by Robert J. Kleine, Vice President and Senior Economist, and Laurie A. Cummings, Senior Consultant for Economic and Education Policy

This Advisor summarizes the highlights of Governor Engler’s recommended state budget for fiscal year 1996–97 and comments on the economic assumptions on which it is based as well as obstacles that must be overcome. Fiscal year 1996–97 will begin on October 1, 1996, and end on September 30, 1997.

Introduction

The FY 1996–97 general fund/general purpose (GF/GP) budget recommendation is $8.246 billion, a decline of 2.5 percent from the current year appropriation. However, adjusted for more state income tax revenue being earmarked for school aid (23 percent, up from 14.4 percent), the budget is 4.4 percent higher. In many ways this is the tightest state budget in several years, with large assumed increases in federal aid (from welfare and Medicaid reform), elimination of the adult education program, savings from declining AFDC caseloads, and $68 million in savings from reduced employee health insurance costs; these reductions provide room in the budget for more GF/GP money for school aid, corrections, higher education, capital outlay, and environmental cleanup. If federal welfare and Medicaid reform does not materialize, however, and adult education is not discontinued—which together save at least $500 million—most areas of the budget will be subject to sharp budget cuts.

Exhibit 1 shows that the major budget increases are $80.2 million for higher education, $73.3 million for capital outlay and debt service, and $50.6 million for law enforcement. Substantial reductions are recommended for the Family Independence Agency, formerly the Department of Social Services, ($147.7 million) and school aid ($279.3 million); the latter is due mainly to increased income tax revenue earmarking.

As shown in Exhibit 2, the governor recommends small reductions or minimal increases for most departments. The largest reduction, other than in school aid, is 17.5 percent for the Department of Labor: The governor proposes applying $5 million in user fees to support administering worker’s disability compensation laws, thereby reducing the GF/GP appropriation. The 16.6 percent reduction in the Department of Agriculture budget will result from shifting $8.9 million in support for horse racing from GF/GP to restricted revenue. The recommendation for the Department of Treasury budget is down 13.8 percent because of the elimination of the one-time $5.4 million paid to local governments, to reimburse them for the homestead affidavits required by the school finance reform legislation. The 13.5 percent reduction in the Department of Management and Budget is due mainly to the reduction of $6.7 million in support for the Michigan Administrative Information Network (MAIN), which is largely completed. As already mentioned, the 12.2 percent reduction in the GF/GP budget for the Family Independence Agency can be credited mainly to declining AFDC caseloads and the increased federal aid expected from welfare reform.

The biggest GF/GP budget increase is recommended for the new Department of Environmental Quality: 61.2 percent, due to a proposed $30-million appropriation for environmental cleanup; the total, all-funds increase for the program is $82 million. Other substantial increases are for debt service (61.2 percent, reflecting $24.2 million in additional GF/GP support for two bond issues); Michigan Jobs Commission (60.9 percent, due mainly to transferring $65 million from the school aid budget for programs designed to replace adult education); capital outlay (29 percent, reflecting new money for university and community college projects, state agency maintenance, new prisons, and aeronautics programs); and local government funding (16.2 percent, due to a $17.4-million appropriation for the state match for the Water Pollution Control Revolving Fund).

The total budget (includes funds from all sources) recommendation is $30.3 billion, a 6.5 percent increase; this is much larger than the recommended GF/GP increase, because the administration expects an estimated 12.8 percent increase in federal aid. The Family Independence Agency and the new Community Health Department (which includes the Medicaid program) are expected to receive an additional $856.5 million in federal funding. As already stated, much of this money will be at risk if Congress and the president do not agree on welfare and Medicaid reforms.

The FY 1996–97 budget provides funding for 67,184 classified full-time equated positions (FTEs), up 701 positions, or 1.1 percent (see Exhibit 3). The only increase of note is in the Department of Corrections, up 852 positions. The largest recommended decline is 193 positions in the Department of Transportation. Since FY 1992, state employment is down 1,619 FTEs, despite a hike of 1,982 in the Department of Corrections. Excluding Corrections, employment since FY 1991 is down 3,601 FTEs, or 6.8 percent.

