In a Nutshell:

• State revenue forecasts have been substantially revised, again, as Michigan incomes and consumer spending continue to be supported by billions in federal stimulus delivered in response to the pandemic.
• Michigan’s General Fund and School Aid budgets are poised to finish FY2021 with over $7 billion in the bank, while, based on current-year spending plans across both funds, the FY2022 budgets are also looking at a similar combined year-end surplus.
• Future spending plans for the use of these surplus funds must match up with the nature of the resources; use these one-time funds to support one-time investments.

Michigan’s state revenue estimators might feel as if they have been cast in a modern-day sequel to the 1993 comedy film Groundhog Day when it came to revising their state tax projections following last Friday’s revenue estimating conference. Instead of waiting for the appearance of the quasi-mythical groundhog to signal whether spring is just around the corner, non-partisan fiscal officials from the House and Senate, along with their counterparts in the executive branch, gathered to revisit their projections of the national and state economies as well as provide updated state revenue estimates for the current and subsequent fiscal years. And just like Bill Murray’s movie character, they too may have felt stuck in a sort of time loop.

Just as they announced following the January 2021 and May 2021 conferences, fiscal officials again revealed that state tax revenues flowing into the General and School Aid Funds are expected to exceed prior projections. And, again, these increases are substantial. This bit of deja-vu is good news for the state budget to be sure, especially given the dour fiscal predictions at the start of the pandemic.

We were not all too surprised by the major uptick in state revenue projections coming out of the recent conference. In late September, following the finalization of the $70 billion state budget for Fiscal Year (FY)2022, we noted that state revenues were coming in significantly higher than the May projections upon which the FY2022 budget is based. At that time, we suggested that the FY2022 state budget might be staring at a $5 billion surplus. Based on Friday’s revenue updates, the Senate Fiscal Agency now projects a combined $7.1 billion surplus across the FY2022 General Fund and School Aid budgets at year-end.

Three Key Takeaways for the School Aid Budget

Unpacking all the details of the state’s biannual Consensus Revenue Estimate Conference (CREC) held last week can take some time, especially when it comes to figuring out how revenue changes translate to Michigan’s current-year spending plans as well as what those updates might portend for supplemental spending and future fiscal year budgets. In the space below, we parse out the post-CREC highlights and offer three key takeaways for the $17 billion School Aid budget.

FY2020-21 Surplus Carried Forward

According to the Senate Fiscal Agency’s post-CREC state budget update, the School Aid Fund will be sitting on a $3.6 billion surplus at the end of the current fiscal year (FY2022). This is up more than three-fold from the $1.1 billion year-end surplus forecast when the FY2022 SAF budget took effect back in October. These good fortunes are owed, in large measure, to the ending condition of the FY2021 budget; it appears now that final book-closing for the FY2021 budget will show a $2.9 billion surplus. This entire amount will carry forward and become available for appropriation in FY2022 or beyond.

As we discussed in our September blog, actual SAF tax revenue growth during the last four months (June to September) of FY2021 greatly exceeded the May estimates upon which the budget was premised. The massive federal stimulus efforts during 2020 and early 2021 pushed Michigan personal income to historic levels and drove state tax revenues to similar heights.  Specifically, sales, use and income tax collections, which account for over two-thirds of total SAF revenue, benefited from the spike in economic activity supported by the stimulus. As the economic effects of the federal stimulus wear off in the coming years (i.e., consumer spending financed by stimulus dollars), Michigan’s tax receipts tied to the economic activity will also recede. Overall, revenue forecasters added over $1 billion to the SAF revenue estimate for FY2021 and $947 million for FY2022 with the January revisions.

But, back to the surplus. 

The increase in SAF tax receipts for FY2021 and FY2022, combined with a $300 million reduction in expected SAF expenditures (see pupil membership discussion below), is projected to yield a year-end surplus of over $3.6 billion.  Of this total, $2.9 billion is carried forward from the FY2021 surplus and, in fact, $1.2 billion of these resources, nearly 40 percent, date back to  the FY2020 budget surplus. The latter category is one-time money, meaning appropriators will want to ensure that plans for spending these resources should be one-time in nature to avoid creating fiscal imbalance in any future budget years.

