Now is the time for investing, not cutting taxes

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May 2017
Rachel Richards, Legislative Coordinator

Budget Brief JPG USE THIS ONE

As Michigan legislators continue to debate state spending for the upcoming budget year, the Michigan League for Public Policy advocates for a budget that helps make Michigan the place where businesses, communities and residents thrive, including affordable, high-quality child care; good public schools and access to college; safe communities; and drivable roads.

The Michigan Senate and House have approved separate versions of the 2018 state budget. Differences between the two will now be worked out in joint House/Senate conference committees which will be convening in the coming weeks after expected revenues for the upcoming year were determined at the May gathering of economists and budget experts.

Both the House and Senate budgets fall short in several key areas, and more could be done. The House underspent the governor’s budget by about $270 million, and the Senate underspent the governor by about $540  million. Neither chamber spent all state General Fund dollars available that could be utilized to help enhance many important state programs instead saving them to be later allocated for tax relief, pension reform or “rainy days.”

The League opposes tax cuts that further reduce the state’s General Fund or School Aid Fund because they could derail the state’s long-term economic vitality. The evidence is clear that investments in education and infrastructure are directly connected to economic growth. Yet, when adjusted for inflation, ongoing General Fund revenues in the current year are lower than they were 50 years ago—increasing the state’s reliance on uncertain federal funds.

WHAT ABOUT REVENUES?

The final budget will be based on state revenue amounts, namely General Fund and School Aid Fund revenues, which were determined at the second Consensus Revenue Estimating Conference of the year. Revenue estimating conferences are held in January, which create the basis for the governor’s proposed budget, and May, which provide the basis for the final budget negotiated between the Legislature and the administration.

At the May revenue estimating conference, combined School Aid and General Fund revenues were slightly up as compared to January. While School Aid revenues are coming in above January estimates, General Fund revenues are not as strong as originally anticipated. When combining adjustments for both the current budget year and next year, lawmakers will have $293 million less in General Fund revenues but $340 million more in school aid fund revenues to craft the 2018 budget. While the state is not in a deficit, and we are anticipating revenues to grow year after year, lawmakers will not be able to provide the necessary investments to help Michigan’s businesses, residents and economy.

BB-Now is the time for investing graphic

NO WIGGLE ROOM FOR TAX CUTS

What is clear from the revenue estimating conference is that the state cannot afford a tax cut. Rolling back the state income tax would ultimately eliminate a funding stream worth about $10 billion and put a significant strain on the state’s ability to fund schools, roads, communities, healthcare, safety net programs and public safety. Even a small 0.1 percentage point reduction in the income tax rate—about $250 million—impacts Michigan’s budget, which includes growing costs. In return for increasingly underfunded schools and crumbling roads, Michigan taxpayers would receive a small annual benefit, which for many would be barely noticeable as it is spread over paychecks. A tax cut would benefit the wealthy most, while the rest of the state would have to deal with worsening roads, underfunded schools and fewer services. Lawmakers should avoid the tax cut gimmick.

Michigan has been down the tax-cut road before. General Fund revenues have not kept up with the rate of inflation; between budget year 2000 and anticipated 2019, inflation increased 73% while General Fund revenues are actually down about 1%.1 Tax policy changes, including Personal Property Tax reform and the recent transportation package, will further constrain General Fund revenue growth. These changes, along with the ongoing costs of business tax credits, will cost the state over $2 billion by budget year 2022. At the same time as the state has been cutting taxes, lawmakers have started looking at spending reforms that put the state’s long-term fiscal stability at risk without improving educational or other important state services. The state will be required to spend more as it has been provided with less, which simply leaves fewer and fewer quality services for Michigan residents. Further tax cuts, and greater spending necessities, would only impair the state’s ability to pay for its basic needs.

Instead, what the revenue estimating conference shows is Michigan’s need for adequate and stable revenue streams, and lawmakers should start looking at revenue enhancements:

  • Regularly review existing tax deductions, exemptions and credits and eliminate those no longer meeting their purposes;
  • Improve the fiscal note process so lawmakers have a clear understanding of the costs of future tax changes;
  • Review Michigan’s current business tax structure to ensure everyone who uses state resources pays their fair share;
  • Implement a graduated income tax; or
  • Diversify Michigan’s sales tax base to tax personal services.