Budget Assumes Moderate Economic Growth

Governor Engler’s FY 1996–97 budget recommendations are based on reasonable economic and revenue assumptions, although there appears to be more risk than in recent years. The budget assumes that real (adjusted for inflation) gross domestic product will slow—from 3.3 percent growth in 1995 to 2.4 percent in 1996 and 2.7 percent in 1997.

Light motor vehicle sales are expected to remain flat in 1996 (at 14.6 million units) and increase slightly in 1997 (to 14.7 million units).

The Michigan economy is expected to grow more slowly than the national economy for the first time in three years. Real Michigan personal income was up 4 percent in 1995, but the rate of increase is expected to slow to 1.8 percent this year and 1.5 percent in 1997. Michigan wage and salary employment increased 2.6 percent in 1995, but the rate of increase is expected to slow to 1.4 percent this year and 1.5 percent in 1997. The unemployment rate is expected to remain slightly below the national rate throughout the forecast period.

The baseline GF/GP and School Aid Fund (SAF) revenue forecast is for 4.8 percent growth in both FY 1995–96 and FY 1996–97. This compares with growth of 6.3 percent in FY 1994–95. There are several enacted and potential policy changes that affect available revenue in FY 1996–97.

  • First, already-enacted tax cuts will reduce revenue by an estimated $75 million.
  • Second, a proposed SBT credit for apprenticeship programs will cost $5 million.
  • Third, the budget assumes passage of federal tax reform, which will reduce capital gains and estate tax revenue; this is estimated to reduce GF/GP revenue by $54 million and total revenue by $72 million.
  • Fourth, earmarking more of income tax revenue for school aid will reduce GF/GP revenue by $583 million; this, however, simply is an interfund transfer and does not affect total GF/GP and school aid revenue.
  • Finally, the budget includes about $12 million in one-time revenue and recommends fee increases of $18.8 million.

The state’s biggest revenue source is federal aid, accounting for about 27 percent of total state revenue, which is estimated at $8.06 billion for FY 1996–97, a 12.8 percent increase over the current fiscal year. Federal funds for the Department of Community Health and the Family Independence Agency are estimated to climb $856.5 million, up 18.6 percent, due largely to the administration’s expectation that federal welfare and Medicaid reform will be enacted. The only other major increase is for the Department of Transportation, $102.9 million, up 26.3 percent from FY 1995–96; much of this transpires from redirecting funds from local governments to the state.

Education and Health Account for Nearly Two-Thirds of the State-Financed Spending

Illustrated in Exhibit 4 is state own-source revenue, which excludes funds from federal, local, and private sources. It includes all revenue directly collected from the residents of the state, both earmarked (dedicated to a specific purpose) and discretionary (GF/GP funds).

Other than federal aid, sales and use taxes are the state’s major revenue source, providing 29.7 percent of own-source state revenue, surpassing the income tax, which provides 27.1 percent. The SBT (and the insurance premiums tax) is the third-largest source, generating 12.2 percent. The new school finance system shifted about $4.5 billion from school property taxes to state revenue sources, principally the sales and use taxes and the six-mill state education property levy, which now accounts for 5.3 percent of state revenue.

Exhibit 5 presents the governor’s recommended FY 1996–97 distribution of own-source revenue among state programs. K–12 education is now the largest program by far, accounting for 38.5 percent of spending. This percentage is down from FY 1995–96 (40.9 percent), due principally to eliminating adult education and transferring some of these funds to the Michigan Jobs Commission.

This budget is different from spending plans of yore: Several departments have been reorganized, and the way in which aid is appropriated to local governments is changed. First, the departments of Public Health and Mental Health have been combined, and the Medicaid program has been transferred from the Family Independence Agency (formerly the Department of Social Services), to form the new Department of Community Health, which accounts for 17.6 percent of state spending. In the current fiscal year, Social Services accounts for 13.3 percent of state spending, but in the coming fiscal year, the new Family Independence Agency will account for only 5 percent, due to the transfer of the Medicaid program to Community Health.

