1. Michigan’s Budget Crisis and the Outlook for School Funding Lenawee ISD September 14, 2006 Adrian Tom Clay, Director of State Affairs Citizens Research Council of Michigan www.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 Relies on charitable contributions of Michigan businesses, foundations, and individuals

3. The Central Message The State of Michigan has a structural deficit affecting: Public K-12 Education General Fund financed programs Its causes have both spending and revenue components We will not grow out of it Only structural policy changes will fix the problem

4. Total State Budget - $41.2B State’s Two Major Funds: General Fund - $9.0B 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 Appropriations

5. Six Years of Budget Problems Worst Budget Problems since World War II Declining General Fund Revenues Slow Growth in School Aid Fund Revenues Structural and Cyclical Deficits at play

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

7. Budget Deficit Pressures Both funds outspending “Regular Revenues” Operating deficits for 6 straight years Significant one-time resources used $6.8 Billion

8. General Fund & School Aid Operating Deficits

9. Summary of One-Time Resources FY2001-FY2006 (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 Revenues324 Temporary Federal Fiscal Assistance655 Bond for pay-as-you-go capital projects211 Revenue Sharing accounting change181 Refinance Bonds250 Employee Wage concessions186 Other1,443 $6,825

10. Causes of Michigan’s Budget Problems Weak Economy Tax Cuts Stock Market Decline Michigan’s deteriorating share of auto and light truck market Structural imbalance between revenues and spending

11. How Weak is the Economy? Michigan’s Recent Statistics: 49 th in Personal Income Growth 47 th in Unemployment Rate 49 th in Employment Growth (Decline for Michigan) 49 th in Index of Economic Momentum (Population, Personal Income, Employment) Economy in Early 1980s Much Worse

12. Big 3 Losing Market Share Source: Automotive News.

13. Michigan Manufacturing Employment Source: U.S. Department of Labor, Bureau of Labor Statistics. March 2006 664,500 Lost 1 in 4 Manufacturing Jobs Jan 1992 775,900 Jul 1999 908,200

14. Perspective On Revenues General Fund revenues in FY03, FY04, & FY05 below FY1995 Inflation-Adjusted General Fund Revenues below 1972 level General Fund revenue problems adversely affecting School Aid allocations

15. General Fund Revenues

16. General Fund Budget FY2007 86% of General Fund spending in 4 areas: -Higher Education ($1.9B) -Community Health-Mental Health, Public Health, Medicaid ($2.9B) -Corrections ($1.8B) -Human Services-Family Services, Juvenile Justice, Public Assistance ($1.2B) -All Other General Fund Programs ($1.3B)

17. Looking Back: Reshaping the General Fund Budget Reductions Higher Education- $275M in 4 Years (13%) Human Services- $172M in 5 years (14%) School Aid- $323M in 5 years (84%) Revenue Sharing- $447M in 5 years (29%) State Employees- 7,400 in 4 years (12%)— smallest workforce since 1974

18. Reshaping the General Fund Budget Increases Department of Community Health-$263M in 5 years (10%) Medicaid Community Mental Health Corrections-$175M in 5 years (11%)

19. States With More Than 500 Prisoners Per 100,000 Residents

20. Percentages of General Fund Spending FY2001-FY2007 FY2001FY2007 Community Health27.331.9 Corrections16.320.2 Human Services12.713.0 Higher Education21.320.8 Other22.414.2 Totals100.0

21. Community Health and Corrections now claim 52.1 percent of General Fund spending Increased from 43.6 Percent in FY2001

22. Beyond FY2007: The General Fund Structural Problem Continues Expenditure Causes Medicaid Corrections Revenue Causes Antiquated revenue structure Revenue sources unresponsive to economic growth

23. 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

24. Corrections Crime rates falling but prison population pressures continue to increase Populations projected to increase 1,000/ year until 2010 (if current policies continue) Annual cost increases about $80M Annual increases about 6% —Twice as fast as revenues will grow

25. 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

27. General Fund Budget Scenario Medicaid & Corrections projections growing faster than revenues Other areas of general fund spending assumed to increase at 3%/year Revenues grow about 3%/year Major revenue sources with no growth —Retard overall growth

28. 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 FY2007

30. Current Issues Business Taxes Health Care cost pressures throughout the budget -Health Insurance—school and state Employees -Health Care for retirees -Medicaid Low Taxes vs. Quality of Life

31. Single Business Tax Eliminated (Effective December 31, 2007) Law change initiated by petition Primary Advocate: L. Brooks Patterson— Oakland County Executive Legislature enacted the law Impervious to gubernatorial veto SBT is gone and with it $1.9 billion of General Fund revenue (22%)

32. The Remaining Business What will replace the revenues? New taxes on business? New taxes on individuals? Full or partial replacement Revenue neutrality implies winners and losers Nearly 30% of businesses pay no SBT (41,000)—45% below $1000 in liability Potential for plenty of losers

33. What Role Will Spending Cuts Play? 86% of General Fund spending in 4 areas: -Higher Education ($1.9B) -Community Health-Mental Health, Public Health, Medicaid ($2.9B) -Corrections ($1.8B) -Human Services-Family Services, Juvenile Justice, Public Assistance ($1.2B) -All Other General Fund Programs ($1.3B)

34. Taxes Not Only Concern of Business Others Include Skilled Workforce Energy Costs Legacy Costs—Pensions and Retiree Health Care Health Insurance for Working Employees Workers’ Compensation Infrastructure Quality Public Services

35. FY2007 Economic Forecast National Indicators: Real GDP Growth2.8% Consumer Prices2.5% Unemployment Rate4.8% Light Vehicle Sales Change-0.6% Oil Prices (per barrel) $63.00 Michigan Indicators: Employment Change-0.2% Unemployment Rate7.0% Consumer Prices (Detroit)2.3% Personal Income Growth4.2%