WHAT SHOULD BE DONE INSTEAD?

In the light of lacking political will to raise revenue, lawmakers this budget season need to start looking at places to get the biggest impact—especially places where small state investments draw down significant federal funds. By providing a small amount of heating assistance, less than $7 million total, the state will leverage more than $300 million in federal funds, and 338,000 families in Michigan would receive an average of $76 more in food assistance each month. Additionally, expanding eligibility for child care assistance would help us meet state match requirements and ensure that we are not turning back federal dollars. Ultimately, investments above and beyond what have been included in either the House or Senate budgets are necessary to make sure Michigan becomes a state where all businesses, communities and residents succeed.2

ENDNOTES

  1. Elizabeth Pratt and David Zinn, Senate Fiscal Agency, General Fund/General Purpose Revenue Growth, State Notes, Spring 2017.
  2. For ways we can improve the state through the budget process, please see “Budget Briefs” produced by the League.

Review tax expenditures to help fix Michigan’s broken revenue stream

pdficonMichigan has a budget problem, and simply put, there just isn’t enough money to go around. Michigan has experienced crisis after crisis—the Great Recession, nearly record-high unemployment, municipal financial emergencies, the city of Detroit’s bankruptcy, the Flint water crisis and the financial struggles of Detroit Public Schools to name a few. In attempting to fix them, the state has relied on budget cuts, temporary Band-Aids or one-time pots of money. It hasn’t worked. Michigan’s disinvestment in its schools, infrastructure, communities and people needs to be reversed, and it cannot do so without more revenue.

Revenue tax expenditures chart 1Unfortunately, at the same time that the state needs more money, policy trends have continually pulled more out of our state budget. In recent history, we have spent more in state and local tax credits, deductions and exemptions each year than we do in total budget spending from state general and restricted funds—a difference of roughly $4 billion in 2015. On top of this, instead of increasing revenues to cover increasing costs, the Legislature shifts around our revenue streams, leaving potential shortfalls to be resolved with budget cuts. Lawmakers need to have a better idea of how much money we are failing to collect, review existing tax expenditures and earmarks to make sure they are still good policy, and provide accountability for new tax breaks and other policy changes.

Revenue tax expenditures chart 2State Revenues Can’t Keep Up

Michigan’s revenues have not been able to keep up with inflation. In terms of actual dollars, total state General Fund and School Aid Fund revenues anticipated for budget year 2017 have grown about 22.7% since 2010, the trough of Michigan’s recent recession. However, when adjusted for inflation, the state is 17.7% below 2000 levels. What is most interesting though is that in actual dollars, for budget year 2017, state General Fund dollars are anticipated to be 4.4% below 2000 levels despite the fund’s more robust growth since 2010.

Revenue tax expenditures table 1While state revenues continued to be negatively affected by the decade-long recession felt in Michigan, the state became increasingly reliant on federal funds to help balance its budget. In 2001, the state General Fund and federal funds contributed nearly equal amounts to the state budget at 26.4% and 27.1% respectively, but the trends have diverged significantly since. Even after the federal government withdrew the American Recovery and Reinvestment Act (ARRA) funds following 2011, federal revenues still contribute over 40% of the funds necessary for Michigan’s budget, while state General Fund revenues have dropped to below 20%. Over the past 10 years, our total budget has grown by 29.7%, and federal funds appropriated in our state budget have grown by 75.1% in that same time period, while state spending from state resources has only grown by 8.8%.

Revenue tax expenditures chart 3It would be easy to blame Michigan’s revenue problems on the economy, but we are in our sixth year of economic recovery and still struggling. Our situation has been compounded by tax changes that have done little to help and even caused harm, including a tax reform that largely benefited businesses but meant less money for Michigan’s people and the state, and policy shifts that have made more of our revenue streams restricted in use. Michigan needs to take a hard look at the money it foregoes due to preferential tax treatment to ensure that Michigan has a fair and adequate revenue system.

