1 Michigan’s Budget Problem Prospects for the Future July 2002 Citizens Research Council of Michigan Prospects for the Future July 2002 Citizens Research Council of Michigan

2 Background zState’s Economy Has Declined zState Revenue Performance Still Weak (April Down 10%, May Down 3%, June Flat) zSpending Reductions Small So Far — Onetime Revenues Used to Fill Gaps zFuture Revenue Growth is Constrained — Income Tax Cuts Will Absorb Significant Increment of Growth

3 Effects of 1998 Tax Cuts zSingle Business Tax — 26% of General Fund Revenue zIndividual Income Tax Cut — 8% of General Fund Revenue zImplication: State Could Afford to Finance Existing Programs With A Third Less Revenue zRecent Actions Contradict That Premise

4 Economy zNational Slowdown — Relatively Mild (Probably No Recession) zNational Economy Growing Again zState Recession — Mild by Michigan Standards zCurrent Michigan Indicators Mixed

5 Revenue Problems zRevenue Declines Started Late in 2000 and Have Continued to Date zSeveral Budget Adjustments Affecting 3 Years zHeavy Reliance on One-time Actions — Over $3 Billion in Three Years zStructural Deficits Have Evolved in the State’s Two Major Funds

6 May Revenue Consensus zLatest Bad News zRevenue Forecasts Lowered Again zGeneral Fund Down $672 Million Over Two Years zSchool Aid Fund Reduced $142 Million zFY2002 Balancing Actions Use One-time Resources

7 FY2003 Balancing Actions zLegislature Had Great Difficulty Choosing Course zPermanent Revenues Became Final Piece of the Solution zSpending Cuts Minimal

8 Postponing A Long-term Solution zGaps Between Ongoing Revenues & Spending zSpending for FY2002 Not Cut Significantly zFY 2002 Structural Gaps Moving Into FY2003 z$933 Million — GF-GP z$853 Million — School Aid Fund

9 General Fund & School Aid Fund Operating Gaps

10 Economic Outlook Assumptions zModerate Economic Recovery — Has Already Started Nationally zModerate Economic Growth in Michigan Assumed to Begin in Summer zEconomy Back on Track by End of Year

11 FY2003 General Fund Revenue Outlook---May Consensus zNet Year-to Year Revenue Reduction — $2 Million zSpending Needs Exceeded Revenues by $1,288 Million zRevenues $1.4 Billion Lower (15%) Than FY2000 z$270 Million Lower than FY1996

12 Original Budget Proposal: Permanent Spending Cuts $308 Million — Only $145 Million Cut State Programs One-time Resources — $660 Million Rainy Day Fund — $207 Million Tobacco Settlement Revenue-$100 Million Special Medicaid Revenue — $247 Million Employment Trust Fund — $80 Million

13 Time to Cut Spending? zLegislature Presented Choices—More Revenue or Cut Spending zSacred Cattle Identified zLegislature Chose to Enhance Revenues

14 Revenue Enhancements Are Approved zCigarette Tax—50 cent Increase y20 cents for School Aid y30 cents for Other Programs xGeneral Fund Receives 22 cents zTotal Revenue Increase $292 Million in FY2003 zSBT Cuts Suspended — $69 Million in FY2003

15 General Fund Arithmetic FY02 FY03 Projected Appropriations $9,307 $9,235 One-time Spending Adjustments Adjusted Spending 9,390 9,482 Revenues 8,406 8,402 Cigarette and SBT Revenues One-time Revenues Structural Gap ($892) ($771)

16 FY2003 School Aid zNet Revenue Growth $400 Million ($501 Million with Cigarette Tax Increase) zFY2002 Carryover Gap $841 Million zIncrease in Foundation Allowance to $6,700 zHow is it Financed?

17 More One-time Revenues zRainy Day Fund--$350 Million (In FY2002) zAdvance the Due Date for State Education (Property) Tax and Cut the Rate From 6 to 5 Mills for 2003 Only — $494 Million zTotal One-time Actions — $844 Million zSmall Surplus at End of FY2003 zSchool Aid Spared Any Cuts in Latest Budget Adjustments

18 The School Aid Arithmetic FY02 FY03 FY 02 Spending Base $11,458 $11,458 $6,700 Basic Allowance 337 Other Adjustments (39) (114) Total Spending 11,420 11,681 Revenues 10,134 10,534 Cigarette Tax Increase Tax Date Shift 494 Fund Balance Rainy Day Fund 350 Other Total Resources $11,624 $11,788 Structural Gap ($841) ($579)

19 Looking Beyond FY2003 zBoth Major State Funds Have Very Large Operating Deficits zBudget Must be Balanced (Michigan Constitution) zExpenditures Must Eventually Be Balanced with Base Revenues zState is Nearly Out of One-time Actions

20 FY2004 School Aid Outlook zFund Balance Will Carry Over To FY2004 ($107M) zRevenue Growth Will Likely Be In Range of $475 Million to $600 Million zProbably Enough Growth to Close Gap ($579M) zSignificant Year-to-Year Spending Increases in FY2004 Unlikely zBudget Difficulties in Local School Districts will Exceed Those Reported in Recent Months zSpending Can Grow After FY2004

21 General Fund Longer Term Projections Scenario zRevenues and Spending Out to FY2009 zSteady Revenue Growth Assumed (4.5%) zIncome Tax Cuts in State Law Occur on Schedule z“Normal” Spending Increases for Inflation zOne-time Revenues Factored Out zLarge Increases in Medicaid Factored In

