Michigan's Long Fiscal Nightmare: March 2009

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Money and scissors

As the automobile industry struggles to survive, is there hope for the state's recession-wracked economy?

By Mark Hornbeck

Michigan’s long-standing state budget crisis is inextricably linked to the domestic auto industry’s freefall and, in some ways, one mirrors the other.

The Midwest state and its once-mighty car giants are in protracted down cycles, unprecedented in their length and severity. Both the state and the automakers have done some restructuring and downsizing, with labor wage concessions and retirement cost reductions among the austerity measures.

As 2009 opened, the Detroit-centered Big Three and the state of Michigan were depending heavily on the promise of federal bailouts. The automakers are hoping a $17.5 billion loan package will help them hold on while the state awaits agreement in Washington on a multi-billion-dollar federal stimulus plan from the new president. (State Legislatures went to press before final action on the economic recovery plan.)

“What’s happened to the state budget is all about the deterioration of the American auto industry,” says Mitchell Bean, director of Michigan’s House Fiscal Agency. “We’re seeing things we’ve never seen. The auto industry is not bouncing back like it has in the past. And we’ve never before had contraction in employment that has lasted this long—eight years and counting.”

As a consequence, two governors and lawmakers in four legislative sessions have contended with eight consecutive years of recession. Aside from budget cuts, they have resorted to tax hikes, accounting gimmicks, borrowing against the lawsuit settlement with the big tobacco companies, and raids on countless other one-time funding pots. Critics say the state should have made changes in its revenue and spending structure that would have provided long-term stability.

Thanks partly to the financial market collapse and the national recession, the long fiscal nightmare in Michigan is far from over. The state enacted $134 million in executive order cuts in December, including the shutdown of a prison, a prison camp and a girls’ reform school. Yet it still faces a $200 million shortfall in the budget year that ends Sept. 30, even when allowing for more than $700 million in carry-over cash from last fiscal year, according to the Senate Fiscal Agency.

What’s more, the hole could grow to $1.5 billion in 2010, the number crunchers forecast. Much depends on the size of the federal stimulus windfall and how state policymakers decide to spend it.

“Michigan has been like an army that doesn’t retreat very well,” says Bob Emerson, state budget director the past two years and before that the Democratic leader in the Senate. “But given the amount of reductions that have occurred in the budget, we’ve coped reasonably well.”

Senate Majority Leader Mike Bishop says substantial reforms and cuts must be executed this year, adding that Michigan citizens “must accept a different form of government.

“I don’t like to say we’ve got to cut, cut, cut. I never thought I’d be in government to say that. But it is the reality of our times. This is the discussion we have to have,” says Bishop.

Governor Jennifer Granholm characterizes the state’s fiscal woes this way: “The recession that is gripping the nation got its start in Michigan where we’ve been losing manufacturing jobs since 2000. The decline of manufacturing has wreaked havoc on our state budget and has forced us to prioritize what is important to citizens. We’ve protected funding for public safety, education and health care, using both one-time and permanent revenue sources.”

Granholm credited bipartisan cooperation in the Legislature for approving new revenue measures in 2007. “It’s when times are tough that education is critical to economic opportunity, when a lack of health care can turn a problem into a crisis, and when safety becomes ever more important as people are feeling vulnerable.”

Representative Matthew Gillard, outgoing vice-chair of the House Appropriations Committee, says Democrats forced the tax-hike solution when they took over the House following the 2006 elections.

“We relied mostly on one-time fixes and cuts until Democrats took control of the House [in 2007]. Then we were able to raise some revenues,” says Gillard, who left the Legislature at the end of December.

Persistent Recession

Numbers sometimes lie, but not this time.

Michigan is the only state that has seen employment decline eight years in a row, having lost 520,000 jobs during that span, the lion’s share in manufacturing.

The rule of thumb for a national recession is two consecutive quarters of gross domestic product decline. Michigan has seen its GDP dip six of the past eight years, when adjusted for inflation.

The steady economic decline has exacted a heavy toll on state tax receipts. The general fund stood at $9.74 billion in FY 2001 and is at $9.70 billion today—even with state income and business tax increases in 2007 that amount to more than $1.4 billion annually.

The state has maintained some overall spending growth, because increases in federal money and restricted state cash have offset declines in the general fund, a House Fiscal Agency study shows.

How have the governor and the Legislature responded?

A review of the state budget by the respected Citizens Research Council of Michigan shows the state used more than $7.8 billion in one-time funding sources between 2001 and 2007.

For example: In the final two years of Governor John Engler’s administration (2001-02) and early in the Granholm tenure, the state used up its $1.36 billion rainy day fund and another $984 million in school fund surplus.

A Medicaid Benefits Trust Fund was drained of $561 million. The state borrowed $407 million against future revenue from the tobacco settlement money in 2007. An infusion of one-time federal cash totaling $655 million rescued the budget from a red-ink bath two years ago.

In addition, bonds were refinanced, higher education payments delayed, education tax collection dates moved up and contributions to retirement systems reduced. In addition, state employees agreed to $186 million in wage concessions.

“There’s been reluctance on the part of two governors and several sessions of the Legislature to make the kind of permanent changes in policies that would help bring spending pressures and revenue growth in line,” says Thomas Clay, former state budget official and an analyst for the Citizens Research Council.