Second, the Department of Natural Resources has been split into two departments, Environmental Quality and Natural Resources. These entities are in the natural resources and regulatory category, which will account in FY 1996–97 for 4.3 percent of state spending, up slightly from the current year.

Finally, there is a new line item in the budget for local funding, which consolidates a number of local-aid programs, including general revenue sharing; transportation fund allocations to county road commissions, cities, and villages; and local cost-sharing payments from the Department of Community Health. Local funding accounts for 10.6 percent of state spending. Because of the transfer of local funds to this new category, the Transportation appropriation falls from 6.4 percent of state spending in FY 1995–96 to only 2.8 percent for FY 1996–97.

FY 1996–97 Spending Policies

Following are highlights of Governor Engler’s budget recommendations. The focus is GF/GP spending, but total recommended spending also is included in cases where federal aid and/or restricted funding is a significant factor in the department budget. (Refer back to Exhibit 2.)

A continuation budget has been recommended for most departments. There are only modest changes in the budgets of most departments, with small reductions offsetting funding for the few new programs recommended by the governor (see Exhibit 6). Department budgets for which major funding or policy changes are recommended are discussed in this section, most being in the education and human services categories.

Education

As mentioned above, the governor recommends a 3-percent increase in funding for K–12 schools, (adjusted for the transfer of $65 million in adult education funding to the Michigan Jobs Commission budget). The per-pupil foundation grant, however, will be only 2.5 percent higher than this year, because of an unexpected enrollment increase that will lower the 1996–97 amount for each student.

There is some dispute over the base foundation grant for the current year. The grant amount originally appropriated was $5,153, but it could be adjusted down to $5,135, in which case next fiscal year’s increase in the current figure would be only 2.2 percent. FY 1996–97 per-pupil funding could change when officials reassess the state of the Michigan economy during the May Revenue Estimating Conference; it likely will be adjusted downward, rather than upward.

The governor has also proposed all but eliminating adult education as we know it. Of the current $185 million adult education budget, he proposes transferring $50 million to new, local “workforce development boards,” which will contract with school districts, community colleges, and other community organizations to educate adults. Of the remaining $135 million, $15 million is slated for a new “Higher Skills Initiative,” for work-force training for 7–12 graders; $105 million will be removed from adult education altogether; and $15 million will be retained for traditional adult education, although students over age 21 (more than half of all adult education students) will have to pay tuition for the service.

The state’s universities are slated to receive a 5 percent increase, their largest in ten years. From the $1,370 million GF/GP operations budget, each university will receive an additional 4 percent for operations, and some will receive additional monies for “funding adjustments.” These adjustments, which total $12.5 million, will give extra dollars to universities that offer high-cost graduate degrees and also to the institutions on the lower end of the funding scale. In addition, the governor recommends a $580-million bond issue for new university buildings and equipment, requiring the schools to pay a 25-percent match.

The governor proposes a 6.1-percent GF/GP increase, to $122.9 million, for student financial aid. He recommends that $4 million of this be used for the HOPE Center for New Technologies, which trains engineers. He also proposes eliminating funding for the Indian Tuition Waiver Program, which allows students who are at least one-quarter Native American to attend colleges and universities tuition-free.

Human Services and Corrections

For the Family Independence Agency the governor is recommending $1,065 million in general funds, a 12.2 percent decline from FY 1995–96. The reduction is due mainly to declining AFDC caseloads (GF/GP savings of $67.3 million) and more federal aid ($83.6 million). The budget assumes a $200-million fiscal dividend from federal welfare reform, because federal payments will be based on FY 1993–94, when caseloads were much higher. If federal welfare reform is not approved, major adjustments in the budget will be necessary

The governor’s proposal transfers Medicaid funding from the Family Independence Agency to the new Department of Community Health, which will receive only a 0.2 percent increase over FY 1995–96 levels. The Medigrant (formerly Medicaid) budget assumes more than $500 million in savings from proposed federal reforms that will convert the program from an entitlement to a block grant and give states more administrative flexibility; of this amount, $400 million is reserved for future use, when costs likely will exceed available funds, and $100 million goes toward expanding medical assistance to low-income children and seniors. If the federal program reforms are not adopted, major adjustments to the Community Health budget will be required.

