by Robert J. Kleine, Vice President and Senior Economist

This Advisor summarizes the highlights of Governor Engler’s recommended state budget for fiscal year 1997–98. It comments on the budget’s economic assumptions as well as its controversial aspects. Fiscal year 1997–98 will begin on October 1, 1997, and end on September 30, 1998.

Introduction

Governor Engler’s FY 1997–98 general fund/general purpose (GF/GP) budget recommendation is $8.525 billion, an increase of 2.7 percent from the current year appropriation. For most departments, this is a continuation budget, with increases near the administration’s projected inflation rate of 2.3 percent (which in our view is a low estimate).

Exhibit 1 shows that the budget’s largest dollar increases are $61.6 million for higher education, $56.8 million for school aid, $43 million for transportation, $34.6 million for law enforcement, and $30.9 million for environmental protection.

Unlike recent years, there are few significant budget reductions. The largest cut is $44 million in the Department of Community Health, but this is a result of technical adjustments to the FY 1996–97 appropriation rather than actual program reductions. The $24 million reduction in the Family Independence Agency is due mainly to a decline in the Family Independence Program (formerly AFDC) caseload and a financing shift to federal aid. On a percentage basis, the largest reductions are 10 percent in the Department of Agriculture and 7.2 percent in the Department of Treasury. Neither decline reflects significant program reductions; the former is due to a technical adjustment to the FY 1996–97 budget and the replacement of general fund support with restricted revenues and the latter to a reduction in required Tax Increment Finance Authority (TIFA) payments (due to changes in the TIFA program under proposal A of 1994) . The state’s new early retirement program is expected to reduce employment by about 3,000 and save about $6 million in GF/GP expenditures and about $19 million in total expenditures; only a portion of the actual savings are assumed in the budget.

As shown in Exhibit 2, the largest budget increases are recommended for capital outlay, 143.1 percent, reflecting almost $16 million in new money for special maintenance and remodeling for state agencies and $10 million for aeronautics projects; the Department of Management and Budget, 35.3 percent, due to a recommended $20 million for ensuring that state computers meet the year 2000 standards; the Department of Environmental Quality, 31.7 percent, due to a proposed $33.3 million appropriation for environmental cleanup, brownfield development, and safe drinking water; and the Department of State, 31.5 percent, reflecting $4.5 million in additional general fund support for technology improvements. The GF/GP School Aid budget is up 19.2 percent, with new monies for Renaissance Zone costs and a new career preparation program, a transfer of school-bond debt service payments from the Department of Treasury, and a $20 million base adjustment to reflect reduced advance cash-flow payments in FY 1996–97.

The total budget recommendation is $30.9 billion, a 4.9 percent increase. This is much larger than the recommended GF/GP increase due primarily to technical adjustments in the Department of Community Health and an increase in restricted funds (mainly child support payments in the Family Independence Agency). For the first time in recent memory, there is no significant increase in federal aid, which is projected to increase only 1 percent in FY 1997–98.

The FY 1997–98 budget provides funding for 64,584 classified full-time equated positions (FTEs), down 1,061 positions, or 1.5 percent from FY 1996–97. The largest recommended reductions are 435 positions in the Family Independence Agency, 528 positions in the Michigan Jobs Commission (MJC) and Consumer and Industry Services (CIS) combined (over 2,000 positions have been transferred from the CIS Department to the MJC), and 216 positions in the Department of Transportation. The only significant increase is 88 positions in the Department of Management and Budget (see Exhibit 3).

Budget Assumes Continued Moderate Economic Growth

The governor’s recommended budget is based on reasonable, though somewhat conservative, economic assumptions. It assumes that real (adjusted for inflation) gross domestic product (GDP) will remain near the 1996 growth rate in 1997 and 1998. Although the budget estimates 1996 GDP growth at 2.3 percent, preliminary year-end numbers indicate a higher rate of 2.7 percent. This means that the forecast for 1997 and 1998 is probably conservative. The key national economic indicator for Michigan is motor vehicle sales, which are projected to remain nearly flat over the forecast period—15 million units in 1997 and 15.1 million units in 1998.

