In a nutshell:

• With the COVID-19 recession in full force, private sector job losses have been frightening, while we have yet to hear about major public sector employment effects
• As state and local tax revenues tank, government at all levels will have to pare back existing spending plans and reduce future ones
• Local education jobs (K-12 and community colleges) along with public safety are likely to be hardest hit by inevitable budget reductions – 

Unlike the private sector, Michigan’s local government employment never recovered from the last recession. It is in for another significant blow by the COVID-19 pandemic’s economic effects on public budgets. 

Without a substantial infusion of federal aid to backfill the imminent tax revenue losses, decision-makers at all levels of government soon will have to navigate murky fiscal waters to maintain balanced budgets while safeguarding critical public health and safety programs. 

The public health crisis gripping the world portends a serious crisis for state and local economies. The dramatic slowdown in economic activity due to shutdowns has staggered Michigan’s labor market. Over 800,000 initial unemployment claims were filed since March 15 with 380,000 more just in the week of March 29. With these numbers still growing, it is probably too soon to predict when Michigan will hit bottom. But, it is not too soon to start planning for the likely repercussions to public finances.

Falling Revenues and Steady Demand for Services
Another casualty of the plunge in economic activity will be state and local government revenues, straining public budgets in the face of steady demand. State revenues are feeling the effects of the economic slowdown immediately; over 85 percent of all state taxes are tied to wages (e.g., individual and business income taxes) or consumption (e.g., sales, use, excise taxes). Sales tax collections are bottoming out with reduced demand for retail items, income tax receipts are taking a nosedive with massive employment losses and postponed tax filings, and business taxes are tanking as production and sales dry up. 

Some have suggested that the revenue drop could be more severe than the Great Recession. Clearly, the drop is happening at a much faster rate than previous downturns because so many parts of the economy were abruptly “turned off.” The University of Michigan revised its state economic and revenue forecast from February and now projects a combined General Fund and School Aid Fund revenue decline of $2.6 billion in the current fiscal year, down 9 percent from Fiscal Year (FY)2018-19. Because of the timing of the pandemic, nearly all of this decrease is occurring over the last two quarters of the fiscal year (Michigan’s runs from  October to September); the annualized drop would be equivalent to 18 percent.

The main revenue source for local governments, property tax, will not be impacted immediately; however, other own-source funding streams (e.g., fee-for-service revenue and city income taxes) are feeling the effects already. Additionally, constitutionally guaranteed revenue-sharing payments, financed by declining state sales tax collections, will begin to scale back starting with the June distributions. Statutory revenue sharing is at risk of being slashed as officials seek to balance the state budget when they reconvene in Lansing.

Unlike the demand for privately produced goods and services, which has nearly dried up in some sectors, demand for many public services (public health, police and fire protection, education, etc.) remains constant. One area seeing increased demand is pandemic-related services (emergency responses, hospitalization, testing). The basic fiscal challenge facing the public sector today is how to meet the steady demand for services with fewer resources.

Cuts to Public Sector Workforce Coming
How will all this loss of revenue be reconciled? Cuts to public budgets are inevitable given strict constitutional and statutory balanced-budget requirements for Michigan’s state and local governments. 

In the near term, governments have few options. Many local governments are over three-fourths through their current fiscal periods, while the state has less than six months to its September 30 fiscal close. With budgets already in place, most spending has already occured. Furthermore, collective bargaining agreements (for the state and most of the larger local governments) will delay implementing reductions. As such, balancing budgets over the remainder of the current fiscal period most likely means re-prioritizing existing fiscal commitments and dipping into “rainy day” reserves (if available) to avoid deficits. 

However, after exhausting these short-term measures, cuts to state and local spending will be the next step. Government spending, especially at the local level, is personnel-intensive. This means a direct hit to the public sector workforce, including positions in K-12 education, public safety, higher education (community colleges and universities), hospitals, and, possibly, Michigan state government. For Detroit, plans to cut part-time staff are already in motion. Other local units are not far behind.

For perspective, public-sector employment accounts for about one of every seven jobs in Michigan, or 14 percent of the state’s total non-farm employment. Local government employment (8.4 percent), which includes public K-12 education, community colleges, and public safety positions, is twice the size of the state government share (4.5 percent). State employment includes positions in the various departments and agencies of the state government headquartered in Lansing, but also all public universities and public hospitals.

The chart below tracks monthly employment changes by sector since the onset of the Great Recession in December 2007. Private-sector employment began a very steep and sustained decline immediately, lasting through the middle of 2009. Employment losses in the government sector were delayed and much more gradual when the decline began in a material way. By the official end of the recession in mid-2009, the private sector had lost about 11.5 percent of its jobs. As Michigan emerged from the recession, private sector jobs grew slowly and only regained lost ground by mid-2014. Today, there are 250,000 more private jobs than at the start of the last downturn.

The number of public-sector jobs, however, is nearly 34,000 lower than before the Great Recession. Dissecting government-sector employment reveals two very different stories. The entirety of job losses has occured at the local level, while state government has experienced periods of substantial growth (mid-2008 through 2009 and late-2012 through present). In fact, the number of state jobs has been growing at a faster annual pace than the private sector since 2012. This growth has been fueled by jobs added at public higher education institutions, the largest component of the sector; State of Michigan employment is down over seven percent during the same period. Combined, state employment is up more than 14 percent, twice the rate of the private sector, since December 2007. In contrast, local government employment is down more than 15 percent, the equivalent of 67,000 jobs.

Change in Monthly Private and Public Sector Employment Since December 2007

Shaded area represents duration of recession (Dec. 2007 to June 2009)
Source: Bureau of Labor Statistics

The next chart provides a further breakdown and tracks changes in various local government jobs since the beginning of the Great Recession. Again, all components of the sector are well below December 2007 employment levels (which were substantially below 2000 employment levels). Education, the largest piece (54 percent), is down 23 percent, while the “public safety & other” category (comprising 43 percent of the total) is down four percent. According to the federal data, the vast majority of the education jobs are in the K-12 setting and police and fire jobs at the county and municipal level are the largest component of the public safety category.

Change in Monthly Local Government Employment Since December 2007

Shaded area represents duration of recession (Dec. 2007 to June 2009)
Source: Bureau of Labor Statistics

Public elementary and secondary education in Michigan is financed largely by state-level taxes; local property taxes constitute less than one-quarter of schools’ operating funding. Of that state aid, over two-thirds comes from sales/use and income taxes – those being hit the hardest by the economic shutdown. This means that local education budgets (and employment) are more directly tied to the fate of state revenues than local property taxes. Faced with lower state aid, and in the absence of substantial infusions of federal aid to backfill for the loss of general operating revenues ($390 million is allocated through the federal CARES Act for COVID-19 response activities, but not general budgetary relief), local schools will face the grim reality of having to cut jobs. 

Schools and local governments have a June 30 fiscal close. With less than one-quarter of their budget year remaining and over three-fourths of their spending on the books, much of the budget pain and job losses will be pushed into the next fiscal year. That means the local government employment contraction that began in December 2007 is likely to resume its course.