Report 397, August 2017

Three key takeaways from Citizens Research Council’s new report Challenges Ahead in Balancing the State Budget –

 

Three key takeaways from Citizens Research Council’s new report Challenges Ahead in Balancing the State Budget –  

  1. The State of Michigan is facing a new turbulent period despite several years of economic rebound. Tax credits and promises by previous legislatures and the governor to fund roads and personal property tax reimbursement are starting to come due to the tune of $2 billion a year and possible federal cuts are on the horizon.
  2. Budget pressures will force the legislature to make tough choices with no future significant unrestricted General Fund revenue sources, and minimal growth of current revenues.
  3. Michigan could see $2 to $5 billion in diversions by FY2022, equal to 20 to 45 percent of the current General Fund budget. Moving into the next decade, this means that Michigan has the potential for a very challenging budget environment.


Summary
Although Michigan is rebounding from two major recessions to start the millennium, policy actions that affected future revenues and created new spending obligations are pushing the state budget into a new turbulent period.  Many spending decisions that have been kicked down the line by previous legislatures are starting to become due, leading to revenue diversions that total $2 billion, and will be compounded by a lack of legislative flexibility over revenue sources, potential federal action, and the risk of a recession in the state.

Recent revenue projections show that General Fund growth has plateaued; while nominal revenues are likely to increase slightly in the near term, projected and recent trends in inflation-adjusted revenue show that General Fund/General Purpose (GF/GP) revenue has reached a peak.  Revenue reached about $10 billion in Fiscal Year (FY)2016, and is expected to remain at about that level over the next three years according to the Consensus Revenue Estimating Conference (CREC).

The CREC projects that the economy will continue to grow at its current pace through at least 2019; if the state were to enter a recession, Personal Income Tax revenues could fall anywhere from 5 to 25 percent, which would lower General Fund revenue.  With no new significant unrestricted General Fund revenue sources on the horizon, and minimal growth of current revenue sources under current economic forecasts, the state budget is about to enter a period that will require policymakers to make tough choices.

The revenue diversions include tax credits associated with the repealed Michigan Business Tax (MBT).  These tax credits have tied the state to agreements that lower General Fund revenue by more than half a billion dollars each year, virtually offsetting revenue generated from the main MBT-replacement tax, the Corporate Income Tax.  Tax credits from the Michigan Economic Growth Authority (MEGA) and the Brownfield MBT Credit program will have a lasting effect on General Fund revenue beyond 2032, when the last of the MEGA credits expire.

Funds also will be diverted from the General Fund account to the Michigan Transportation Fund for highway spending as part of the recent transportation investment package.  Money for infrastructure spending alone will siphon $600 million per year without any new revenue sources.  The transportation package also increased the eligibility for the Homestead Property Tax Credit as a means of lowering the impact of the increase in fuel taxes and registration fees for lower income households, which will lower collections by an additional $200 million annually.

Recent state exemption of certain personal property from local property taxes is another significant loss of resources.  While local governments lost revenue from these exemptions, the state made the exemption more palatable for local governments by including a provision to reimburse localities for the lost revenue.  The School Aid Fund also lost revenue with the exemptions, and that revenue is scheduled to be replaced with General Fund dollars.  The net effect of this reform will be a decline in General Fund revenue by nearly $500 million a year by FY2023.

Some tax changes will have relatively small revenue effects individually, but are significant when considered as a whole.  The state was required by federal law to stop collecting the Use Tax on Medicaid Managed Care Organizations, which will lower General Fund revenue nearly $200 million in FY2018.  The phase-out of the “tax on the difference”, a provision where the state taxed the trade-in value of automobiles, will reduce revenue more than $15 million a year once fully implemented.  Exempting data center equipment and over-the-counter drugs from taxation, and diverting taxes on aviation fuel to the State Aeronautics Fund will reduce General Fund revenue by tens of millions when combined.

The sum of all revenue losses and diversions will total more than $2 billion by FY2023, as Chart A shows.  This is equivalent to 20 percent of today’s General Fund revenue.

 

Projected General Fund Revenue and Diversions, FY2015-FY2021
Source: House Fiscal Agency, Senate Fiscal Agency, CREC

 

With pressure building from new spending and revenue diversions, many state fiscal constraints will limit the decisions legislators can make in the budget process.  The state’s heavy use of earmarking limits options for managing revenue streams, and legislated reductions in the Personal Income Tax rate and increases in exemptions for the Personal Income Tax could lower revenue even further.

Federal spending cuts could also be on the horizon, including a potential multi-billion dollar change in the funding structure of Medicaid and a reduction of the Supplemental Nutrition Assistance Program (SNAP, formerly known as the food stamps program) that could increase the cost of the program to the state by more than $3 billion over the next decade, along with cuts to other programs that provide funding for a wide variety of state services.  While these cuts have not been decided on yet, they add another significant level of uncertainty that state policymakers need to consider when making decisions that affect the budget.

When viewed as a whole, the possibility of a decline in General Fund revenue, increase in costs to the system, and decline in federal funding approaches $5 billion, close to half of the current General Fund budget.  Moving in to the next decade, the state has the potential to see a budget environment with a higher demand for funding with a lower level of funding relative to inflation.

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