The Michigan economy is expected to grow faster than the national economy in 1997 and 1998, following slower growth in 1996, with real Michigan personal income accelerating from 1.6 percent in 1996 to 2.5 percent in both 1997 and 1998. Michigan wage and salary employment is projected to increase 1.5 percent in 1997 and 1.4 percent in 1998 (compared with a 1.6 percent increase in 1996). The unemployment rate is expected to remain slightly below the national rate throughout 1997 and 1998. Inflation in Michigan is forecast at 2.4 percent in 1997 and 2.3 percent in 1998, compared with a 2.9 percent increase in 1996 (the budget estimates a 2.6 percent increase for 1996). This estimate is inconsistent with the budget projections for faster economic growth in 1997 and 1998 than in 1996. Our forecast is that inflation will increase 2.8–3 percent in 1997 and 1998.

The baseline GF/GP and school aid fund (SAF) forecast is for 4.5 percent growth in both FY 1996–97 and FY 1997–98. This compares with growth of 5.1 percent in FY 1995–96. Several enacted tax policy changes have reduced available revenue. In FY 1996–97, previously adopted tax cuts and other tax adjustments are expected to reduce revenue by about $105 million. In FY 1997–98, tax changes are expected to reduce revenue by $209 million. As a result, available GF/GP revenue is expected to decline 2.1 percent in FY 1996–97 and increase only 2.8 percent in FY 1997–98. The budget also includes about $17 million in one-time revenue and recommends fee increases of $4.4 million (see Exhibit 4).

The state’s largest revenue source is federal aid, accounting for about 24 percent of total revenue. Federal aid is estimated at $7.46 billion for FY 1997–98, a 0.9 percent increase. The Department of Community Health and the Family Independence Agency account for about 68 percent of total federal aid.

Education and Health Nearly Two-Thirds of State-Financed Spending

Depicted in Exhibit 5 is state own-source revenue, which excludes funds from federal, local, and private sources. It includes all revenue directly collected from state residents, both earmarked (dedicated to a specific purpose) and discretionary GF/GP funds. Sales and use taxes are the state’s largest revenue source (excluding federal aid), providing 30.1 percent of own-source state revenue, followed by the income tax, which provides 26.7 percent, and the SBT (and the insurance premiums tax), which generates 11.7 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 tax. The state education property tax now accounts for 5.3 percent of state revenue.

Exhibit 6 presents the governor’s recommended FY 1997–98 distribution of own-source revenue among state programs. K–12 education now is by far the largest program, accounting for 41.6 percent of spending. The Department of Community Health, which includes the former departments of Mental Health and Public Health and Medicaid, is the second largest category (health), accounting for 12.5 percent of spending. None of the other budget categories account for more than 8.8 percent of state spending.

Most Department Receive Continuation Budgets

As was the case last year, the FY 1997–98 budget provides modest increases for most departments. One significant difference is that there are fewer recommended budget cuts than last year. The FY 1997–98 recommended cuts are about $125 million, compared with cuts of $253 million (excluding school aid) in the FY 1996–97 budget. About $325 million (GF/GP) is recommended for new program increases, with the largest share going to the departments of Community Health and Transportation, higher education, and capital outlay (see Exhibit 7). This section discusses those departmental budgets for which major funding or policy changes are recommended in FY 1997–98.

Education

The governor recommended a 6.3 percent increase in funding for K-12 schools. The per pupil foundation grant, however, will be only 2.6 percent higher than last year because of an enrollment increase of 25,000 students that will lower the amount for each student. The GF/GP grant to the school aid fund is recommended at $348.8 million, a 19 percent increase. Adult education, which was cut sharply last year, is recommended to receive $80 million, the same amount as last year. However, $20 million of this amount has been shifted into competitive adult education grants in accordance with legislative intent, for a total of $40 million allocated to competitive grants. The total All Funds1 budget recommendation is $9.14 billion, a 6.3 percent increase.

The state’s universities are recommended to receive a 3.5 percent increase. Each university will receive an additional 2.5 percent for operations, and $17.3 million will be provided for State Building Authority (SBA) rent to reflect the increased cost of new university buildings that will open in FY 1997–98. In addition, the Michigan College Tuition and Fees Credit Act, which provides income tax credits for tuition payments to universities that keep tuition increases at or below the rate of inflation, will provide $13.7 million in tax relief. For tax year 1996, tuition payments to 9 of the 15 state universities qualified for the credit.