Tax Expenditures: Not Just Loopholes Anymore

Revenue tax expenditures chart 4Tax expenditures, commonly called loopholes, are broadly defined as revenue foregone because of preferential tax treatment in the form of credits, deductions and exemptions, or lower tax rates given to individuals and businesses. The state generally divides them into five main categories: business privilege, consumption (such as sales and use taxes or tobacco taxes), personal income, transportation and local/property. These tax expenditures are often called silent spending because, like appropriations, they allocate resources for public purposes but do so through the tax code rather than through the annual state budget process. They have a significant impact on the annual budget process as they reduce or eliminate revenue that would have otherwise been collected, but are not regularly reviewed and evaluated.

Typically, these tax credits, deductions and exemptions are used for two purposes. First, they redistribute or reduce the impact of taxes on low-income individuals and businesses. For example, the Homestead Property Tax Credit helps lower property taxes and makes living in Michigan more affordable for residents with high property taxes. Additionally, the constitutional sales tax exemption on food helps level the playing field for lower income families as they tend to spend a higher proportion of their incomes on food, and without the exemption, would also spend more of their money on taxes. However, even with this targeted tax relief, Michigan’s lower-income families still pay nearly twice the tax rate of the wealthiest in terms of state and local taxes.

Revenue tax expenditures chart 5The second purpose of tax expenditures is to influence the behavior of individuals or businesses. The federal and state Earned Income Tax Credits are only provided to individuals who have income from a job or self-employment and are intended to encourage work while helping individuals make ends meet. And local property tax abatements encourage either the establishment of or the renovation or replacement of various business facilities (e.g., industrial facilities tax abatements or obsolete property rehabilitation abatements).

While they are commonly called loopholes, most true “loopholes” do not exist. The foregone revenue resulting from these credits, exemptions or deductions is not an unintended consequence of tax changes or unintended tax avoidance methods. Most of these expenditures were purposely written in the tax code. However, other intended policy changes can have tax implications whether intended or not. For example, changes made in 2012 to the Insurance Code resulted in automobile insurance providers being able to claim a tax credit amounting to $60 to $80 million per year. But this unintended consequence was not discovered until 2016. However, once these tax expenditures are written into the tax code, they are difficult to be unwritten, and their effect often grows.

Revenue tax expenditures chart 6Continued Erosion of the General Fund

Another trend in Michigan fiscal policy is to make funds restricted in use. These revenues are restricted by the State Constitution or state statute, or otherwise are only available for specified purposes, and generally remain in the restricted fund if they go unused during a budget. These include most fee revenue, the School Aid Fund and most funds that are used for transportation purposes. Most of the state-sourced revenue in Michigan’s budget is restricted funds.

Revenue tax expenditures table 2Over the past five years, the Legislature has passed two main packages that have continued the trend in making funds restricted: the Personal Property Tax repeal and the roads plan of 2015. The repeal of the Personal Property Tax was originally enacted in 2012, amended in 2014, and made effective by a ballot initiative in August of 2014. Most of the discussion centered on how to reimburse schools and local units of government for the revenue lost due to the repeal, and the mechanism for making them whole was dedicating some of the currently unrestricted Use Tax revenue exclusively for that purpose.

Revenue tax expenditures chart 7Furthermore, in 2015, lawmakers enacted a road funding plan that included some new restricted revenue in tax and fee increases, but also dedicated a significant amount of currently unrestricted income tax revenue to transportation purposes. Ultimately, this will shift $600 million annually away from our General Fund to be used for road repairs and maintenance.
These two changes are anticipated to divert over $800 million away from our state General Fund by budget year 2020, potentially squeezing our budget and jeopardizing other funding priorities. Once changes to the Homestead Property Tax Credit are taken into consideration, the diversion and foregone revenue total around $1 billion. This will have a long-term, lasting and detrimental impact on our state budget.

Where to Go from Here?

Michigan has already endured enough crises—the state’s dissolution of two public school districts, the city of Detroit bankruptcy, the Flint water crisis, the Detroit Public Schools financial crisis, in addition to many other schools and municipalities that are struggling—and is one more crisis away from not being able to fund the basic services Michigan residents rely on. Policymakers are intentionally stifling the state from being able to invest in its infrastructure, schools, people and businesses. Michigan must take a look at its inadequate revenue streams to determine where there is room for improvement.

