Citizens Research Council of Michigan 1 November 3, 2004 Standard Federal Bank Troy, Michigan Sponsored by Standard Federal Bank; Varnum, Riddering, Schmidt & Howlett LLP; and Michigan Manufacturers Association November 3, 2004 Standard Federal Bank Troy, Michigan Sponsored by Standard Federal Bank; Varnum, Riddering, Schmidt & Howlett LLP; and Michigan Manufacturers Association Michigan’s Structural Budget Deficit: Its Causes & Prospects for Resolution

Citizens Research Council of Michigan 2 Founded in 1916 Statewide Non-partisan Private Not-for-profit Promotes sound policy for state and local governments through factual research Relies on charitable contributions of Michigan businesses, foundations, and individuals Founded in 1916 Statewide Non-partisan Private Not-for-profit Promotes sound policy for state and local governments through factual research Relies on charitable contributions of Michigan businesses, foundations, and individuals

Citizens Research Council of Michigan 3 Michigan’s Structural Deficit An Overview Tom Clay, Director of State Affairs Citizens Research Council of Michigan Tom Clay, Director of State Affairs Citizens Research Council of Michigan

Citizens Research Council of Michigan 4 Five Years of Budget Problems Declining GF Revenues Slow Growth in School Aid Fund Cyclical & Structural Causes Future Prospects Declining GF Revenues Slow Growth in School Aid Fund Cyclical & Structural Causes Future Prospects

Citizens Research Council of Michigan 5 State Budget ($39.1 B) Two Major Funds: –General Fund ($8.7 B) –School Aid Fund ($12.5 B) Other Funds Restricted Purposes, e.g. Transportation, Federal Revenues State Budget ($39.1 B) Two Major Funds: –General Fund ($8.7 B) –School Aid Fund ($12.5 B) Other Funds Restricted Purposes, e.g. Transportation, Federal Revenues The Michigan Budget

Citizens Research Council of Michigan 6 General Fund Budget 83% of GF Spending in 4 Areas: Higher Education ($1.8 B) Community Health — Mental Health, Public Health, Medicaid ($2.5 B) Corrections ($1.7 B) FIA — Family Services, Juvenile Justice, Public Assistance ($1.1 B) All Other General Fund Programs - $1.5 B 83% of GF Spending in 4 Areas: Higher Education ($1.8 B) Community Health — Mental Health, Public Health, Medicaid ($2.5 B) Corrections ($1.7 B) FIA — Family Services, Juvenile Justice, Public Assistance ($1.1 B) All Other General Fund Programs - $1.5 B

Citizens Research Council of Michigan 7 External Causes Weak Economy Stock Market Falling Share – Auto Industry Weak Economy Stock Market Falling Share – Auto Industry

Citizens Research Council of Michigan 8 Internal Causes Spending Growth Outpacing Revenue Increases: –Medicaid (Double Digit Growth) –Corrections –Programs Crowded Out Cuts Eroding Revenue Base Limited Permanent Budget - balancing Changes $6.5 B of one-time fixes – 5 Years Spending Growth Outpacing Revenue Increases: –Medicaid (Double Digit Growth) –Corrections –Programs Crowded Out Cuts Eroding Revenue Base Limited Permanent Budget - balancing Changes $6.5 B of one-time fixes – 5 Years

Citizens Research Council of Michigan 9 Perspective On Revenues GF Revenues in FY03, FY04, & FY05 below FY1995 Inflation-adjusted GF Revenues Below 1972 Level GF Revenues in FY03, FY04, & FY05 below FY1995 Inflation-adjusted GF Revenues Below 1972 Level

Citizens Research Council of Michigan 10 Significant Cuts Higher Ed. Cut 14% in 2 yrs ($297 M) Rev. Sharing Cut 15% in 3 yrs ($293 M) State Workforce Down 8,500 in 3 yrs (14%) Smallest Workforce Since 1974 Higher Ed. Cut 14% in 2 yrs ($297 M) Rev. Sharing Cut 15% in 3 yrs ($293 M) State Workforce Down 8,500 in 3 yrs (14%) Smallest Workforce Since 1974

Citizens Research Council of Michigan 11 Medicaid Spending Up More Than 40% in 4 yrs Caseload Up 30% Program Now Covers 1.4 Million Pressures on Rates Paid Providers – Could Add Significantly to Growth in Future Spending Up More Than 40% in 4 yrs Caseload Up 30% Program Now Covers 1.4 Million Pressures on Rates Paid Providers – Could Add Significantly to Growth in Future

