U.P. Education Legislative Summit Marquette, MI September 8, 2005 U.P. Education Legislative Summit Marquette, MI September 8, 2005 Michigan’s Financial Crisis and the Outlook for School Funding Tom Clay, Director of State Affairs Citizens Research Council of Michigan Tom Clay, Director of State Affairs Citizens Research Council of Michigan

Citizens Research Council of Michigan 2 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

Citizens Research Council of Michigan 3 Total State Budget - $41.2B State’s Two Major Funds: General Fund - $8.9B School Aid Fund - $12.8B Other State Funds Restricted for Other Purposes, e.g. Transportation, Federal Revenues Over 80% of All Revenues Spent Outside State Government Total State Budget - $41.2B State’s Two Major Funds: General Fund - $8.9B School Aid Fund - $12.8B Other State Funds Restricted for Other Purposes, e.g. Transportation, Federal Revenues Over 80% of All Revenues Spent Outside State Government The Michigan Budget FY2006 Proposal

Citizens Research Council of Michigan 4 Five Years of Budget Problems Worst Since World War II Declining General Fund Revenues Slow Growth in School Aid Fund Revenues Structural and Cyclical Deficits at Play General & School Aid Funds Affected Worst Since World War II Declining General Fund Revenues Slow Growth in School Aid Fund Revenues Structural and Cyclical Deficits at Play General & School Aid Funds Affected

Citizens Research Council of Michigan 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 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

Citizens Research Council of Michigan 6 Budget Deficit Pressures Both Funds Outspending “Regular Revenues” Causes –Economy –Tax Cuts –Structural Imbalances In Spending and Revenues Both Funds Outspending “Regular Revenues” Causes –Economy –Tax Cuts –Structural Imbalances In Spending and Revenues

Citizens Research Council of Michigan 7 General Fund & School Aid Operating Deficits

Citizens Research Council of Michigan 8 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 Date455 Tobacco Settlement/Merit Award Revenues317 Temporary Federal Fiscal Assistance655 Bond for Pay-as-you-go Capital Projects211 Revenue Sharing Accounting Change181 Refinance Bonds209 Employee Wage Concessions186 Other1,200 $6,534

Citizens Research Council of Michigan 9 Causes of Michigan’s Budget Problems Structural Imbalances Weak Economy Tax Cuts Stock Market Decline Michigan’s Deteriorating Share of Auto and Light Truck Market Structural Imbalances Weak Economy Tax Cuts Stock Market Decline Michigan’s Deteriorating Share of Auto and Light Truck Market

Citizens Research Council of Michigan 10 How Weak is the Economy? Michigan’s Recent Statistics: 50 th in Personal Income Growth 50 th in Unemployment Rate 50 th in Employment Growth (Decline for Michigan-Only State in the U.S.) 50 th in Index of Economic Momentum (Population, Personal Income, Employment) Michigan’s Recent Statistics: 50 th in Personal Income Growth 50 th in Unemployment Rate 50 th in Employment Growth (Decline for Michigan-Only State in the U.S.) 50 th in Index of Economic Momentum (Population, Personal Income, Employment)

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Citizens Research Council of Michigan 12 Michigan Manufacturing Employment Source: U.S. Department of Labor, Bureau of Labor Statistics. June ,400 Lost 1 in 4 Manufacturing Jobs Jan ,900 Jul ,200

Citizens Research Council of Michigan 13 The General Fund Revenues May Be Spent for Any State Program Income Tax and Single Business Tax Comprise Nearly 3/4 of Revenues Both Taxes Have Been Cut Significantly in Recent Years Annual Cuts Now Total $1.3 Billion Revenues May Be Spent for Any State Program Income Tax and Single Business Tax Comprise Nearly 3/4 of Revenues Both Taxes Have Been Cut Significantly in Recent Years Annual Cuts Now Total $1.3 Billion

Citizens Research Council of Michigan 14 Perspective On Revenues General Fund Revenues in FY03, FY04, & FY05 Below FY1995 Inflation-Adjusted General Fund Revenues Below 1972 Level General Fund Revenues in FY03, FY04, & FY05 Below FY1995 Inflation-Adjusted General Fund Revenues Below 1972 Level