 

Revenue tax expenditures chart 8Stop the erosion of state funds: Every year, the state nickels and dimes away at state funds without regard to—or sometimes knowledge of—the possible budget implications. These changes include new tax breaks, tax policy changes and shifting funds to pay for different services and programs. The funding that is left is often strained by growing budgetary pressures. Lawmakers should review existing restricted fund streams to ensure that they are sufficient to meet the state’s needs. Legislators must also understand the costs of each tax policy change to make sure that the benefit actually offsets the cost to other important state programs.

Review existing tax expenditures: Michigan lawmakers need to determine whether the benefits of various forms of preferential tax treatment still outweigh the costs to the state. While some of these credits, deductions and exemptions continue to suit the purpose for which they were intended, many go unchecked and simply cost the state money with little return. Michigan does have an annual report on state tax expenditures, but it does not include vital information as to the funds affected, the history of the expenditure, or an analysis as to whether it is serving its purpose. The state should establish a process for reviewing these spending measures to ensure that they are still accomplishing set goals and that the loss of state revenue is justified. As part of this evaluation, expenditures that no longer meet their intended purposes—or are no longer necessary—should be eliminated.

Revenue tax expenditures chart 9Make tax relief strategic, measurable and adjustable: The truth is, no one really likes paying taxes. But we should not cut taxes simply for this reason. Tax benefits should be given for a reason, whether to balance the scales for lower-income individuals through the Homestead Property Tax Credit or to encourage specific behaviors like the Earned Income Tax Credit, and the outcomes should be measurable. New tax expenditures should include measures to allow lawmakers to determine their usefulness, such as expiration sunsets for periodic review, accountability measures, or clawbacks to reclaim money from recipients that do not comply with requirements.

Endnotes:

  1. Patricia Sorenson. Losing Ground: A Call for Meaningful Tax Reform in Michigan. Michigan League for Public Policy. January 2013. Rachel Richards and Alicia Guevara Warren. Enough is Enough: Business Tax Cuts Fail to Grow Michigan’s Economy, Hurt Budget. Michigan League for Public Policy. November 2015.
  2. Both the Personal Property Tax repeal and the 2015 road funding plan took parts of revenue streams currently devoted to the General Fund and made them restricted funding.
  3. State of Michigan, Department of Treasury. Executive Budget Appendix on Tax Credits, Deductions, and Exemptions: Fiscal years 2015 and 2016. 2014. Retrieved from http://www.michigan.gov/documents/treasury/ExecBudgAppenTaxCreditsDedExempts_FY_20152016_476553_7.pdf.
  4. Institute on Taxation and Economic Policy. Who Pays? A Distributional Analysis of the Tax Systems in All 50 States, 5th edition. January 2015. Retrieved from http://www.itep.org/whopays/.
  5. David Eggert. Michigan Budget: Inadvertent Tax Break for Car Insurers Targeted for Repeal. Associated Press. February 20, 2016.
  6. Mary Ann Cleary and Kyle Jen. A Legislator’s Guide to Michigan’s Budget Process. House Fiscal Agency. October 2014.
  7. See House Fiscal Agency analyses for House Bills 6022 and 6024-6026 and Senate Bills 1065-1071 of 2012; Senate Bills 821-830 of 2014, and Ballot Proposal 1 of 2014.
  8. See Senate Fiscal Agency analyses for House Bills 4370, 4376-4378, 4614 and 4616 and Senate Bill 414 of 2015.
  9. Michigan League for Human Services. Silent and Stealthy: Michigan Gives Away $35 Billion a Year. April 2010.

 

 

 

Crumbling roads, poisoned water and unsafe schools: The effects of a decade of disinvestment

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crubling roads chart 1Cities in crisis logo SNIPThe water we drink. The schools we send our kids to. The roads we drive on. These are public services that we depend on. But for too long, our public servants have been devaluing and disinvesting in them. Our infrastructure is the fabric of our society, and as we’re seeing in Flint and Detroit, it’s unraveling after a decade of budget cuts.

The Flint water crisis and the Detroit Public Schools struggles shouldn’t be unexpected, and should serve as foreshadowing of what may come if our state government doesn’t change its course. Michigan’s history of disinvestment in its infrastructure, communities, education and people, if not reversed, will cause Michigan to become the “come apart” state rather than the comeback state.

A Numbers Game: State Spending is Down, Not Up

Our budget seems to be growing. However, when you factor in inflation, our purchasing power has significantly dropped.