The community colleges budget is recommended at $281.1 million (all GF/GP), a 4.6 percent increase. About $6.5 million of the increase is allocated for college operations, a 2.5 percent increase; $2.8 million is recommended as a special one-time adjustment to meet technology needs, with the funds to be distributed on a per-student basis. Also included in the budget is $2.8 million for SBA-debt service to reflect the increased costs of new college buildings that will soon be opening.

Human Services

The Family Independence Agency (FIA) is recommended to receive a 2.2 percent, or $24 million, reduction in FY 1997–98 GF/GP funds. The cut is partially due to a decline in caseloads for the Family Independence Program (formerly AFDC), amounting to a $112.4 million savings. The decline is also due to the replacement of some GF/GP funds with federal block grants under the federal Temporary Assistance to Needy Families program.

The budget includes an additional $20 million for the Work First program ($18 million of which would come from the Jobs Commission budget), $16.7 million more for day care, and $12 million to implement the Lieutenant Governor’s Children’s Commission recommendations. It also includes federal block grant funding to offset $80 million in general fund costs and to create an $85 million reserve for future FIA costs. The All Funds recommendation is $3.10 billion, a 3.7 percent increase.

The governor recommended a 2.6 percent increase in GF/GP funds for the Department of Corrections and a 2.8 percent increase in total funding. The increase continues last year’s trend of slowing growth in corrections spending, which, at 3.8 percent, had been the smallest increase in twenty years. (Corrections spending increased at an annual rate of 9.6 percent from 1990 to 1996.) Despite slower growth in spending, which the governor attributes to increased efficiencies, an additional $13.8 million in GF/GP funds is recommended for prisoner health care services. This includes a $3.5 million increase in funding to treat AIDS, $5 million for higher health care costs to support new prisoner housing units, and $1.8 million more for substance abuse treatment. While the slowdown in corrections costs is good news for the state budget, Michigan’s prisons are currently at 98 percent of capacity, and it is doubtful that increased efficiencies will be able to hold costs down much longer.

The GF/GP recommendation for the Department of Community Health, formerly Medicaid and the departments of Public Health and Mental Health, is $2.04 billion, a decrease of $44.3 million, or 1.8 percent, from FY 1996–97 spending. Total funding for the department is recommended to increase 3.5 percent to $7 billion, about 23 percent of total state spending. The drop in GF/GP funds is due to technical adjustments rather than program reductions. These adjustments partially reflect lower-than-expected FY 1996–97 spending for Medicaid, which had been estimated to increase 5.5 percent but actually rose less than 4 percent. The governor also recommended consolidation or closure of three of the state’s psychiatric hospitals—The Detroit Psychiatric Institute, Pheasant Ridge Children’s Center, and Clinton Valley Center.

Other Departments and Programs

The GF/GP recommendation for the Department of Environmental Quality is $144 million, a 31.7 percent increase. It includes $25.8 million to cover debt service for bonds used to finance environmental cleanup and brownfield redevelopment programs. The recommendation also provides $17.5 million to match federal funds that Michigan receives for the state water pollution revolving fund. This fund provides loans to local units of government for combined sewer overflow projects. Also included in the budget are restricted fee increases totaling $3.6 million, the largest being a $1.6 million increase in existing oil and gas surveillance fees, which will be used to expand regulation of oil and gas wells. The total All Funds budget recommendation for the department is $462 million, a 9 percent increase.

The GF/GP recommendation for capital outlay is $59.8 million, a 143.1 percent increase. The budget includes $15.8 for special maintenance and remodeling projects for state agencies, $10 million to fund aeronautics projects, and an $8.7 million increase in SBA rent for projects already completed. The budget includes a partial offset of $8.2 million due to the elimination of one-time general fund support for SBA-financed construction projects. The total All Funds budget recommendation is $397.1 million, a 20.8 percent increase. The governor also is recommending that the bonding capacity of the SBA be increased from $2 billion to $2.7 billion, a repeat of last year’s request that was never approved.

