

Appropriations• Additional Requirements---$916 Million

– Medicaid---$447 Million– Additional Medicaid Requirements--$100+Million – Employee Compensation-Existing Contract and

Expiring Concessions---$246 Million– Corrections---$44 Million – Family Independence Agency---$25 Million– Higher Education Tuition Restraint---$52 Million– Other---$102 Million

31

FY2005 Proposed Revenue ChangesFY2005 Proposed Revenue Changes

• Increase Cigarette Tax $.75 - $295M• Decouple From Federal Estate Tax-$94M• Increase Liquor Markup - $32M• Merit Scholarship Accounting Change -

$64M (One-time)

• Increased Revenue Enforcement - $30M• Most of Revenue Earmarked for Medicaid

• Increase Cigarette Tax $.75 - $295M• Decouple From Federal Estate Tax-$94M• Increase Liquor Markup - $32M• Merit Scholarship Accounting Change -

$64M (One-time)

• Increased Revenue Enforcement - $30M• Most of Revenue Earmarked for Medicaid

32

FY2005 Proposed General Fund Spending Changes

FY2005 Proposed General Fund Spending Changes

• Eliminate Revenue Sharing for Counties-$183 M - Create One-time Fund For Counties By Collecting All Property Taxes In Summer

• Close Women’s Prison - $23 M• Proposed Employee Savings & Concessions -

$148 M• Eliminate Private College Scholarships - $65 M• Limit Payments in Lieu of Taxes - $10 M• Reduce GF Grant to School Aid - $196 M

• Eliminate Revenue Sharing for Counties-$183 M - Create One-time Fund For Counties By Collecting All Property Taxes In Summer

• Close Women’s Prison - $23 M• Proposed Employee Savings & Concessions -

$148 M• Eliminate Private College Scholarships - $65 M• Limit Payments in Lieu of Taxes - $10 M• Reduce GF Grant to School Aid - $196 M

33

Closing The General Fund GapOriginal Proposal

Closing The General Fund GapOriginal Proposal

• Revenues - $451 M

• Spending Reductions - $705 M

• One-time Resources - $104 M

• Total - $1.260 B

• Revenues - $451 M

• Spending Reductions - $705 M

• One-time Resources - $104 M

• Total - $1.260 B

34

The FY2005 School Aid ProposalThe FY2005 School Aid Proposal

• Foundation Allowance Minimum at $6,700• General Fund Grant Reduced by $196 M to

$132M---Lowest in More Than 25 Years• Membership Count Change “Saves” $43M• Project Great Start Partly Funded By Decreasing

ISD Operations Support• Total Spending Lower Than FY2003, $104M

Above FY2004• Retirement Rate up 1.88 Percentage Points to

14.87 Percent

• Foundation Allowance Minimum at $6,700• General Fund Grant Reduced by $196 M to

$132M---Lowest in More Than 25 Years• Membership Count Change “Saves” $43M• Project Great Start Partly Funded By Decreasing

ISD Operations Support• Total Spending Lower Than FY2003, $104M

Above FY2004• Retirement Rate up 1.88 Percentage Points to

14.87 Percent

35

FY2005 School Aid Will Cause Significant Financial PressuresFY2005 School Aid Will Cause Significant Financial Pressures

• Retirement Percentages Will Consume More Than The Small Increase

• Large Increases in Health Insurance Costs to Fund

• No Room for Other Higher Costs Without Cutting Staff or Using Fund Balances (a slippery slope)

• Retirement Percentages Will Consume More Than The Small Increase

• Large Increases in Health Insurance Costs to Fund

• No Room for Other Higher Costs Without Cutting Staff or Using Fund Balances (a slippery slope)

36

Outlook For FY2005 General Fund ProposalOutlook For FY2005

General Fund Proposal• Additional Adjustments Needed to Deal With

Medicaid Spending Requirements• Many Elements of Governor’s Proposal At Risk• Resistance to Tax Increases• Some Spending Changes Appear to be

Unacceptable to Legislature

-Private College Scholarships

-County Revenue Sharing• Completion of Budget By July Will Be Difficult

• Additional Adjustments Needed to Deal With Medicaid Spending Requirements

• Many Elements of Governor’s Proposal At Risk• Resistance to Tax Increases• Some Spending Changes Appear to be

Unacceptable to Legislature

-Private College Scholarships

-County Revenue Sharing• Completion of Budget By July Will Be Difficult

37

The Ongoing General Fund Structural Problem - The Budget

Beyond FY2005

The Ongoing General Fund Structural Problem - The Budget

Beyond FY2005

• Pressures On Health Care & Corrections Spending to Outpace Future Revenue Growth

• Only Fundamental Structural Changes Will Solve the Problem• Revenues - Antiquated Tax Structure• Medicaid Responsibilities -