Pupil Membership Estimates Ratcheted Down

One component of the pandemic’s effect on in-person instruction and public school enrollment in the fall of 2020 has been well documented. Public schools across the United States experienced an overall three percent decline in enrollment after years of slow growth. Michigan’s total K-12 enrollment also fell by a similar amount as schools across the state chose to engage in remote or hybrid learning models and families chose to delay enrolling their children in public school or shifted to homeschooling or private education options. Unlike the nation, prior to the onset of the pandemic, the Great Lakes state had been experiencing a steady decline for the better part of the last 20 years. 

Fall 2020 enrollment losses nationally and in Michigan were concentrated in the early grades; families were hesitant to enroll their youngest students in remote learning for non-compulsory kindergarten as well as some early elementary classrooms. Michigan saw an 11 percent year-over-year decline in kindergarten students from the pre-pandemic (fall 2019) level. At the other end of the grade spectrum, high school enrollment dipped by one percent. 

The hope moving into fall 2021 and the reopening of schools to in-person instruction was that many of the delayed entrants, as well as some of those students that shifted to alternative settings, would return this school year (2021-22). However, this does not appear to be the case according to revised K-12 pupil membership estimates coming out of the recent revenue conference. The table below summarizes the changes in pupil estimates from the May and January conferences.

K-12 Pupil Membership Estimates: May 2021 and January 2022

Source: Senate Fiscal Agency, January 2022 Estimates
* For 2020-21, pupil figures are based on “super blend” count (75 percent weight on 2019-20 student count and 25 percent weight on 2020-21 student count). 

The first thing to note from the table is the delay in recognizing the actual student enrollment decline that Michigan experienced in the fall of 2020. This full decrease didn’t show up in the 2020-21 numbers.  That is because Michigan policymakers adopted a modified method for counting students for state aid purposes. This modified method weighted prior year enrollment from 2019-20 school year much more heavily (75 percent) than the regular method (10 percent). The change was meant to ease the immediate financial strain many districts would have felt from receiving less per-pupil funding. This policy change, along with the working assumption that a number of students would return to public schools in the fall of 2021, was intended to smooth the actual three percent enrollment decline from fall 2020 over two years. We see this in the year-over-year changes column based on May 2021 pupil estimates.

Michigan shifted back to its regular method for counting students for the 2021-22 school year. However, the working assumption that many of the exiting students would return to public school classrooms this fall does not appear to be bearing out. Instead of an increase in full-time equated pupils (using the traditional count method) from fall 2020 to fall 2021, the numbers remained basically flat (decline of 200 pupils). As a result, updated estimates show that instead of declining just 1.1 percent from the 2020-21 level, total enrollment in 2021-22 is now forecasted to drop 3.0 percent, a change that more accurately reflects what occurred at the local level. With the use of the one-time “super blend, Michigan effectively delayed recognizing its actual enrollment decline by one year. 

From a state budget perspective this change is substantial. School districts are paid a per-pupil foundation allowance that is based on these pupil counts. It is now estimated that there will be 27,500 fewer students eligible for state aid compared to the enacted School Aid budget. This equates to a reduction of nearly $300 million in School Aid Fund expenditures for the FY2022 budget, contributing to the year-end surplus.

One-time Resources for One-time Spending

With the welcomed news of a much larger FY2022 budget surplus, both public and legislative attention will pivot to plans for putting those dollars to use. While there may be no shortage of ideas put forth to use some of this funding, appropriators must ensure that the nature of all approved spending matches up with the nature of the resources. In other words, use one-time funds to support one-time investments.

Within the School Aid budget, debt repayment is one area worth examining closely for added one-time investment in FY2022. 

Because the state has not saved enough in past years, it has made public school employees its largest creditors and amassed massive unfunded liabilities in the school pension system. These liabilities are effectively state-issued IOUs for services already rendered by teachers and other school employees. 

As of the end of FY2020 (latest data currently available), Michigan taxpayers owe the Michigan Public School Employees Retirement System’s (MPSERS) retirees and current workers $33.8 billion more than the state has saved to finance promised pension benefits. Paying down these pension debts will benefit current and retired teachers and taxpayers alike. Using these surplus dollars for a sizeable, one-time principal payment will save interest costs over the remaining term of the debt (scheduled for repayment in 2038).

With the School Aid budget’s revenue base updated, fiscal attention will now shift to supplemental spending plans for FY2022 as well as the development of the FY2023 budget. We expect to see proposals for spending down some of the projected $3.6 billion surplus beginning with the FY2023 executive budget proposal to be released next month. Appropriation decisions must ensure that the one-time surplus dollars are matched to one-time expenditures to maintain structural balance in the current year as well as future budget years.