36. School Aid Outlook for 2007 Structural Deficit beyond 2007

37. School Aid Fund Revenues earmarked exclusively for public schools FY2007 forecast $13.0 billion Slow growth in revenues since FY2003 Main Sources of Revenue: Sale and Use Taxes- $5.6 Billion (43%) Income Tax- $2.1 Billion (16%) State Education Property Tax- $2.1 Billion (16%) Other Revenues Include Lottery, Cigarette, Federal

38. School Aid Fund Revenues

39. General Fund Revenues

40. 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

41. FY2007 School Aid State Revenue Increase- $353 Million (3.2%) Federal Funds Up- $20M General Fund Grant Cut $28M One time revenues from FY2006 not available- $48M FY2006 Surplus used- $93M Total Spending increase $393M (3.1%)

42. School Aid Spending Increases Foundation Allowance increase ($210/student)- $168M Special Education- $73M Equity Payment- $20M Engineering Michigan’s Future- $20M Great Start- $10M School Lunch Program- $16M (Federal) ISDs ($2.4M) and Adult Education ($3M)- $5.4M

43. Spending Shifts to School Aid Budget $63.4 Million (16% of Total Increase) Cash Flow borrowing costs- $22.8M MEAP Tests costs- $19.5M School Breakfasts- $9.6M Hearing and Vision Screening- $5.2M DHS Juvenile Facilities Education expenses- -$3M Other- $3.3M

44. General Fund Spending Pressures Spill Over to School Aid General Fund support down $357 million since FY2000 FY2007 reduces grant to “Irreducible Minimum” Shifts of spending to School Aid Fund in FY2007 Appropriations- $63 Million Total Effect- $420 million ($250 per pupil) Will Higher Education be next?

45. FY2007 Spending Pressures Retirement—Increases 16.34% to 17.74% — about $80 per pupil on average Employee Health Insurance averages about $1200 per student likely will rise by more than $50 per student Pay and Step Raises cost nearly $60 per student on average—4% = $240 per student Other—Fuel, Utilities, Supplies—$50 per student Total could exceed $400 per student Not enough growth in total School Aid resources ($230) to cover all cost pressures

46. Proposal 2006-05: Educational Funding Guarantee Law “The K-16 Proposal” Proposed initiated law Not subject to veto by governor Requires vote of people or 3/4 of each house to amend Amends State School Aid Act (PA 94 of 1979) – appropriations and policy

47. Summary of Proposal Funding guarantees for Universities, Community Colleges, and K-12 Reduces per pupil funding gap from $1,300 to $1,000 by FY12 Caps employer contribution at 80% of Total Contribution percentage or 14.87% of Payroll, whichever is less, with the State picking up the difference

48. Education Funding Guarantees FY2007 Base funding increase – “catch up” provision $180 million to $322 Million Retroactive Retirement Cap--$385 million Immediate $565+ Hole in the General Fund Budget Cover with Budget Cuts? Other General Fund Programs Revenue Sharing Budget Base $7.7 billion $565 million = 10% for 9 months

49. Annual Spending Guarantee FY2007 and After Increase by rate of inflation No More—No Less In Good and Bad Economies Loophole??—”.....appropriated under this act” Cuts in non-education programs would occur in recession Revenue growth in good times probably enough to prevent crowding out non- education programs

50. Retirement Funding Guarantee FY07 rate is 17.74% of payroll Employer share: 14.19% of payroll State share: 3.55% of payroll FY08 rate (projected) would result in employer share capped at 14.87% FY07 state costs: $385 million FY13 state costs: $1 billion State responsible for entire annual marginal cost associated with rate change

51. Beyond Fiscal Year 2007 A Structural Deficit in School Aid Fund? Deficits Defined Cyclical—Caused by Economic Downturn -Revenues Worsen -Some Spending Pressures Increase -Deficit Erased When Economy Recovers Structural—Caused by costs increases to maintain current policies outpacing revenue growth, Even in Good Economic Times

52. School Aid Structural Deficit Spending Pressures Outpace Revenue Growth Retirement Contributions Employee Health Insurance General Pay Raises Other—Fuel, Utilities, Supplies Revenues Growing Slowly

53. School Aid Outlook Beyond FY2007 Moderate Revenue growth ($280 Per Pupil) Revenue growth rate below general economy Annual State revenue increases about 3% Not enough growth to match spending pressures

54. School Retirement Funding School Districts pay contributions for employees Rate for FY2007 17.74% of Payrolls Contribution rate composed of two parts -Regular Pension Benefit -Health Care Benefits Both parts will continue to increase in the future

56. Financial Significance School District contributions exceeded $1.35 billion in FY2005 Costs will likely average $1000 per student in FY2007 Incremental increases exceed $90 per pupil after FY2008 Rising contribution rates will continue to claim significant share of future revenue increases

57. Employee Health Insurance Double-digit premium increases recently FY2007 increases moderated Schools spend over $1200 per pupil on Health Insurance Premiums Annual increases could exceed $100 per pupil

58. School Aid Numbers —FY2008 and Beyond Revenues grow about $280 per pupil per year Spending Pressures and “Requirements” -Retirement- $90+ -Health Insurance- $100+ -Salaries and Wages (4%)- $240+ -Fuel, Utilities, Etc.- $50+ Structural Deficit about $200 per pupil (over 2%)

59. 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

60. 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

61. 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

62. 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

63. Retirement Changes Being Considered in Lansing Earn retiree Health Benefits based on years of service Defined Contribution program for pension benefits Both changes would likely only affect new employees Financial effects would be negligible at first

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