Citizens Research Council of Michigan 12 Corrections Largest State-Operated Program 50,000 Prisoners Over 30% of State Workers High Incarceration Rate Largest State-Operated Program 50,000 Prisoners Over 30% of State Workers High Incarceration Rate

Citizens Research Council of Michigan 13 States With More Than 500 Prisoners Per 100,000 Residents

Citizens Research Council of Michigan 14 State Government Employment Trends

Citizens Research Council of Michigan 15 Revenue Forecasts for FY2005 Economy – Recovery & Growth Projected Forecast – 4% Revenue Growth Collections on Track Risk is Likely on the Downside Economy – Recovery & Growth Projected Forecast – 4% Revenue Growth Collections on Track Risk is Likely on the Downside

Citizens Research Council of Michigan 16 Spending Pressures Outpacing Economy Revenue Structure Cannot Keep up Structural Deficit – Must Be Solved Spending Pressures Outpacing Economy Revenue Structure Cannot Keep up Structural Deficit – Must Be Solved Budget Outlook

Citizens Research Council of Michigan 17 FY2005 General Fund Budget Significant Progress Made Permanent Solutions Total ($1 B) GF Spending Cuts ($340 M) Revenue Sharing – Counties ($182 M) Reduce GF Grant to School Aid ($163 M) Revenue Increases ($390M) Funding Shifts & Other Cuts ($299 M) New Revenues Total ($390 M) Permanent Solutions Total ($1 B) GF Spending Cuts ($340 M) Revenue Sharing – Counties ($182 M) Reduce GF Grant to School Aid ($163 M) Revenue Increases ($390M) Funding Shifts & Other Cuts ($299 M) New Revenues Total ($390 M)

Citizens Research Council of Michigan 18 FY2006 General Fund Outlook Problem Approaching $1 Billion Medicaid – $500 to $600 M Debt Service – $55 M FY05 Employee Concessions – $76 M Retirement & Health Insurance – $50 M FIA – $60 M Corrections Increases – $60 M Replace One-time Revenues – $95 M Pressures for 3% (e.g. Higher Ed.) – $115 M Medicaid – $500 to $600 M Debt Service – $55 M FY05 Employee Concessions – $76 M Retirement & Health Insurance – $50 M FIA – $60 M Corrections Increases – $60 M Replace One-time Revenues – $95 M Pressures for 3% (e.g. Higher Ed.) – $115 M

Citizens Research Council of Michigan 19 Beyond FY2006 The Structural Problem Continues Expenditure Causes – Medicaid – Corrections Revenue Causes – Antiquated Structure – Sources Unresponsive to Growth Expenditure Causes – Medicaid – Corrections Revenue Causes – Antiquated Structure – Sources Unresponsive to Growth

Citizens Research Council of Michigan 20 Medicaid Projected Spending Exceed Revenue Growth Significant Revenue Sources Will Not Grow – e.g. Tobacco Revenues GF Requirements Grow at 150% of Total Spending Growth Near Term Increases at 12% Projected Spending Exceed Revenue Growth Significant Revenue Sources Will Not Grow – e.g. Tobacco Revenues GF Requirements Grow at 150% of Total Spending Growth Near Term Increases at 12%

Citizens Research Council of Michigan 21 Medicaid Funding Projections

Citizens Research Council of Michigan 22 Corrections Largest State-operated Program Employs 50% of Employees Paid from GF Crime Rates Falling – Prison Populations Increase Projected to Increase 1,800/yr until 2010 Annual Cost Increase – ($100M) Annual Increases about 7% Largest State-operated Program Employs 50% of Employees Paid from GF Crime Rates Falling – Prison Populations Increase Projected to Increase 1,800/yr until 2010 Annual Cost Increase – ($100M) Annual Increases about 7%

Citizens Research Council of Michigan 23 General Fund Budget Shares

Citizens Research Council of Michigan 24 Structural Revenue Issues Revenue System – Economy of 50s, 60s, and 70s Revenues Grow Slower than Economy Consumption Taxes – Goods Oriented Few Services Taxed Services are Over 50% Private Sector Economic Activity Revenue System – Economy of 50s, 60s, and 70s Revenues Grow Slower than Economy Consumption Taxes – Goods Oriented Few Services Taxed Services are Over 50% Private Sector Economic Activity