For the first time in recent memory, a GF/GP appropriation for the Department of Transportation(MDOT) has been recommended. The governor recommended creating a State Economic Development Fund, financed with $43 million from the general fund, which would be used to improve and expand the state’s highway and road system. The total All Funds budget is $2.3 billion, up 9.5 percent from FY 1996–97.

The governor recommended $181 million in additional revenue for highway maintenance and construction, with $80 million allocated to local governments and $101 million to state highway, road, and bridge construction projects. The proposed sources are: (1) $30 million from earmarking revenue-sharing growth above the rate of inflation; (2) $12 million in MDOT administrative savings; (3) $43 million from the general fund; (4) $28.5 million from the recently enacted increase in the diesel-fuel tax; (5) $11 million from elimination of the spillage allowance; (6) $30 million in anticipated collections of delinquent child support payments, which will require legislative approval; and (7) $25 million in growth from current revenue sources. The governor also proposed that Michigan lobby Washington to increase federal transportation aid to Michigan by $200 million annually. The transportation revenue estimate assumes this $200 million will be received beginning in FY 1996–97, but it has not been reflected in the recommended appropriation.

The GF/GP recommendation for the Department of Management and Budget is $64.4 million, a 35.3 percent increase. It includes a $20 million ($37.1 million in total) GF/GP request to fund a multi-year programming effort to ensure that state computers meet Year 2000 standards. Excluding these new monies, the budget is 6.7 percent below the FY 1996–97 appropriation, due mainly to the replacement of capital outlay monies with restricted funds ($2.2 million) and technical adjustments.

The FY 1997–98 request for the Department of State is $21.7 million, a 31.5 percent increase. This large increase is due mainly to a $3.4 million recommendation for technology improvements to the branch-office intelligent-terminal system and $1 million for data center consolidation costs. The All Funds appropriation is $169.5 million, a 6.9 percent increase.

Other Issues

The FY 1997–98 budget assumes that no withdrawals from or payments to the Budget Stabilization Fund (BSF) will be required. The FY 1995–96 budget ended with a surplus of $88.1 million, and $58.1 million of this amount was transferred to the BSF. The BSF will have an estimated balance of about $1.3 billion at the end of FY 1997–98. The Senate Fiscal Agency estimates the BSF trigger would require a payment of about $91 million in FY 1997–98.2

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. The limit for FY 1997–98 is an estimated $21.2 billion. FY 1997–98 estimated revenue is about $1.4 billion below the limit, up from about $1.3 billion (below the limit) in FY 1996–97. This cushion leaves room for an increase in transportation taxes, although the likelihood of an increase in the near future has diminished. Even if such an increase is enacted, revenue is likely to remain below the limit for the foreseeable future because state revenue—over the longer term—grows slower than income.

Comment

One of the controversial aspects of the budget is the governor’s failure to recommend an increase in transportation taxes. The revenue measures included in the budget are deemed inadequate by highway interest groups and others. There appears to be little disagreement outside the Engler Administration that road maintenance needs are well in excess of available resources. About 44 percent of interstate mileage in Michigan is in poor or mediocre condition, according to the U.S. Department of Transportation, ranking the state 13th highest (or worst) among the 50 states (1993 data). In Ohio, for example, only 10.3 percent of interstate miles are rated as poor or mediocre. Michigan per capita spending for highways is $200 (the U.S. average is $261), ranking the state 49th (1992 data). Only South Carolina is lower, and its roads are in less need of repair. Highway spending in Michigan is 5.3 percent of total state and local spending, ranking Michigan 47th; the national average is 6.9 percent.

A major cause of this low level of spending is that the Michigan gas tax is only 15 cents—only six states have a lower rate—and 46 states have raised their rate since Michigan last raised the tax in 1984.3 The governor’s position is that the MDOT must become more efficient before he will support a tax increase. There is ample evidence, however, that the department has made major strides in becoming more efficient through reductions in employment, reorganization, privatization, and better planning. Michigan has 13.5 state and local highway employees per 10,000 population (1992 data), ranking the state 49th. The national average is 21.3 employees, and the average of the other five Great Lakes states is 21.1. This is dramatic evidence that the department has carried efficiency about as far as it can go.

