1 May 19, 2004 Tom Clay Director of State Affairs Citizens Research Council of Michigan May 19, 2004 Tom Clay Director of State Affairs Citizens Research Council of Michigan Michigan’s Chronic Budget Problem: Its Magnitude, Causes and Implications

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 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 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 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 Budget

6 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 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 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

9 How Weak is the Economy? Michigan’s Recent Statistics: -46 th in Personal Income Growth -48 th in Unemployment Rate -49 th in Employment Growth (Decline for Michigan) -49 th in Index of Economic Momentum (Population, Personal Income, Employment) Michigan’s Recent Statistics: -46 th in Personal Income Growth -48 th in Unemployment Rate -49 th in Employment Growth (Decline for Michigan) -49 th in Index of Economic Momentum (Population, Personal Income, Employment)

10 Michigan 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 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

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13 Internal 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

14 The 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) Rainy Day Fund$1,363 FY2000 School Aid Fund Surplus984 FY2000 General Fund Surplus212 Medicaid Benefits Trust Fund561 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 Concessions110 Other759 $6,017

16 General Fund & School Aid Operating Deficits

17 Perspective On Revenues Actual General Fund Revenues in FY03, FY04, & FY05 Below FY 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 FY Years of Higher Costs & Increased Needs Go Unfunded Some Programs Crowding Out Others School Aid Revenues Up $3.5 B Over Same Period (45%)

18 FY2004 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

19 FY2004 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?

20 Summary 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

21 Revenue Sharing Payments Fiscal Years ’93 through ‘04

22 Medicaid 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

23 Corrections 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%)

24 States With More Than 500 Prisoners Per 100,000 Residents

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26 State Government Employment Trends

27 State 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

28 Areas 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

29 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 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 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 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 Gap Original 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 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 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 Percent

35 FY2005 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 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 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 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 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 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 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

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43 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 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 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

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47 Citizens Research Council of Michigan