Citizens Research Council of Michigan 25 A Medium-Range General Fund Budget Scenario Medicaid & Corrections Projections Incorporated Starting Point is FY2005 Appropriations – Ongoing Revenues and Spending are Nearly Balanced FY06 Spending Pressures Reflected Other Areas of GF Spending 3% per yr Medicaid & Corrections Projections Incorporated Starting Point is FY2005 Appropriations – Ongoing Revenues and Spending are Nearly Balanced FY06 Spending Pressures Reflected Other Areas of GF Spending 3% per yr

Citizens Research Council of Michigan 26 General Fund Revenues Projections – Moderate Average Growth Rates Grow about 3% per yr. Major Revenue Sources with No Growth Retard Overall Growth SBT Eliminated at End of Calendar 2009 (23% of GF Revenue) Projections – Moderate Average Growth Rates Grow about 3% per yr. Major Revenue Sources with No Growth Retard Overall Growth SBT Eliminated at End of Calendar 2009 (23% of GF Revenue)

Citizens Research Council of Michigan 27 Combining Revenues and Spending Pressures Constitutionally Required Balanced Budgets Incremental Problem Each Year – Exceed $300 M – Over 3% of Spending Base after FY06 Holding All Programs Except Medicaid & Corrections Constant Would Not Close Gap Constitutionally Required Balanced Budgets Incremental Problem Each Year – Exceed $300 M – Over 3% of Spending Base after FY06 Holding All Programs Except Medicaid & Corrections Constant Would Not Close Gap

Citizens Research Council of Michigan 28 General Fund Structural Deficit

Citizens Research Council of Michigan 29 Expanding Structural Deficit

Citizens Research Council of Michigan 30 Implications Balanced Budget w/Spending Cuts: Will Require Changes to Medicaid & Corrections Changes to Rev. Sharing & Higher Ed. Failure to Slow Medicaid & Corrections Means Slow Starvation for Others Balanced Budget w/Spending Cuts: Will Require Changes to Medicaid & Corrections Changes to Rev. Sharing & Higher Ed. Failure to Slow Medicaid & Corrections Means Slow Starvation for Others

Citizens Research Council of Michigan 31 Responsiveness of Taxes to the Economy – AKA ‘Elasticity’ Most Major State Taxes Increase More Slowly Than Michigan Personal Income Personal Income Tax Slightly Elastic Sale Tax, Use Tax, Gasoline Tax All Somewhat Inelastic Most Major State Taxes Increase More Slowly Than Michigan Personal Income Personal Income Tax Slightly Elastic Sale Tax, Use Tax, Gasoline Tax All Somewhat Inelastic

Citizens Research Council of Michigan 32 State Taxes as Percent of Michigan Personal Income

Citizens Research Council of Michigan 33 New Revenues? Replace “Lost” SBT before 2010 Broaden Base of Sales & Uses Taxes to Include Services Revenue Neutral w/More Growth Potential Net Revenue Gain? Replace “Lost” SBT before 2010 Broaden Base of Sales & Uses Taxes to Include Services Revenue Neutral w/More Growth Potential Net Revenue Gain?

Citizens Research Council of Michigan 34 Broadening the Sales & Use Taxes Base Most Services not Taxed Services – Over 50% Economic Activity If Revenue-neutral, Rate Reduction Could Occur Revenues Grow Faster Than Current Sales & Use Taxes Most Services not Taxed Services – Over 50% Economic Activity If Revenue-neutral, Rate Reduction Could Occur Revenues Grow Faster Than Current Sales & Use Taxes

Citizens Research Council of Michigan 35 Issues With Services Taxation Would Services Such as Medical Care & Education be Exempt? Business to Business Services –Pyramiding Could Create Multiple Taxation Would Services Such as Medical Care & Education be Exempt? Business to Business Services –Pyramiding Could Create Multiple Taxation

Citizens Research Council of Michigan 36 Importance of Restoring Fiscal Balance Fiscal Problems Crowd Out Other Important Issues Budget Situation Threatens Credit Rating –Affects Credit Standing of Schools & Local Government Units –Increases Borrowing Costs Fiscal Problems Crowd Out Other Important Issues Budget Situation Threatens Credit Rating –Affects Credit Standing of Schools & Local Government Units –Increases Borrowing Costs

Citizens Research Council of Michigan 37 Citizens Research Council of Michigan