With his signature in mid-July, Governor Snyder put to bed the Fiscal Year 2018 (FY2018) state budget. Eight years removed from the end of the Great Recession and benefitting from an expanding state economy and projected solid revenue growth, this year’s budget process was a pretty typical affair.

The $56.5 billion total spending plan, which takes effect October 1, includes $10.0 billion in appropriations from the state’s discretionary General Fund checkbook, about the same amount authorized in the current year. While budget deliberations this year centered around maintaining current spending levels or marginally increasing funding in specific areas (e.g., all levels of education), our new report shows that a number of decisions made by previous legislatures will muddy the waters, making the challenge of balancing the state budget much more difficult in future years. What does this mean for public services financed by the state budget?

Despite projections for continued economic growth, the General Fund is not expected to grow over the next three years relative to inflation because of a few major revenue diversions, including some that have yet to come online.

Although the Corporate Income Tax has served as the primary business tax for more than half a decade, many businesses continue to file under its predecessor, the Michigan Business Tax, so they can claim tax credits enacted during Michigan’s single state recession. Those credits reduce potential revenues by around $600 million annually, and will continue to drain discretionary resources for years to come.

The 2015 transportation investment package will eventually provide an additional $1.2 billion for road and bridge funding with approximately half coming from tax increases (motor fuel and vehicle registration taxes) and the other half from income tax revenues that would otherwise flow into the General Fund. The General Fund contribution will start in FY2019 at $150 million and ramp up to $600 million in FY2021.

Additionally, the transportation package included expansions to the Homestead Property Tax Credit for low-income households as an offset to the fuel and vehicle tax increases. These tax credits are expected to draw an additional $200 million from the General Fund annually beginning in FY2019. All told, the transportation package will reduce money flowing into the General Fund by $350 million in FY2019 and $800 million by FY2021.

Another noteworthy revenue diversion comes from the 2014 plan to expand exemptions on business personal property. The state agreed to reimburse local governments and school budgets for the revenue loss associated with exemptions for industrial and commercial personal property. To make local government and school budgets whole from the state exemptions, a portion of the state Use Tax will be used as a dollar-for-dollar replacement, costing the General Fund $500 million annually by FY2023.

In addition to these and some other smaller revenue issues, a smattering of upcoming spending increases will put more pressure on the budget as state costs for the Healthy Michigan Plan and the Michigan Indigent Defense Commission will begin to come due. All told, our new report estimates that more than $2 billion in potential General Fund revenue will be diverted or dedicated to these programs by FY2023, which accounts for 20 percent of the state’s General Fund budget.

Compounding factors could make the state’s budget even more difficult to balance in future years. Congress may look to cut federal spending, which could impact dozens of state-administered programs, particularly Supplemental Nutrition Assistance Program (formerly known as food stamps) and Medicaid, and could reduce the federal money coming to Michigan by billions of dollars, forcing choices on whether that spending needs to be replaced.

Past experience shows that if and when the state’s economy cools, revenues from the Income Tax, which is responsible for two-thirds of all General Fund revenue, could decrease by up to 25 percent. Remember, Michigan is over eight years into the current economic expansion; the average length of previous ones was just under five years.

Some of Michigan’s revenue rules will further complicate problems by limiting the flexibility the legislature has to respond to revenue declines. Many revenue sources are directed to specific funds (for example, more than 70 percent of the Sales Tax is directed to the School Aid Fund), and where the money goes is set in statute or sometimes even the state constitution.

In addition, increases to the individual exemption for the Personal Income Tax and a cap on the growth of Income Tax revenues will constrain the growth of General Fund’s largest source.

The bottom line is that beginning with the FY2019 budget and well into the next decade, General Fund programs are likely to face increasing competition for a smaller pool of resources. The legislature will have to make decisions about what programs can afford to take cuts, and how to distribute them across the General Fund in order to maintain a balanced budget.

What this means for specific state-funded public services is unclear. However, we know that the General Fund portion of the state budget largely serves as a “pass-through” to finance public services delivered by a myriad of entities outside of state government. Think general purpose local governments (e.g., cities, townships, counties) as well as various types of special purpose local governments (e.g., school districts, public transit agencies, universities). Additionally, state funds finance services delivered by private and nonprofit entities (e.g., hospitals).  These non-state entities provide all kinds of services that Michigan taxpayers rely on every day, ranging from child immunizations to assistance to the elderly.

It is impossible to say where state officials will turn in the future to maintain budget balance. Past experience shows that balancing the General Fund budget came at the expense of spending in the areas of healthcare, local government revenue sharing, and higher education, areas that make up the largest share of the General Fund budget.

Founded in 1916, the Citizens Research Council of Michigan works to improve government in Michigan. The organization provides factual, unbiased, independent information concerning significant issues of state and local government organization, policy, and finance. By delivery of this information to policymakers and citizens, the Research Council aims to ensure sound and rational public policy formation in Michigan. For more information, visit www.crcmich.org.

The new Citizens Research Council report, Challenges Ahead in Balancing the State Budget is  available free of charge at www.crcmich.org.  The Council will host a webinar to highlight the findings of the report at 2PM on August 10 (Register Here).  The recorded webinar also will be available on the website.

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