“That’s understandable, because elected officials are not interested in angering their constituents, advocates of programs don’t want them cut and residents don’t want their taxes increased. But we’ve seen eight years of more one-time patches than permanent changes and the tax structure is not fundamentally different than it was eight years ago.”

Reduction in Growth

The governor’s office reports more than $3 billion in budget cuts over the past six years, but much of that is a reduction in growth rather than actual program slashing.

“There’s not been an effort to do major cuts in the budget,” says Gary Olson, director of the Senate Fiscal Agency. “Instead, we initially ran down all our reserves, we changed retirement funding assumptions, we made accounting assumptions for one-time savings, we borrowed against tobacco settlement revenues. And we raised taxes significantly because we ran out of other things to do.”

Representative Craig DeRoche, who served the last two years as House minority leader and was speaker of the House the two years prior to that, said the Legislature didn’t make the profound changes state government and taxpayers needed.

“We have changed individual things beneath the surface but we haven’t had a core government change in the way we serve people and the function of Michigan’s government,” says DeRoche, who also left the Legislature at the end of December.

When cutting was done, higher education and revenue sharing with local governments suffered the brunt of the budget ax. A review by the Senate Fiscal Agency shows revenue sharing down 13 percent, funding of state universities down 4.8 percent and community colleges off 3.7 percent since 2002.

All other general spending categories were stable or increased, led by a whopping 51 percent boost in community health (Medicaid) and 21 percent in corrections.

“It’s easier to push a solution onto somebody else rather than cut a specific program,” says Summer Minnick, lobbyist for the Michigan Municipal League, which opposed the revenue sharing cuts. “Revenue sharing is an innocuous term. People don’t understand that means sidewalks, senior programs, police and fire protection.”

Revenue sharing totaled $1.5 billion in 2001 and $1.1 billion today. The league reports municipalities have cut 2,400 firefighters and 1,800 police officers since 2000, at least partly because of revenue sharing reductions.

Emerson, the state budget director, says revenue sharing was a relatively easy target because communities can go to their taxpayers for property tax increases to maintain essential programs.

“If services are that important, they can levy local taxes to make up the money,” he says.

State funding of higher education peaked at $1.6 billion in 2001-02 and is at $1.47 billion now. No other state has had an overall reduction during that time. Mike Boulus, who heads the Presidents Council of State Universities of Michigan, says the cut has amounted to $2.4 billion when taking inflation into account.

“It’s easier to cut higher education for a couple of reasons,” Boulus says. “First, we have an alternative source of revenue in tuition. Also, we don’t have a tremendous political constituency. They can cut universities and go home and not feel the pain. Only 15 senators and 15 representatives have state universities in their districts.” (The state has 38 senators and 110 representatives.)

Public school aid has generally been protected from cuts, but lagged inflation. Human services programs also have survived largely intact, although advocates decry restrictions on eligibility for cash assistance and temporary cuts to some health care programs for the poor.

“There’s been steady erosion, like death from a thousand cuts,” says Sharon Parks, CEO of the Michigan League for Human Services.

New Taxes

On the revenue side of the equation, the governor and Legislature passed a couple of cigarette tax hikes totaling 75 cents per pack early in the decade. A variety of user fee increases—for items such as driver’s licenses, environmental permits and professional certifications—also won approval.

But political leaders held off on major tax hikes until 2007. In that year—after a lot of teeth-gnashing, arm-twisting, marathon sessions and a brief state government shutdown—the Legislature raised the state income tax from 3.9 percent to 4.35 percent.

Also, a 22 percent surcharge was tacked onto the new Michigan Business Tax as a replacement for a levy on services that prompted so much howling from the business community it was struck down before it was implemented. Business leaders and many lawmakers now are looking for ways to quickly roll back the surcharge, which is seen as a detriment to economic development.

The tax hikes triggered a series of recall attempts against Democratic House members. Only one recall made that ballot, however, and it was unsuccessful.

“The Legislature eliminated the state shortfall by increasing the citizens’ personal shortfalls,” says former Representative Leon Drolet, who organized the recall efforts. “By increasing taxes, government was able to protect itself from the hardship citizens are facing. It’s a continuing pattern of irresponsibility.”

There’s a growing cry in Michigan for government to enact profound tax and spending reforms to erase a structural deficit that threatens to eclipse $1 billion in the coming year, especially in light of the national economic distress. Discussions have focused on reforming the corrections department, because Michigan has a larger inmate population and higher per-prisoner costs than its Midwest neighbors.

Republican lawmakers also are expected to take aim at optional Medicaid programs, although such efforts generally have been resisted by the Democratic House and governor in past years. It’s unclear whether there will be state employee layoffs or further wage and benefit concessions.

Senate Appropriations Chairman Ron Jelinek concedes that it’ll be difficult to fight the temptation to make ends meet over the next couple years mainly by using the federal stimulus windfall along with a few minor program cuts.

“We’ve done some serious cutting of budgets, but certainly there’s been some smoke and mirrors,” Jelinek says. “If we had done fewer accounting shifts and one-time measures over the years we’d be better off today. But it’s hard to reach agreements on cuts. Everybody has something in the budget that’s near and dear to them.

“The great debate this year will be over whether to use the federal stimulus money to balance the budget, and that will be a temptation. But we really should use it to stimulate the economy, not balance the books.”

Mark Hornbeck has been covering state government for 25 years, the last 20 as a staff writer for the Detroit News Lansing Bureau.