Under the governor’s recommended budget, the Department of Corrections will receive $1,315.3 million in GF/GP funds, a 3.7 percent increase over the current year—its smallest increase in years. However, when the figures are adjusted for the recommended reduction of $31.7 million in employee health-care costs, the department budget is up 6.1 percent. The capital outlay budget contains a yet-unspecified amount to build four new prison facilities, to ease overcrowding. The governor includes $15.5 million to operate two of the new prisons. Also recommended for Corrections is $5.2 million for 140 new parole and probation officers.

Other Departments and Programs

The GF/GP recommendation for the Department of Environmental Quality is $71.1 million, a 61.2 percent increase. The budget includes $82 million for environmental cleanup, shifting to”pay-as-you-go” rather than relying on long-term bonding as a funding source. Of the total amount, $30 million is GF/GP, with the remainder coming largely from the Natural Resources Trust Fund and unclaimed bottle deposits. The total, all-funds budget recommendation for the department is $309.3 million, a 33.7 percent increase.

The FY 1996–97 GF/GP recommendation for capital outlay is $218.6 million, a 29- percent increase. Funds include a $37.5 million increase in State Building Authority (SBA) rent for projects already approved, $10 million in special maintenance funds for state agencies, and $10 million for aeronautics projects. The budget includes a partial offset of $8.2 million, due to eliminating one-time GF/GP support for SBA-financed construction projects.

The governor also recommends that the SBA’s bonding capacity be raised, from $2 billion to $2.7 billion, to finance new buildings at 6 community colleges and 14 of the 15 universities. The universities must finance 25 percent of the new buildings’ cost

The FY 1996–97 GF/GP recommendation for the Michigan Jobs Commission is $181.5 million, a 60.9 percent increase. The governor proposes transferring $65 million from the school aid budget to the commission, for a Community and Workplace Literacy Grants Program and a new Higher Skills Initiative; also being transferred is $5 million to fund a tax credit to businesses providing apprenticeship opportunities for high school students. These programs are intended to replace the adult education program, which is being eliminated from the school aid budget. Also in the Jobs Commission budget is $3.9 million for economic development job-training grants. The total, all-funds budget for the Jobs Commission is $539.1 million, an 8.1 percent increase.

The GF/GP recommendation for the Department of State Police is $252.8 million, a one-percent increase. The budget includes $3.5 million for a new trooper school, $2 million to boost retirement benefits for troopers who retired prior to the enhanced retirement package secured under collective bargaining, $1.1 million to continue to fund the public safety communications system, and $3.7 million in economic increases (inflation and pay increase adjustments). These new monies are largely offset by a $7.1-million reduction in employee health-insurance costs and a $3.4-million spending adjustment in the FY 1995–96 appropriation. The total, all-funds budget includes $2.4 million from a $1 fee on all insured motor vehicles, which will be used for a program to reduce automobile thefts.

For debt service the FY 1996–97 recommendation is $63.5 million, a 61.2 percent increase. The budget includes a hike of $24.2 million, to cover debt-service obligations of $14.8 million on school-bond loan payments and $9.5 million on quality- of- life bonds.

As mentioned above, this is the first budget in which the major state appropriations for local units of government are consolidated into one line item. The GF/GP recommendation for local funding is $112.7 million, up 16.2 percent. This amount includes an additional $17.4 million for the state match for the Water Pollution Control Revolving Fund (these funds are redirected from the savings achieved from basing general revenue-sharing payments on the prior year); this fund consists of Federal Clean Water Act funding and matching sate/local funds and provides communities with low-interest loans to complete needed work on combined-sewer overflow problems. The total, all-funds local funding appropriation for FY 1996–97 is $2,289 million, a 4.3-percent increase. This budget continues to use the prior-year payment as the basis for general revenue sharing, resulting in a budget savings of $84.6 million (less the $17.4 million diversion decribed above). General revenue sharing payments for FY 1996–97 are $1.32 million, a 5.1-percent increase.