Citizens Research Council of Michigan 15 General Fund Revenues

Citizens Research Council of Michigan 16 General Fund Budget 83% of General Fund Spending in 4 Areas: 1.Higher Education ($1.8B) 2.Community Health—Mental Health, Public Health, Medicaid ($2.5B) 3.Corrections ($1.7B) 4.Human Services—Family Services, Juvenile Justice, Public Assistance ($1.1B) All Other General Fund Programs — $1.5B 83% of General Fund Spending in 4 Areas: 1.Higher Education ($1.8B) 2.Community Health—Mental Health, Public Health, Medicaid ($2.5B) 3.Corrections ($1.7B) 4.Human Services—Family Services, Juvenile Justice, Public Assistance ($1.1B) All Other General Fund Programs — $1.5B

Citizens Research Council of Michigan 17 Significant Cuts Higher Education Cut 14% in 2 Yrs - $297M Revenue Sharing Cut 26% in 4 Yrs - $399M General Fund Support for School Aid Cut 75% in 3 Yrs - $284M State Workforce Down 8,500 in 3 Yrs (14%) - Smallest Workforce Since 1974 Higher Education Cut 14% in 2 Yrs - $297M Revenue Sharing Cut 26% in 4 Yrs - $399M General Fund Support for School Aid Cut 75% in 3 Yrs - $284M State Workforce Down 8,500 in 3 Yrs (14%) - Smallest Workforce Since 1974

Citizens Research Council of Michigan 18 Medicaid Spending Up 40% in 4 Yrs — Nearly Double Digit Increases Caseload Up 27% Covers 1.4 Million Michigan Citizens Pressures on Rates Paid Providers — Could Add Significantly to Growth in Future Spending Up 40% in 4 Yrs — Nearly Double Digit Increases Caseload Up 27% Covers 1.4 Million Michigan Citizens Pressures on Rates Paid Providers — Could Add Significantly to Growth in Future

Citizens Research Council of Michigan 19 Corrections Spending Up 14% in 3 Years Largest State-Operated Program 50,000 Prisoners Over 30% of State Workers Over Half of Workers Paid From General Fund Revenues Higher Incarceration Rate Than Neighbors Spending Up 14% in 3 Years Largest State-Operated Program 50,000 Prisoners Over 30% of State Workers Over Half of Workers Paid From General Fund Revenues Higher Incarceration Rate Than Neighbors

Citizens Research Council of Michigan 20 States With More Than 500 Prisoners Per 100,000 Residents

Citizens Research Council of Michigan 21 Beyond FY2006: The General Fund Structural Problem Continues Expenditure Causes – Medicaid – Corrections Revenue Causes – Antiquated Revenue Structure – Revenue Sources Unresponsive to Economic Growth Expenditure Causes – Medicaid – Corrections Revenue Causes – Antiquated Revenue Structure – Revenue Sources Unresponsive to Economic Growth

Citizens Research Council of Michigan 22 Medicaid Projected Spending Pressures Exceed General Fund Revenue Growth Significant State Revenue Sources Will Not Grow—e.g. Tobacco Revenues General Fund Requirements Grow at 150% of Total Spending Growth Near Term General Fund Increases at 12% - 3 to 4 Times as Fast as Revenues Projected Spending Pressures Exceed General Fund Revenue Growth Significant State Revenue Sources Will Not Grow—e.g. Tobacco Revenues General Fund Requirements Grow at 150% of Total Spending Growth Near Term General Fund Increases at 12% - 3 to 4 Times as Fast as Revenues

Citizens Research Council of Michigan 23 Corrections Crime Rates Falling but Prison Populations Continue to Increase Populations Projected to Increase 1,800/ Year until 2010 (if Current Policies Continue) Annual Cost Increases About $100M Annual Increases About 7%—Twice as Fast as Revenues Will Grow Crime Rates Falling but Prison Populations Continue to Increase Populations Projected to Increase 1,800/ Year until 2010 (if Current Policies Continue) Annual Cost Increases About $100M Annual Increases About 7%—Twice as Fast as Revenues Will Grow

Citizens Research Council of Michigan 24 Structural Revenue Issues Revenue System Reflects Economy of the 50s, 60s, and 70s Revenues Grow More Slowly than Economy Consumption Taxes Goods-Oriented Relatively Few Services are Taxed Services are Over Half of Private Sector Economic Activity Revenue System Reflects Economy of the 50s, 60s, and 70s Revenues Grow More Slowly than Economy Consumption Taxes Goods-Oriented Relatively Few Services are Taxed Services are Over Half of Private Sector Economic Activity

