March 28, 2005 Michigan’s Budget Crisis: Its Causes & Prospects for Resolution 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 Declining General Fund Revenues Slow Growth in School Aid Fund Revenues Declining General Fund Revenues Slow Growth in School Aid Fund Revenues

Citizens Research Council of Michigan 5 Dual Deficits at Play Structural and Cyclical General and School Aid Funds Affected Structural and Cyclical General and School Aid Funds Affected

Citizens Research Council of Michigan 6 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 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 General and School Aid Funds Face Structural Deficits General Fund Somewhat More Severe Schools Face Retirement & Health Insurance Costs Outpacing Revenue Increases General Fund Somewhat More Severe Schools Face Retirement & Health Insurance Costs Outpacing Revenue Increases

Citizens Research Council of Michigan 10 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 11 External Causes of Michigan’s Budget Problems 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

Citizens Research Council of Michigan 12 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) -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) -50 th in Index of Economic Momentum (Population, Personal Income, Employment)

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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 Spending Total Spending Down $1.2B in 4 Years (12%) Additional Spending in Some Areas — Medicaid and Corrections — Obscures Magnitude of Cuts in Others Cuts Exceed $3 Billion Total Spending Down $1.2B in 4 Years (12%) Additional Spending in Some Areas — Medicaid and Corrections — Obscures Magnitude of Cuts in Others Cuts Exceed $3 Billion

Citizens Research Council of Michigan 16 Significant Cuts Higher Education Cut 14% in 2 Years - $297M Revenue Sharing Cut 26% in 4 Years - $399M State Workforce Down 8,500 in 3 Years (14%) - Smallest Workforce Since 1974 Higher Education Cut 14% in 2 Years - $297M Revenue Sharing Cut 26% in 4 Years - $399M State Workforce Down 8,500 in 3 Years (14%) - Smallest Workforce Since 1974

Citizens Research Council of Michigan 17 Medicaid Spending Up 40% in 4 Years — 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 Years — 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 18 Corrections 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 Our Neighbors 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 Our Neighbors

Citizens Research Council of Michigan 19 States With More Than 500 Prisoners Per 100,000 Residents

Citizens Research Council of Michigan 20 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 21 FY2006 General Fund Proposed Budget FY2006 Revenues Less Than FY2005 Appropriations Medicaid Pressures Exceed $500 Million Total Funding Gap---$772.6 Million Programs Reductions---$389.6 Million Reduced School Aid Support---$145.0 Million Revenues and Other Adjustments--- $241.7 Million FY2006 Revenues Less Than FY2005 Appropriations Medicaid Pressures Exceed $500 Million Total Funding Gap---$772.6 Million Programs Reductions---$389.6 Million Reduced School Aid Support---$145.0 Million Revenues and Other Adjustments--- $241.7 Million

Citizens Research Council of Michigan 22 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 23 FY2006 School Aid Proposal Risks and Uncertainties Tax Expenditures Recommended For Reduction or Elimination---$48 Million Interstate Communications---$7M Interstate Trucks and Trailers---$11M Films---$9M Vending Machines and Mobile Facilities---$18M Misc---$3M School Bond Loan Fund Proposal---$45 Million Beginning Surplus---$24 Million Tax Expenditures Recommended For Reduction or Elimination---$48 Million Interstate Communications---$7M Interstate Trucks and Trailers---$11M Films---$9M Vending Machines and Mobile Facilities---$18M Misc---$3M School Bond Loan Fund Proposal---$45 Million Beginning Surplus---$24 Million

Citizens Research Council of Michigan 24 Beyond FY2006 The 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 25 Medicaid Projected Spending Pressures of Medicaid 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% Projected Spending Pressures of Medicaid 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%

Citizens Research Council of Michigan 26 Corrections Crime Rates Falling but Prison Populations Continue to Increase Populations Projected to Increase 1,800/ Year until 2010 (if Current Policies Continue) Annual Increase in Costs About $100M Annual Increases About 7% — Twice the Rate General Fund Revenue Increase Crime Rates Falling but Prison Populations Continue to Increase Populations Projected to Increase 1,800/ Year until 2010 (if Current Policies Continue) Annual Increase in Costs About $100M Annual Increases About 7% — Twice the Rate General Fund Revenue Increase

Citizens Research Council of Michigan 27 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 29 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 SBT Eliminated at End of Calendar 2009 — 23% of General Fund Revenue 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 SBT Eliminated at End of Calendar 2009 — 23% of General Fund Revenue

Citizens Research Council of Michigan 30 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 31 General Fund Spending Pressures General Fund Revenues

