- COVID-19 has resulted in a significant decline in wages and economic activity in Michigan that is projected to result in a $3 billion reduction in revenue for both FY2020 and FY2021.
- In addition to diminished revenue, Medicaid spending will likely add more than $500 million in spending pressures for FY2021.
- The Governor and Legislature will have to reconcile more than $2 billion in projected shortfalls over each of the next two years, and the two sides have few good options at their disposal.
The May 15 Consensus Revenue Estimating Conference provided detail, but did little to change the narrative that has been in discussion for a while: Michigan’s economy, and state revenue sources, are in rough waters. With employment and income declines due to the COVID-19 pandemic, and other spillover effects caused by the virus, state budgets will be facing both revenue and spending pressure in the coming years. For Michigan, the effects on the state budget will be measured in the billions; yes that’s with a ‘B’.
Wage and Salary Employment Reductions
COVID-19 is wreaking havoc on the U.S. economy. With states restricting economic activity, and people choosing to avoid behaviors likely to contribute to the spread, the nation has seen an unprecedented increase in unemployment and wage loss.
Michigan was hit particularly hard by the pandemic, from a health and economic perspective. The automotive sector has seen steep declines in sales, with April sales reaching the lowest annualized levels in the last 40 years. At the same time, Detroit was at the epicenter of one of the worst COVID outbreaks in the U.S. Combined with the standstill in many economic sectors, wage and salary income is expected to fall by nearly $20 billion in Fiscal Year (FY)2020 (a 9 percent decline). This would translate into more than a $1 billion decline in income tax revenue; wiping out the last five years of growth. Sales tax revenue is also facing one of the steepest declines in history, with current year revenue estimated to decline by more than 10 percent.
These sharp declines are estimated to be in the billions. In the current year, combined General Fund/School Aid Fund revenue is expected to decline by 12 percent from last year, amounting to $3 billion less than in FY2019. General Fund sources account for a majority of the loss, with the discretionary account expected to decline $2.1 billion relative to the previous year, matching the decline of the Great Recession in FY2009. The expected drop in School Aid Fund revenue of $875 million would be the largest single-year decline in state history. Revenue reductions are just as bleak for FY2021, with reductions from previous estimates reaching $3 billion.
Medicaid Spending Increase
While the Consensus Revenue Estimating Conference typically focuses squarely on the revenue side of the picture, a portion of the day’s discussion was focused on the spending side. Experts projected that traditional Medicaid enrollment (all Medicaid enrollment other than the Healthy Michigan Plan) will surpass 2 million (roughly one-fifth of the state population), well beyond the state’s peak historical enrollment.
The increase will drive additional spending. While the temporary increase in the FMAP (the percentage of Medicaid spending the federal Government pays) will defray cost increases in FY2020, the experts at the conference projected a $500 million increase in total Health and Human Services spending in FY2021, and a $300 million increase in FY2022.
Multi-Billion Dollar Deficit?
While nothing said at the conference was unexpected, the discussion provided a sobering picture of the state budget. Michigan is expected to raise $3 billion less in revenue than initially projected each of the next two years, without a lot of options to replace those dollars. Even prior to COVID-19, the General Fund was going through a period of slow growth.
Based on the Senate Fiscal Agency’s estimates, the General Fund and School Aid Fund are each expected to face deficits greater than $1 billion during FY2020 and FY2021. Table 1 shows the initial General Fund projections, with an expected year-end deficit of $1.1 billion for the current fiscal year, and $2.2 billion for the next. The projection for the School Aid Fund in Table 2 shows similar challenges, with the Senate Fiscal Agency estimating a $1.1 billion deficit for FY2020 and a $1 billion deficit for FY2021.
General Fund Year-End Balance, FY2020-22 (millions)
Source: Senate Fiscal Agency
School Aid Fund Year-End Balance, FY2020-22 (millions)
Source: Senate Fiscal Agency
And so now the budget machinations must begin. State budget makers are confronted with the daunting task of balancing the current-year budget that has only a few months left in it at the same time they must start anew on crafting a budget for FY2021. The state may look to:
- The Rainy Day Fund, which has nearly $1.2 billion in savings. This is hardly a panacea, as the entire fund would cover only about one-third of the FY2020 shortfall. Recent legislation limits withdrawals to 25 percent of the fund balance, but that can be addressed legislatively.
- A second round of federal aid. Over the last two recessions, states have relied heavily on federal dollars to make it through recessions (particularly the 2008 recession), yet it is uncertain what, if anything, the federal government will do for a second package.
- Tax increases, which need to be considered even more cautiously in a recession as they could harm an already fragile economy. Given that FY2020 is already more than halfway over, it also would require a significant increase to bring the budget into balance.
- Spending cuts, forcing choices among state programs when they are most needed.
Whatever decisions are made, adjustments must deal with the $6 billion in lost revenue over the next two years.