  • School Aid Fund (SAF) revenue for the 2017 budget year, adjusted for inflation, will still be about 6% below the level in budget year 2000.
  • General Fund (GF) revenue for the 2017 budget year, adjusted for inflation, is about 29% below the level in budget year 2000. Future budget pressures, such as road funding, will continue to strain this pot of funding.
  • There’s also room for growth; Michigan revenue collections for the 2017 budget year will be about $9.6 billion below the constitutional revenue limit.
  • Looking back over the past decade, in overall appropriations, most budget areas are doing better. However, a significant portion of our budget growth has resulted from an increase in available federal funds. In terms of state-sourced appropriations, many important areas of our budget have been negatively affected, and others have failed to keep up with inflation.

crubling roads chart_photo 2Disinvestment Leads to Deterioration

crubling roads chart 3Communities: Michigan communities receive most of their revenue from property taxes and state aid through revenue sharing. Property tax revenue has decreased as has state aid. Statutory revenue sharing for cities, villages and townships has fallen from over $600 million in budget year 2001 to less than $250 million in the current year budget. Michigan is currently funding statutory revenue sharing at about 70% below its statutorily-set level. This means there is less money available for important public services, such as local water systems and police and fire protection. Communities like Flint have rapidly deteriorating infrastructure and less money every year to fix it, which contributed in part to the city’s water crisis.

Education: To grow, Michigan’s businesses need access to a highly skilled workforce, which means that our residents need to receive a high quality education—from early childhood to postsecondary. However, annual budget decisions are making that more difficult:

  • Between budget years 2001 and 2014, per-student state aid for state colleges, universities and community colleges has dropped about 40% when adjusted for inflation; and
  • While schools have seen increases in state aid for retirement costs, specific grants and, recently, in at-risk dollars, per-pupil spending through the foundation allowance, which is the largest unrestricted source of state aid for schools, has failed to keep up with inflation. At-risk funding, which provides funding for schools for programs and support of students at risk for educational failure, has been historically underfunded. In the current budget year, $134 million more would be necessary to fully fund it. As we look at the current struggles of Detroit Public Schools students and the likely future struggles of Flint students, this funding is more necessary than ever.

People: The impact of budget decisions on people is not often easy to see, but it is the most severe. A diminishing pot of discretionary funding and recent policy changes have adversely affected our ability to provide for our most important asset, our people. A perfect example is cash assistance; in Michigan the percentage of children living in extreme poverty (a family of four making less than $12,125 per year) has grown while the number of children under 18 receiving cash assistance has shrunk. Policymakers would not be scrambling to provide education, health and nutrition services to people exposed to lead in Flint if they had adequately maintained those support systems to begin with.

crubling roads chart 4Infrastructure: Michigan’s roads and bridges have continually deteriorated over the last several years. Even with the recently-enacted roads plan, Michigan roads will continue to crumble as the plan fails to produce a significant investment in roads until budget year 2021 and, even then, fails to provide enough money to fix the problem. The so-called solution passed in 2015 doesn’t solve Michigan’s roads mess, it perpetuates it, while putting an increasing strain on our General Fund.

Recommendation: Invest in Infrastructure to Protect People

State government has to change its approach if policymakers want to protect all Michiganians and prevent the crises in Flint and Detroit schools from happening elsewhere. If Michigan wants to become a place where people want to stay, live and raise families and where businesses want to invest and grow, it must have the resources to invest in the services our residents want and need. However, we cannot do so with the existing budget. Our recent road funding debate showed that, but we still fail to adequately invest in our state, such as repairing deteriorating school buildings and replacing dangerous lead pipes, increasing the support we provide to keep our communities safe and providing vital services for our residents. Michigan must reverse this history of disinvestment and look at increasing the amount of revenue available to prevent another disaster from harming our communities and our residents.

Michigan revenues still not enough to fix ongoing problems

There’s good news, but there’s also bad news. Michigan’s January Consensus Revenue Estimating Conference (CREC)—the first step in crafting a budget for the next fiscal year—was held in Lansing this week, and it looks like Michigan will have some unexpected one-time money left over from last year. On the other hand, we can’t count on continued robust growth of this nature; in fact, the state is looking at less revenue than was projected last May for this budget year and the next. (more…)