Funding for education also will generate a spirited debate in the legislature. Both K-12 and higher education supporters are unhappy with the recommended level of support. The school aid appropriation is $9.136 billion, up $348.8 million, up 6.3 percent from the FY 1996–97 appropriation. This seems generous by any standard. However, the basic foundation allowance is $5,445 per pupil, up only 2.6 percent on average, and up even less for districts spending in excess of the average. Since the new financing system took effect in FY 1994–95, the foundation grant has increased 8.9 percent, an average annual increase of 2.9 percent. Over the same period, the Detroit-Ann Arbor CPI has increased at an annual rate of 3 percent, which means the average district is just treading water. Most school officials were expecting larger increases under the new financing system, particularly during a period of economic growth that has been labeled by the governor and others as the best in 30 years.

The culprit is higher enrollments and a mature economic recovery. Original estimates were that school enrollments would increase about 3/4 percent annually; the actual increase has been twice that. The FY 1997–98 school aid budget projects an increase of 25,000 students (on a funding basis, the increase is 32,000), which will cost about $190 million. If enrollments had increased at the original projected rate, the foundation grant would have increased another $41, or 3.4 percent in total. It is true that the economy continues to do well, but the growth rate has slowed, and this fact—combined with state tax cuts—has meant smaller increases in revenue: a projected increase of about 4 percent in school aid revenue in FY 1996–97 and FY 1997–98, compared with increases of 6–7 percent from 1992 to 1995. School officials are rightly concerned about what will happen during the next recession. The good news is that enrollment increases statewide will begin to slow significantly by the year 2000, relieving some of the financial pressure on those districts not experiencing enrollment gains.

For the short term, there will be pressure to put more money into school aid, as was done in the current budget, to ensure that the foundation grant increases about 3 percent, which is the consensus forecast for inflation. The governor’s budget, however, uses an inflation forecast for Michigan of 2.3 percent for 1998. Our view is that this is more of a political prediction than a reasonable economic forecast. This number might make sense if slower economic growth was projected, but the forecast is for faster growth in 1997 and 1998 than in 1996 (for example, real Michigan personal income is projected to increase 2.5 percent in both 1997 and 1998, compared with 1.6 percent in 1996, when the Detroit CPI increased 2.9 percent).

The recommended appropriation for state universities is up 3.5 percent, but the proposed increase for operations is up only 2.5 percent. University officials are generally not happy, after being spoiled by a 5.5 percent increase last year. The Executive Budget points out that per pupil appropriations increased 32 percent from 1990 to 1998, compared with a 25 percent increase in inflation. University officials, however, could point to Michigan’s parsimonious state spending of only $3,281 per pupil (1992 data), compared with a U.S. average of $5,351. Michigan ranks 42nd among the 48 states for which data are available. The average per-pupil spending of the other five Great Lakes states was $5,253. This explains in large part why the average tuition (and fees) at Michigan’s public universities was $3,481 in FY 1993–94, 8th highest in the nation and 37 percent above the U.S. average. Michigan’s average tuition was 6.8 percent above the tuition in Ohio, which was second highest among the Great Lakes states.

The governor and the legislature would like universities to keep tuition increases to no more than the rate of inflation (and an income tax credit is available to those who pay tuition to encourage such behavior), but a 2.5 percent increase in state funding will not be enough to allow universities the luxury of such modest tuition increases. There will be pressure to add to the higher education appropriation, but we do not expect any significant increase.

1All Funds refers to the total appropriation for a department or program. In most cases, it is larger than the GF/GP appropriation because it includes federal, restricted, local, and private funds in addition to GF/GP funds.
2If real Michigan personal income increases more than 2 percent in the calendar year prior to the beginning of the fiscal year (1997 for FY 1997–98), a payment to the BSF is triggered. The amount is determined by multiplying the percentage growth above 2 percent by GF/GP revenue.
3Michigan also levies the 6 percent sales tax on gasoline, which is the practice in only a few states. If the sales tax is included, Michigan is near the national average. The sales tax on gasoline, however, is not allocated to transportation programs.

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Copyright © 1997

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