Other Issues

The FY 1996–97 budget assumes that no withdrawals from or payments to the Budget Stabilization Fund (BSF) will be necessary. At the end of FY 1996–97, the BSF will have an estimated balance of about $1.2 billion. In FY 1994–95, $94 million was withdrawn to finance the Nordhouse Dunes settlement. This will be offset largely by a transfer in the current year of $84.5 million from the FY 1994–95 surplus of $112.2 million (preliminary figure).

Article IX, Section 26 (state tax limit) of the state constitution restricts the amount of money the state may collect in any fiscal year to 9.49 percent of Michigan personal income. We project the limit for FY 1996–97 to be $21.1 billion. Estimated revenues are about $1.1 billion below the limit, up from about $0.7 billion (below the limit) in FY 1995–96. This cushion leaves room for raising transportation taxes, a subject likely to resurface as a major issue after the general election. Even if such an increase is enacted, revenues likely will remain under the limit for the foreseeable future, because state revenue, over the long term, grow more slowly than does income.

The FY 1996–97 budget includes $74.6 million to fund the pay package negotiated between the state and the unions representing classified state workers. Much of this cost will be offset by a $68-million reduction in department budgets, reflecting lower health care costs for state employees. Over the last few years the state has been saving money on health care costs, and this is now being reflected in the budget. There is no reduction in health care benefits for state employees.

Comment

The FY 1996–97 budget stands on shaky ground, principally for five reasons.

  • First, without a resolution of the budget impasse in Washington, there will be no welfare or Medicaid reform, and the $400–450 million (Senate Fiscal Agency [SFA] estimate) in savings assumed in the state budget will not materialize, requiring significant reductions in the overall budget. Our view is these reforms will not occur until after the 1996 election, if at all, and they will not be as generous to Michigan as the governor has assumed in the budget.
  • Second, the proposal to eliminate adult education will meet strong legislative resistance. If this recommendation is not approved, an additional $105 million will have to be appropriated to the school aid fund or the foundation grant, or “at-risk” funds will have to be reduced. Also, there already is pressure to add more funds to raise the foundation grant.
  • Third, the administration assumes moderate economic growth in 1996 and 1997. This is reasonable, but recent economic indicators appear to be signaling a sharper slowdown. Our view is that the revenue forecast for FY 1995–96 is achievable, but that the revenue forecast for FY 1996–97 could be at least one percent too high. This would translate into a GF/GF and SAF revenue shortfall of $168 million.
  • Fourth, the recommended increase for the Department of Corrections is only 3.8 percent, the smallest in many years (as far back, in fact as the SFA has records). One reason for the small increase is a $31-million drop in employee health-care costs; adjusted for this reduction, this increase is 6.1 percent. The recommended amount may not be enough: a supplemental appropriation may be required in FY 1996–97, or more costs may be shifted to local governments.

    For the longer term, the corrections outlook is not encouraging. There has been much publicity recently about a drop in the crime rate, due in part to there being fewer people in the prime crime-age group (15–29)—the number dropped about 30 percent from 1980 to 1995 (see Exhibit 7). However, from 1995 to 2000 there will be only a slight decline, and then the size of this age group begins to increase, until 2015. Without some major changes, many of which have yet to be identified, Corrections will continue to be a major growth industry in Michigan (and most other states).

  • Fifth, there still appears to be considerable legislative support for more tax cuts, although Governor Engler is urging caution. A group of Democrats are advancing a plan to cut the state income tax, reducing revenue by as much as $2 billion over the next five years. We will be surprised if this passes, but not if more modest cuts are enacted.

Over the last four years the state budget has benefitted from a solid economic recovery, favorable demographic trends, increasing federal aid, and a downsizing and increased efficiency of many state programs. All these favorable developments are about to end. Increasing school- (see Exhibit 8) and crime-age populations, declining federal aid, slower revenue growth, and slower gains in state government efficiency will strain available resources. At risk will be K–12 and higher education and most general-government functions. Fortunately, the $1-billion-plus balance in the BSF will provide a cushion for a few years, but if the economy falls into a recession, this money could be used up in two years.

Governor Engler and the legislature have done an admirable job of managing the state’s finances and reducing taxes, with some help from the economy and the federal government, but it remains to be seen if they can do as well without a net.

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Copyright © 1996

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