• The May Consensus Revenue Estimating Conference increased revenue estimates for the General Fund while decreasing revenue estimates for the School Aid Fund.
• Typically the May conference sets the stage for the budget process, but uncertainty in federal trade policy could have significant ramifications for revenue projections.
• This leaves the process in a wait-and-see spot; it is possible nothing changes, but estimates could also be revised before the budget is finalized.

On May 17, the House Fiscal Agency, Senate Fiscal Agency, and the State Treasurer  convened for this year’s second Consensus Revenue Estimating Conference (CREC). While the January conference sets the revenue assumptions underlying the Executive Budget released at the beginning of the year, May’s conference typically sets the stage for legislative proposals and the negotiations between the governor and lawmakers around the final budget.

While trends leading up to the January conference ramped up projections for the School Aid Fund and lowered projections for the General Fund, those trends have reversed in recent months (see Table 1). Projected General Fund revenues for Fiscal Year (FY)2019 increased by $152 million relative to the January estimate, while projections for FY2020 and FY2021 increased by about $59 million and $68 million respectively. The School Aid Fund saw reductions of similar magnitude; $68 million for FY2019, $87 million for FY2020, and $85 million for FY2021.

Table 1

Change in estimates from January to May, in millions of dollars

Why the changes? Well, it turns out federal policy can have a number of unintended effects on state revenues.

Uncertain effects of federal tax policy

Two federal tax policy changes have made it more difficult to estimate state revenues, contributing to some of the adjustments seen in the most recent CREC estimates.

The first piece comes from the federal Tax Cuts and Jobs Act, passed in late 2017. Some of the state-level effects from the federal tax code modifications were preempted, like the elimination of the federal personal exemption. Other changes were not as predictable and have not been addressed by state-level tax policy changes. One example is the $10,000 cap on the state and local tax deduction (SALT) under the individual income tax, designed to broaden the base of the federal tax.

Part of the SALT deduction effects were seen at the end of 2017 as filers took advantage of their ability to claim uncapped deductions for 2017 taxes. For tax year 2018, there was no incentive to file before the end of the calendar year. As such, the state saw a significant increase in annual income tax payments closer to the April deadline (and a decrease in December 2018 filings). The SALT deduction change contributed to the change in the CREC estimates. Because Individual Income Tax revenue is primarily deposited into the General Fund, these changes led to an upward revision for FY2019.

Another major federal change affecting state revenue projections resulted from the U.S. Supreme Court decision in Wayfair. The Court ruled last year that states could collect sales tax on online sales shipped to the state if the seller did a substantial amount of business in that state. The Michigan Department of Treasury announced soon after that it would start requiring sellers to remit the Michigan Sales Tax if they meet that threshold.

Revenues increases as a result of the Wayfair changes have been slower than initially projected. As a result, sales tax collections are lower than their January estimate. The School Aid Fund, which is the primary recipient of Sales Tax revenues, saw downward revisions as a result.

Challenges for future projections

While past policies have had different effects on revenue than initially projected, decisions being made today could drastically shift where revenues are likely to be in future years. Of particular note amongst presenters at the CREC was the potential for a ramped up trade dispute with China. While a trade war would have global implications, a lot is at stake for Michigan industry in current trade negotiations. Increased tariffs imposed on Chinese steel and retaliatory tariffs would hurt two of Michigan’s larger industries: agriculture and manufacturing.

The increased cost of supplies could put manufacturers out of business or lower their overall sales as their products become more expensive. The retaliatory tariffs could make it more difficult for farmers to sell their crops overseas. As consumer goods increase in price, consumers might purchase fewer things. Each of these would have a negative impact on state revenue collections. The presenters from the fiscal agencies and Treasury based their revenue projections on the scenario they deemed more likely: trade issues resolving without significant disruption. They did, however, note that the potential effects from a dispute are large enough that the short-term revenue estimates (FY2020 and FY2021) may require adjusting if negotiations deviated too far from the expected outcome.

What does this mean for the state budget?

The potential uncertainty of trade policy looms over projections for FY2020 revenues and the budget process. The revisions leave a net reduction of $28 million in combined General Fund and School Aid Fund revenues compared to the January estimate. Some of that revenue is offset by increased revenues from this year, as the state is projected to raise $83 million more than originally projected. On the scale of the $10.7 billion General Fund budget, these revisions are relatively small.

While the Senate has passed its versions of the General Fund and School Aid Fund budgets (which has the School Aid Fund relying on General Fund resources), the House has yet to pass its full versions, and there are many negotiations to happen before the Governor signs the budget. If the trade dispute is not resolved, or other potential revenue shocks occur between now and then, the process could be delayed and require a reexamination of the work that has already been completed.