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Citizens Research Council of Michigan 26 A Medium-Range General Fund Budget Scenario Medicaid & Corrections Projections Incorporated Other Areas of General Fund Spending Assumed to Increase at 3%/Yr Revenues Grow about 3%/Yr Major Revenue Sources w/No Growth —Retard Overall Growth Medicaid & Corrections Projections Incorporated Other Areas of General Fund Spending Assumed to Increase at 3%/Yr Revenues Grow about 3%/Yr Major Revenue Sources w/No Growth —Retard Overall Growth

Citizens Research Council of Michigan 27 Combining Revenues and Spending Pressures State Will Have Balanced Budgets — Constitutionally Required Incremental Problem Each Year Will Exceed $300M (Over 3% of Spending Base) After FY2006 State Will Have Balanced Budgets — Constitutionally Required Incremental Problem Each Year Will Exceed $300M (Over 3% of Spending Base) After FY2006

Citizens Research Council of Michigan 28 General Fund Spending Pressures General Fund Revenues

Citizens Research Council of Michigan 29 Implications Balancing Budget W/Spending Cuts Will Require Structural Changes Likely Affecting Medicaid & Corrections Significant Changes in State Financial Support for Local Government & Higher Education Would Likely Continue Balancing Budget W/Spending Cuts Will Require Structural Changes Likely Affecting Medicaid & Corrections Significant Changes in State Financial Support for Local Government & Higher Education Would Likely Continue

Citizens Research Council of Michigan 30 School Aid: Growing Spending Pressures and Weak Revenue Performance Retirement Contributions Employee Health Insurance General Pay Raises Revenues Growing Slowly Retirement Contributions Employee Health Insurance General Pay Raises Revenues Growing Slowly

Citizens Research Council of Michigan 31 School Aid Revenues

Citizens Research Council of Michigan 32 The School Aid Fund Revenues Earmarked Exclusively for Public Schools FY2006 Forecast $12.6 Billion Slow Growth in Revenues Since FY2003 Main Sources of Revenue: –Sale and Use Taxes- $5.5 Billion (40%) –Income Tax- $2.1 Billion (16%) –State Education Property Tax- $2.0 Billion (15%) –Other Revenues Include Lottery, Cigarette, Federal Revenues Earmarked Exclusively for Public Schools FY2006 Forecast $12.6 Billion Slow Growth in Revenues Since FY2003 Main Sources of Revenue: –Sale and Use Taxes- $5.5 Billion (40%) –Income Tax- $2.1 Billion (16%) –State Education Property Tax- $2.0 Billion (15%) –Other Revenues Include Lottery, Cigarette, Federal

Citizens Research Council of Michigan 33 State-Local School Finance Relationship Amounts of Total Revenue for Each District Determined By The State Pursuant to State Law and Appropriations School Aid Revenues and Total Local Operating Property Taxes Determine The Amount the State Can “Afford” Local School Operating Property Taxes Subtracted From The Total to Determine State Payments to District School Districts Cannot Levy Operating Taxes Districts Pay Retirement Contributions As A Flat Percentage of Payrolls Amounts of Total Revenue for Each District Determined By The State Pursuant to State Law and Appropriations School Aid Revenues and Total Local Operating Property Taxes Determine The Amount the State Can “Afford” Local School Operating Property Taxes Subtracted From The Total to Determine State Payments to District School Districts Cannot Levy Operating Taxes Districts Pay Retirement Contributions As A Flat Percentage of Payrolls

Citizens Research Council of Michigan 34 The Economic and Revenue Outlook for FY2006 Moderate Economic Recovery Small Employment Gains Improved Income Growth General & School Aid Fund Revenue Growth — 3.5 to 4% Moderate Economic Recovery Small Employment Gains Improved Income Growth General & School Aid Fund Revenue Growth — 3.5 to 4%

Citizens Research Council of Michigan 35 FY2006 School Aid Proposal $175 Per Pupil Increase $50 Increase for High School Students Increases for At-Risk Students, Intermediate School Districts, and Special Education Funding Increases Will Be Absorbed by Higher Retirement and Health Insurance Costs $175 Per Pupil Increase $50 Increase for High School Students Increases for At-Risk Students, Intermediate School Districts, and Special Education Funding Increases Will Be Absorbed by Higher Retirement and Health Insurance Costs