Federal/State• Corrections Policies• Eliminate Some Programs

• Pressures On Health Care & Corrections Spending to Outpace Future Revenue Growth

• Only Fundamental Structural Changes Will Solve the Problem• Revenues - Antiquated Tax Structure• Medicaid Responsibilities -

Federal/State• Corrections Policies• Eliminate Some Programs

38

The School Aid Outlook Beyond FY2005

The School Aid Outlook Beyond FY2005

• FY2005 Proposal Balances Spending & Ongoing Revenues

• Continued Economic Growth Translates to Budget Growth in FY2006

• Continued Revenue Growth Could Permit: • About 4% Spending Growth in FY2006 & Beyond• Foundation Allowance Increases• Retirement and Health Insurance Will Continue to Claim

Larger Shares of Revenues

• FY2005 Proposal Balances Spending & Ongoing Revenues

• Continued Economic Growth Translates to Budget Growth in FY2006

• Continued Revenue Growth Could Permit: • About 4% Spending Growth in FY2006 & Beyond• Foundation Allowance Increases• Retirement and Health Insurance Will Continue to Claim

Larger Shares of Revenues

39

Revenue Structure IssuesRevenue Structure Issues

• Level of Revenues-Sufficient to Finance Desired

Programs -Now or in the Future?

• Source of Revenues-Equitable?-Representative of Economy?

• Level of Revenues-Sufficient to Finance Desired

Programs -Now or in the Future?

• Source of Revenues-Equitable?-Representative of Economy?

40

Level of RevenuesLevel of Revenues

• Jury Still Out

• Elected Officials Have Not Yet Devised Permanent Solution

• Actions So Far Suggest Level Insufficient

• Economic Growth Will Not Solve Problem

• Jury Still Out

• Elected Officials Have Not Yet Devised Permanent Solution

• Actions So Far Suggest Level Insufficient

• Economic Growth Will Not Solve Problem

41

Source of RevenuesSource of Revenues

• Tax System

• Narrow Base for Sales and Use Taxes• Single Business Tax Scheduled for Repeal

in 2010• Revenues Increase More Slowly than

Michigan Economy

• Overhaul of Tax System May be Desirable

• Tax System

• Narrow Base for Sales and Use Taxes• Single Business Tax Scheduled for Repeal

in 2010• Revenues Increase More Slowly than

Michigan Economy

• Overhaul of Tax System May be Desirable

42

State Taxes as a Percent of Michigan Personal Income

0.01.02.03.04.05.06.07.08.09.0

Year

Pe

rce

nt

State Taxes as a Percent of Michigan Personal Income

0.01.02.03.04.05.06.07.08.09.0

Year

Pe

rce

nt

43

Broadening the Sales and Use Taxes Base

Broadening the Sales and Use Taxes Base

• Most Services not Taxed• Services Constitute More Than 1/2 Private

Economic Activity• If Starting Point is Revenue-neutral,

Significant Rate Reduction Could Occur• Revenues Would Grow Faster Than Current

Sales & Use Taxes• Some Services Might be Excluded - e.g.

Health Care, Educational Services

• Most Services not Taxed• Services Constitute More Than 1/2 Private

Economic Activity• If Starting Point is Revenue-neutral,

Significant Rate Reduction Could Occur• Revenues Would Grow Faster Than Current

Sales & Use Taxes• Some Services Might be Excluded - e.g.

Health Care, Educational Services

44

Reform Business TaxesReform Business Taxes

• Is it Realistic to Eliminate SBT Without Replacement?

• Is it Time to For Many to Replace One?

• SBT Replaced 7 Taxes in 1970s

• Is Business Paying the Wrong Share of Taxes?

• Should Taxes Focus on Wealth? Profits?

• SBT Produces About 25 Percent of General Fund Revenue

45

A Medium-Range General Fund Budget Scenario

A Medium-Range General Fund Budget Scenario

• Assumed Revenue Growth - 4%

• Community Health Growth - 9%

• Corrections Growth - 7%

• Remaining Programs Grow 3% • Projections Begin w/FY2005 Proposed

Budget

• Assumed Revenue Growth - 4%

• Community Health Growth - 9%

• Corrections Growth - 7%

• Remaining Programs Grow 3% • Projections Begin w/FY2005 Proposed

Budget

46

General Fund Projections to FY2010

$6.0

$7.0

$8.0

$9.0

$10.0

$11.0

$12.0

Fiscal Year

Bill

ion

s Revenues

SpendingPressures

General Fund Projections to FY2010

$6.0

$7.0

$8.0

$9.0

$10.0

$11.0

$12.0

Fiscal Year

Bill

ion

s Revenues

SpendingPressures

47

Citizens Research Council

of Michigan

Citizens Research Council

of Michigan www.crcmich.orgwww.crcmich.org