Rick Haglund: Inflation, war in Ukraine could darken rosy Michigan budget outlook

Bob Schneider has worked on Michigan budgets for nearly 30 years, but said he has never seen as much money pour into to state government coffers as in the past couple of years.

“These are unprecedented surpluses,” said Schneider, senior research associate for state affairs at the Citizen Research Council of Michigan. “It’s unusual to talk about an abundance of resources” in a slow-growing state that has often struggled to balance its budget.

Michigan is forecast to end the current fiscal year on Sept. 30 with an extra $7 billion, split between the General Fund and the School Aid Fund. That gives state policymakers a rare opportunity to reverse years of disinvestments in roads, higher education, local government revenue sharing and other responsibilities of state government.

It’s a remarkable turnaround from the early days of the COVID-19 pandemic in 2020, when state revenue forecasters predicted big drops in state general fund and school aid fund revenues.

But the falloff never occurred. That’s in part because of a major shift in consumer spending from non-taxable services to taxable goods that ballooned sales tax revenues.

The state also saw much higher than anticipated income taxes, much of it a result of massive federal supplemental jobless payments that were subject to the state’s personal income tax. And many who were able to work from home during the pandemic maintained healthy incomes.

Current fiscal year General Fund revenues are expected to reach $12.4 billion, $2.3 billion above what forecasters were predicting in May 2020. School aid fund revenues are predicted to hit $16.1 billion, an increase of $2.2 million in the same period, according to the January state revenue estimating conference.

But all that extra cash could disappear as fast as it came in, the result of a sudden, brutal war in Ukraine that threatens to plunge the U.S. economy — if not the world — into a deep recession.

An old adage that says when the nation catches a cold, Michigan gets pneumonia still applies. A fairly mild national recession in the early 2000s spiraled Michigan into a decade-long economic crisis, dubbed “the lost decade.”

“I wouldn’t be surprised to see downgrades” in state revenue projections when forecasters meet in May, Schneider said.

State lawmakers and Gov. Gretchen Whitmer were already proposing big tax cuts before Russia’s unprovoked attack on Ukraine on Feb. 24.

The Republican-controlled Legislature has passed a $2.5 billion tax-cut package that includes lowering the personal income tax rate from 4.25% to 3.9% and dropping the corporate income tax rate from 6% to 3.9%.

Whitmer has criticized those tax cuts as “fiscally irresponsible” and “unsustainable,” but also has offered some big cuts in her proposed fiscal 2023 budget, which starts Oct. 1.

The governor wants to repeal the income tax on pensions, enacted during former Gov. Rick Snyder’s administration.

Snyder and lawmakers also reduced the Earned Income Tax Credit (EITC) for low-income families from 20% of the federal credit to 6% in 2011. Whitmer would restore the credit to 20%.

Those moves would cut general fund revenue by $767 million by 2025, according to the Citizens Research Council. Whitmer’s two tax reduction proposals would consume 62% of projected general fund revenue growth from now through 2025.

Whitmer’s proposed $74 billion budget still leaves lots of room for needed investments. It calls for billions of dollars in new spending for public schools, workforce development, public health, infrastructure and local governments.

Plus, Michigan is receiving $6.5 billion in federal American Rescue Plan funding that cannot be used for tax cuts. The money is to be used for investments in water and sewer systems, broadband internet, premium pay for essential workers and replacing lost COVID-related revenue.

And the state is expecting to receive about $10 billion from the recently passed federal infrastructure law for roads, bridges, public transportation, high-speed internet, water infrastructure and electric vehicle charging systems.

But raging inflation and economic fallout from the escalating war in Ukraine is hitting consumers’ pocketbooks hard, increasing the pressure on policymakers to return a large share of state dollars to taxpayers.

It’s also an election year, a time when a politician’s fancy turns to tax cuts. (With apologies to Alfred, Lord Tennyson.)

In addition to the Legislature’s passage of $2.5 billion in tax cuts, Republicans want to suspend Michigan’s 27.2 cent-a-gallon gas tax until Sept. 30. Critics say the move would cut gas-tax revenue by $725 million, jeopardizing badly needed road repairs.

Meanwhile, Whitmer joined has joined five Democratic governors calling for a pause in the 18.4 cents-per-gallon federal gas tax until the end of the year.

But while Michigan is experiencing an unprecedented increase in state revenues, much of the money represents a short windfall that will largely be eaten up by 2024, said Schneider of the Citizens Research Council.

And in many areas of the budget, the new money won’t even get the state back to the inflation-adjusted revenue levels of 20 years ago.

Michigan’s general fund hauled in $10.7 billion in 2000. Adjusted for inflation, the 2024 general fund is expected to bring in $8.3 billion in 2024, a 22% decrease, according to the Citizens Research Council.

That shows just how much work Michigan must do to improve its economic competitiveness and improve life for its 10 million residents.