Citizens Research Council of Michigan 36 School Aid Outlook Beyond FY2006 Moderate Revenue Growth ($250 Per Pupil) Revenue Growth Rate Below General Economy Annual Revenue Increases in 3 to 3.5 Percent Range Not Enough Growth to Match Spending Pressures Moderate Revenue Growth ($250 Per Pupil) Revenue Growth Rate Below General Economy Annual Revenue Increases in 3 to 3.5 Percent Range Not Enough Growth to Match Spending Pressures

Citizens Research Council of Michigan 37 Significant Continuing Demands On Revenues Retirement Contributions Employee Health Insurance General Pay Raises Fuel and Utilities Retirement Contributions Employee Health Insurance General Pay Raises Fuel and Utilities

Citizens Research Council of Michigan 38 Public School Employees Retirement System CRC Report Issued in September, 2004 Covers Pension and Health Benefit Contributions Projections Still on Target CRC Report Issued in September, 2004 Covers Pension and Health Benefit Contributions Projections Still on Target

Citizens Research Council of Michigan 39 School Retirement Funding School Districts Pay Contributions for Employees Rate for FY % of Payrolls Contribution Rate Composed of Two Parts –Regular Pension Benefit –Health Care Benefits Both Parts Will Continue to Increase Dramatically in the Future School Districts Pay Contributions for Employees Rate for FY % of Payrolls Contribution Rate Composed of Two Parts –Regular Pension Benefit –Health Care Benefits Both Parts Will Continue to Increase Dramatically in the Future

Citizens Research Council of Michigan 40 Pension Funding Component Stock Market Crash in 2001 and 2002 Lost 22% of Market Value In 2 Years Gap Between Assumptions and Actual Returns Was Nearly 40% Contribution Rate Subsidized By Reserves in FY04, FY05 and FY06 Rate Jumps From 7% in FY04 to 12% in FY08 Stock Market Crash in 2001 and 2002 Lost 22% of Market Value In 2 Years Gap Between Assumptions and Actual Returns Was Nearly 40% Contribution Rate Subsidized By Reserves in FY04, FY05 and FY06 Rate Jumps From 7% in FY04 to 12% in FY08

Citizens Research Council of Michigan 41 Retiree Health Benefits Component Funded on a Pay-As-You-Go Basis Now Costs 6.55% of Payroll Unfunded Liability Has Increased Tenfold Since 1985 Pre-funding and Amortizing Liability Would Jump the Rate to 15% of Payroll Under Current Funding Practice Contribution Rate Will Climb to Over 20% by End of Next Decade Funded on a Pay-As-You-Go Basis Now Costs 6.55% of Payroll Unfunded Liability Has Increased Tenfold Since 1985 Pre-funding and Amortizing Liability Would Jump the Rate to 15% of Payroll Under Current Funding Practice Contribution Rate Will Climb to Over 20% by End of Next Decade

Citizens Research Council of Michigan 42 Combining Health and Pension Contribution Rates Rate Jumps From 12.99% in FY04 to 16.34% in FY06 to 20% in FY08 Incremental Requirement For FY06 Through FY08 Averages More Than $200 Million Per Year ($125 Per Student) FY2006 Rate Subsidized With $50 Million of Reserves Per Pupil Increase In FY $80 Total Three-year Increase About $600 Million Three Years of 3.5% School Aid Revenue Growth Produces About $450 Million Per Year Rate Jumps From 12.99% in FY04 to 16.34% in FY06 to 20% in FY08 Incremental Requirement For FY06 Through FY08 Averages More Than $200 Million Per Year ($125 Per Student) FY2006 Rate Subsidized With $50 Million of Reserves Per Pupil Increase In FY $80 Total Three-year Increase About $600 Million Three Years of 3.5% School Aid Revenue Growth Produces About $450 Million Per Year

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Citizens Research Council of Michigan 44 Employee Health Insurance Double-digit Premium Increases Recently Schools Spend About $1000 Per Pupil on Health Insurance Premiums Annual Increases Around $100 Per Pupil Likely For Next Several Years Double-digit Premium Increases Recently Schools Spend About $1000 Per Pupil on Health Insurance Premiums Annual Increases Around $100 Per Pupil Likely For Next Several Years

