May 23, 1997

The Good Times Continue

by Robert Kleine, Vice President and Senior Economist

The current economic expansion has now reached 75 months, the third longest since World War II, and there is no end in sight. Michigan, with its continued dependence on the manufacturing sector, has benefitted as much as any state. Michigan per capita income grew at an annual rate of 5.4 percent from 1991 to 1996, compared with the national rate of 4.3 percent. In 1991 Michigan per capita income was 2.6 percent below the national average; five years later, in 1996, it was 2.4 percent above it. In the past year the Michigan economy has begun to cool, due in part to a slowdown in the growth of motor vehicle sales; in 1996, Michigan per capita income increased 3.6 percent compared with a 4.5 percent nationally.

The strong economy has had several positive effects on the state’s finances.

• State leaders have been able to significantly reduce taxes while maintaining a reasonable level of spending (adjusted gross appropriations less school aid increased at an annual rate of 4.8 percent from FY 1989–90 to FY 1996–97, or 1.8 percent adjusted for inflation); in FY 1996–97, cumulative state and local tax cuts amount to about $1.9 billion.
• The state’s "rainy day fund" now has a balance of $1.2 billion, up from only $20 million in FY 1991–92.
• The combination of the strong economy and system-wide reforms has pushed the welfare caseload to a 25-year low.

How long can this good news continue? Apparently, a while longer. Despite the length of the current recovery and evidence of a slowdown in Michigan, state revenues continue to outpace estimates. On Thursday, state revenue officials from the legislature and the executive branches agreed on revised revenue estimates for FY 1996–97 and FY 1997–98. The new projections for general fund/general purpose (GF/GP) and school aid fund (SAF) revenues are $185.4 above the current estimate for this fiscal year (1996–97) and $91.2 million higher for next fiscal year (1997–98). The increase is due mainly to a surge in income tax, use tax, and lottery revenues.

• The income tax revenue estimate is up $105 million for FY 1996–97 and $58 million for FY 1997–98.
• The use tax collections estimate is up $40 million for FY 1996–97 and $35 million for FY 1997–98.
• The lottery receipts estimate is up $12 million for both FY 1996–97 and FY 1997–98.

These new estimates assume slower growth in FY 1997–98, 3.9 percent, down from the January projections of 4.5 percent. Our view is that these figures are conservative. The Senate Fiscal Agency estimates were up, from the January consensus, by $261 million for FY 1996–97 and $168 million for FY 1997–98, and we believe these numbers may be closer to the truth.

The new revenue estimates have two immediate implications.

• Some of the new money added to the governor’s recommended budget, particularly for education, likely will stay in the budget.
• There now is a strong chance that there will be additional tax cuts. The Senate GOP caucus agreed this week on how to divide the new revenue between tax cuts and increases in education spending.

There are, of course, almost as many proposals for what to do with the extra revenue as there are legislators. Some want to put the money in the Budget Stabilization Fund (BSF); others, to prevent a gasoline tax increase, want to give some of the money to transportation; still others would like to use all of it for tax cuts.

Our view is that the money should be divided among education funding, tax cuts, and a modest contribution to the BSF. The BSF balance currently equates to about 7 percent of GF/GP and SAF spending. Although this is one of the highest levels in the nation, it still is inadequate to protect against a major economic downturn. We would not, however, want to see the balance exceed 10 percent of the state budget; at that point it would be appropriate to revise the formula and use excess revenues for tax cuts.

Tax cuts almost always make good political sense, and sometimes they make good economic sense. If the gasoline tax is hiked, it makes sense both politically and economically to cut other taxes if excess revenue is available. The gasoline tax is likely to most heavily affect low-income taxpayers, which means the most equitable tax relief would be (1) an income tax credit tied to the amount of gasoline tax one pays, (2) a state earned-income tax credit, or (3) an increase in the income tax personal exemption. The most prudent cut would be a one-time income tax refund of 2–4 percent, similar to that on 1995 income taxes, as there is no guarantee that the good times will continue for much longer. For business, the major tax issue is the personal property tax, and although some of the excess revenue could be used as a down payment on phasing out or reducing the level of the tax, the amount available for tax relief is small compared with the $1.7 billion in annual revenue generated by the personal property tax.

Good times cannot last forever, but no one likes a Cassandra. It makes news if one says that the sky is falling, but the fact is that it isn’t. This legislature and governor have done a good job of managing the state’s finances, and we have no reason to believe that they will not make prudent use of the state’s latest windfall.