Citizens Research Council of Michigan 32 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 33 Revenue Changes Replace the “Lost” SBT Before 2010 Governor’s Proposal “Revenue- Neutral” Broaden the Base of the Sales & Uses Taxes to Include More Services Replace the “Lost” SBT Before 2010 Governor’s Proposal “Revenue- Neutral” Broaden the Base of the Sales & Uses Taxes to Include More Services

Citizens Research Council of Michigan 34 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 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

Citizens Research Council of Michigan 35 Issues With Services Taxation Would Socially Valuable Services Such as Medical Care and Education be Exempt? Business to Business Services — Pyramiding Could Create Multiple Taxation Problem Would Socially Valuable Services Such as Medical Care and Education be Exempt? Business to Business Services — Pyramiding Could Create Multiple Taxation Problem

Citizens Research Council of Michigan 36 School Aid Outlook Beyond FY2006 Moderate Revenue Growth ($200 to $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 ($200 to $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 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 CRC Report Issued in September, 2004 Covers Pension and Health Benefit Contributions

Citizens Research Council of Michigan 39 School Retirement Funding School Districts Pay Contributions for Employees FY2005 Percentage of Payroll 14.87% Proposed Rate for FY % 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 FY2005 Percentage of Payroll 14.87% Proposed Rate for FY % 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 Percent of Market Value In Two Years Gap Between Assumptions and Actual Returns Was Nearly 40 Percent Contribution Rate Subsidized By Reserves in FY04, FY05 and FY06 Rate Jumps From 7% in FY04 to 12% in FY08 Investments Beat the Assumptions in FY2004 Stock Market Crash in 2001 and 2002 Lost 22 Percent of Market Value In Two Years Gap Between Assumptions and Actual Returns Was Nearly 40 Percent Contribution Rate Subsidized By Reserves in FY04, FY05 and FY06 Rate Jumps From 7% in FY04 to 12% in FY08 Investments Beat the Assumptions in FY2004

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 By a Factor of Ten Times 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 By a Factor of Ten Times 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, 14.87% in FY05, 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 of Reserves Per Pupil Increase In FY $80 Total Three-year Increase About $600 Million Three Years of 4% School Aid Revenue Growth Produces About $500 Million Per Year Rate Jumps From 12.99% in FY04, 14.87% in FY05, 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 of Reserves Per Pupil Increase In FY $80 Total Three-year Increase About $600 Million Three Years of 4% School Aid Revenue Growth Produces About $500 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 Group Insurance Premiums---Mostly Health Insurance Annual Increases Around $100 Per Pupil Likely For Next Several Years Double-digit Premium Increases Recently Schools Spend About $1000 Per Pupil on Group Insurance Premiums---Mostly Health Insurance 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 A Structural Deficit in School Aid Fund? Cost Increases to Maintain Current Policies Outpacing Revenue Growth, Even in Good Economic Times Cost Increases to Maintain Current Policies Outpacing Revenue Growth, Even in Good Economic Times

Citizens Research Council of Michigan 47 The Numbers—School Aid Revenues Grow About $200 to $250 Per Pupil Per Year Spending Pressures and “Requirements” -Retirement and Health Insurance--$200+ -Salaries and Wages (3%)--$150+ Structural Deficit Exceeds $100 Per Pupil Each Year Revenues Grow About $200 to $250 Per Pupil Per Year Spending Pressures and “Requirements” -Retirement and Health Insurance--$200+ -Salaries and Wages (3%)--$150+ Structural Deficit Exceeds $100 Per Pupil Each Year

Citizens Research Council of Michigan 48 Structural Deficits Require Structural Changes Expenditures -Retirement Costs—Retiree Health Care -Health Insurance -Program Delivery Changes Revenues -Broaden Base of Sales and Use Taxes -Review Tax Expenditures Expenditures -Retirement Costs—Retiree Health Care -Health Insurance -Program Delivery Changes Revenues -Broaden Base of Sales and Use Taxes -Review Tax Expenditures

Citizens Research Council of Michigan 49 Importance of Restoring Fiscal Balance Fiscal Problems Crowd Out Consideration of Other Important Issues Michigan’s Budget Situation Affects Credit Rating –Recent Downgrade –Reflects on Schools & Local Government Units –Increases Borrowing Costs Fiscal Problems Crowd Out Consideration of Other Important Issues Michigan’s Budget Situation Affects Credit Rating –Recent Downgrade –Reflects on Schools & Local Government Units –Increases Borrowing Costs

Citizens Research Council of Michigan 50 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