Citizens Research Council of Michigan 45 Employee Salaries and Wages Largest Component of School Budgets General Raises and Step Increases Add to Payroll Costs Each Percentage Point of Increase in Payrolls Costs About $50 Per Pupil Total Payroll Increase of 3% Would Cost About $150 Per Pupil Largest Component of School Budgets General Raises and Step Increases Add to Payroll Costs Each Percentage Point of Increase in Payrolls Costs About $50 Per Pupil Total Payroll Increase of 3% Would Cost About $150 Per Pupil

Citizens Research Council of Michigan 46 The Numbers—School Aid Revenues Grow About $250 Per Pupil Per Year Spending Pressures and “Requirements” -Retirement and Health Insurance--$225+ -Salaries and Wages (3%)--$150+ Structural Deficit Exceeds $125 Per Pupil Each Year (Nearly 2%) Revenues Grow About $250 Per Pupil Per Year Spending Pressures and “Requirements” -Retirement and Health Insurance--$225+ -Salaries and Wages (3%)--$150+ Structural Deficit Exceeds $125 Per Pupil Each Year (Nearly 2%)

Citizens Research Council of Michigan 47 Structural Deficits Require Structural Changes Expenditures –Retirement Costs—Retiree Health Care –Health Insurance –Change Programs Revenues –Broaden Base of Sales and Use Taxes –Eliminate Some Tax Expenditures Expenditures –Retirement Costs—Retiree Health Care –Health Insurance –Change Programs Revenues –Broaden Base of Sales and Use Taxes –Eliminate Some Tax Expenditures

Citizens Research Council of Michigan 48 Who Can Change the Structure? Influence of School Boards or Local Voters Very Limited State Controls Most Financial Policies –Retirement Contributions and Benefits –Tax Rates and Taxable Items –Total Revenue Received By Districts Areas of Local Control or Influence –Employee Compensation –Instructional and Other Programs Influence of School Boards or Local Voters Very Limited State Controls Most Financial Policies –Retirement Contributions and Benefits –Tax Rates and Taxable Items –Total Revenue Received By Districts Areas of Local Control or Influence –Employee Compensation –Instructional and Other Programs

Citizens Research Council of Michigan 49 Some Policy Options The State State Could Allow Some Local District Taxing Authority State Financial Incentives for Inter-district Cooperation and Consolidation State “Take-over” of Employee Health Insurance Modify Retiree Health Benefits and Vesting Provisions Change Basic Pension Benefit (Prospectively) to Defined Contribution Plan State Could Allow Some Local District Taxing Authority State Financial Incentives for Inter-district Cooperation and Consolidation State “Take-over” of Employee Health Insurance Modify Retiree Health Benefits and Vesting Provisions Change Basic Pension Benefit (Prospectively) to Defined Contribution Plan

Citizens Research Council of Michigan 50 Some Policy Options Local Districts Make Greater Use of ISD Services Contract (“privatize”) Some Non- instructional Services (e.g. Food Service, Transportation, Custodial) Reduce Number of Days in Attendance and Increase Length of Days to Offset Reduction Make Greater Use of ISD Services Contract (“privatize”) Some Non- instructional Services (e.g. Food Service, Transportation, Custodial) Reduce Number of Days in Attendance and Increase Length of Days to Offset Reduction

Citizens Research Council of Michigan 51 Responsibility and Authority Public Education a State Constitutional Responsibility Providing Tax Revenues to Pay the Expenses of State Government is a State Constitutional Responsibility Legislature and Governor Have Both the Responsibility and Authority to Deal With the Problem The Solutions Reside Primarily in Lansing Public Education a State Constitutional Responsibility Providing Tax Revenues to Pay the Expenses of State Government is a State Constitutional Responsibility Legislature and Governor Have Both the Responsibility and Authority to Deal With the Problem The Solutions Reside Primarily in Lansing

Citizens Research Council of Michigan 52 Citizens Research Council of Michigan CRC Publications Available at Providing Independent, Nonpartisan Public Policy Research Since 1916 CRC Publications Available at Providing Independent, Nonpartisan Public Policy Research Since 1916