22 Medicaid Problems Looming zFY 2002 and FY2003 Short $100 to $150 Million in State Funds zTemporary Revenues Used to Avoid Cuts zReplacement Revenues Needed zFederal Limits on Medicaid Special Financing Adds $375 Million to State Funding Requirements over Three Years zMedicaid Reimbursement Rates to Service Providers Under Pressure

23 General Fund Outlook zRevenue Growth Not Enough to Catch Up With Current Spending zIncreases in FY2004 and FY2005 Constrained By Income Tax Cuts and Federal Tax Reform zUnder Current Law, Revenues Will Not Grow To FY2002 Spending Level Until FY2006 zBudget Problem in FY2004 Exceeds $1 Billion Even After Cigarette Tax Hike and SBT Cut Pause

24 The Overall General Fund Result zGap of $1 Billion For FY2004 zGap Widens as Federal Medicaid Funding Declines zReaches $1.2 Billion in FY2006 zGap Starts to Decline Slowly After FY2006

25 Time to Decide zSolve the Policy Contradiction zSpending Policy Has Been Validated By Use of One-time Resources zShortfall in Permanent Revenue Lays Future of Programs Open to Question zWhich Direction Will the State Choose? zDoes Recent Action Indicate the Future Course?

26 Approaches to Balancing Budget in FY2004 and Beyond zCut Spending zRaise More Revenue zCombination of Both Approaches zMust Find $1 Billion in Total Revenues or Spending Reductions zOver 10% of Spending Base

27 Cutting Spending z80% of General Fund in Four Areas: zHigher Education ($2.1B) zCommunity Health — Mental Health, Public Health, Medicaid ($2.7B) zCorrections ($1.6B) zFIA — Family Services, Juvenile Justice, Public Assistance ($1.2B)

28 The Remaining 20 Percent zOther Areas Include: zState Police zJudiciary zEnvironmental Quality zNatural Resources zAttorney General zRevenue Sharing at Risk — An Indirect Way to Increase GF-GP Revenues

29 Balancing by Cutting Spending zAcross-the-board Reductions Not An Option zFundamental Changes in Priorities Would Be Needed — Such As: yWho Pays For Higher Education? yOptional Medicaid Services yPrison Sentencing and Prison Populations

30 Higher Education zState Pays Half of University Operating Costs (One third of Community Colleges) zAcross-the-board Share Of Reductions Implies Over 20% University Tuition Increases zHigher Education Could be a Tempting Place to Cut—Larger Reductions Might be Made

31 Medicaid--State’s Options Are Limited--Federal Requirements zTwo Largest Optional Services: yPharmaceuticals yNursing Home Care zComprise About 40% of Medical Services Spending zReducing Either Program Would Have Serious Consequences

32 Other Community Health Programs zCommunity Mental Health (Nearly $1 Billion) zMental Health Institutions zSubstance Abuse Prevention & Treatment zWomen, Infant, and Children Food and Nutrition Programs zPrograms for the Aging

33 Corrections zMost of Budget Spent Housing Prisoners zUse of Less-costly Options Would Require Reductions in Length of Sentence and/or Length of Stay in Prison zCurrent Policies Imply Larger Prison Populations in Next Several Years

34 Family Independence Agency zMaximum Grant for Family of Three ($459 per month) is 37% of Poverty Level zFood Stamps Raise Support to 60% of Poverty Level zCaseloads Now One-third of 1994 Level zJuvenile Justice Programs zFoster Care, Adoption, Domestic Violence Programs zDay Care for Working Public Assistance Recipients

35 Local Government at Risk zState Revenue Sharing—Statutory Payments Already Cut by 13 Percent zCuts are Likely to be Permanent zMore Reductions Could Occur z$868 Million Remains of Statutory Allocations

36 Local Government zCommunity Mental Health — Nearly $1 billion in State funds zTransportation —Funds Already Diverted to help General Fund —Revenues not Responsive to Economic Growth zLibraries ($20M) zLocal Health Departments ($41M), Other Health Grants ($27M)

37 Other Programs At Risk zPrograms for the Aging ($26M) zPayments in Lieu of Taxes ($18M) zLocal Corrections Programs ($82M) zSecondary Road Patrol Grants ($13M) zArts Grants ($22M)

38 Is Increasing Revenue an Option? zCigarette Tax and Pausing SBT Tax Cut Provide Resources That Will Build in Future — The First “Permanent” Revenue Increase Used to Balance Budget zRedirect Tobacco Settlement Revenues — Might Redirect $150 Million Annually — Ballot Proposal Could Render Moot zDelay or Suspend Individual Income Tax Cuts

39 Delaying/Suspending Income Tax Cuts zIf Cuts For January 2003 and Beyond are Delayed — Cumulative Effects — For Each Fiscal Year zFY2003$144 Million zFY2004$352Million zFY2005$421 Million zFY2006$440 Million zFY2007 $460 Million zNot Enough to Close Gap

40 Who Will Solve the Problem? zNew Governor zNew Legislature — Majority of Legislators May be New zMost Leadership and Experience With Budget Problem of Current Magnitude Will Be Gone

41 Most Difficult Budget Situation in 40 Years? zWhat Makes it Different? zNot Economy—Recession Mild by Michigan Standards zExpenditure Commitments and Tax Cuts Made When Economy at Peak of Business Cycle zOver $1 Billion in General Fund Tax Cuts Already zOver-reliance on Temporary Revenue Sources zGeneral Fund Revenue Growth Was Committed to Future Tax Cuts

42 Citizens Research Council of Michigan

43 The Overall General Fund Result zGap of $1 Billion For FY2004 zGap Widens as Federal Medicaid Funding Declines zReaches $ 1.2 Billion in FY2006 zGap Starts to Decline Slowly After FY2006