Michigan’s $9 billion multi-year surplus may trigger tax rate cut

Michigan’s projected surplus swelled to more than $9 billion in a new revenue forecast, giving the state a healthy cushion to cut taxes and lift at least one-time spending while managing economic clouds ahead, state officials said.  

The state is now expected to have closed out fiscal 2022 in September with revenues of $33 billion, providing an additional balance of $1.4 billion over the state’s May revenue estimating forecast for the two major funds, the general fund and the school aid account, according to the forecast approved by the state’s estimating revenue conference Friday at its regular January meeting.

The latest forecast brings the state’s total pool of additional revenues in play as the state crafts a fiscal 2024 budget to more than $9 billion, Budget Director Christopher Harkins said. It may be enough to trigger a formula that cuts the state income tax rate.

The total figure covers the additional $1.5 billion expected when the fiscal 2022 numbers are finalized, which brings the overall surplus balance for that year to $5.1 billion. About $3 billion is “one-time” in nature and the remainder recurring revenues, Harkins said. The latest projections raise the balance expected this year to $4 billion with $2.8 billion being one-time in nature.

Between the surplus balances and the rainy day fund “I think we are still in a very strong position with the balance sheet,” Harkins said.

With Republicans controlling the legislature and Democrat Gretchen Whitmer the governor’s office prior to the November election, the state had left billions of previously announced surpluses on the table for future deliberation.

Democrats won control of the legislature in November and Whitmer was reelected.

General fund revenues account for $1 billion of the higher fiscal 2022 figure and the school fund for the remainder. Sales tax revenues shot up, rising 14.6%, due to inflation and strong spending providing a $485 million boost while income tax withholding and corporate income taxes were up by $104 million and $200 million, respectively.

While growth is projected to shrink in the current fiscal year, the numbers still look brighter than in May with estimates raised for fiscal 2023 by $1.24 billion to $32.41 billion. They were also raised by $1.26 billion to $32.94 billion for the fiscal 2024 which begins next Oct. 1.

The general fund accounts for $800 million of the increase and the school aid $400 million in both years. State forecasters are projecting $33.8 billion of revenue in fiscal 2025. The projections don’t trigger any changes, up or down, in the state’s budget stabilization fund which rose to a peak level of $1.6 billion after a $180 million infusion in the fiscal 2022.

The May conference had raised revenue projections for fiscal 2022 by $3 billion with an additional $2 billion then expected in fiscal 2023.

“The numbers show that Michigan strong recovery from early the early impacts of the COVID-19 pandemic remains on course but “there is uncertainty in the near term,” said State Treasurer Rachel Eubanks. “As the economy moves into this next chapter, we need to be cautious and deliberative in our policy choices.”

Harkins and Eubanks are members of the conference along with Kathryn Summers, director of the Senate Fiscal Agency, and Mary Ann Cleary, director of the House Fiscal Agency.

The group approved the estimates after representatives of Treasury and the House and Senate agencies laid out their projections and after hearing presentations on the national and state economy from the University of Michigan’s Research Seminar in Quantitative Economics’ Daniil Manaenkov and Gabriel Ehrlich. Gianluca Benigno, head of International Studies at the Federal Reserve Bank of New York, provided a report on global supply chain issues.

“The nature of this forecast also reminds us that revenues may fluctuate, and it remains important that we continue to ensure that any available one-time revenues be used for one-time investments to grow and build Michigan,” Harkins said.

The state agencies all agree that a mild recession looms but differ slightly on the degree and duration with economic growth expected to return between late 2023 and early 2024.

“We do expect a recession in the next year, however the size and magnitude of that is certainly unknown at this point,” Eric Bussis from the state Treasury told the conference citing the Federal Reserve’s monetary policy moves, international conflicts, inflation, and consumer spending as the central drivers.

Michigan’s unemployment is expected to fare more poorly than the national average but the state could escape the deeper blows it has suffered in past recessions due to its high reliance on the automobile industry. That’s because pent up demand should fuel strong sales as production picks up from recovering supply chains.

Once the numbers are final, the sharp jump in fiscal 2022 could trigger a cut in the state’s 4.25% flat income tax rate under the formula built into 2015 road funding legislation. The cut would be triggered beginning in fiscal 2023 when a cap based on revenue collections and inflation is hit. Based on the preliminary numbers, the rate could be cut to 4.05%, reports noted.

Eubanks and other state officials cautioned that it’s too early to say for sure as the fiscal 2022 financial statements must first be finalized. The statutory deadline for publishing the results is six months from the Sept. 30 fiscal year close and they are typically released in March. “Certainly there is potential for a trigger however to say it’s likely at this point, I think is premature,” Eubanks said.

Whitmer has declined to say if she would seek to repeal the trigger.

The forecast sets the stage for negotiations over tax relief and the next budget with the May estimating conference results providing a clearer fiscal 2024 picture as the budget is finalized.

Earlier last week, Whitmer and legislative leaders, now fellow Democrats, unveiled plans to phase out taxes on retirement income which would result in a roughly $1,000 annual benefit to 500,000 residents. They also want to raise the earned income tax credit for lower earning families which would provide a $3,000 increase for 700,000 homes.

Republicans last week unveiled similar legislation raising the earned income credit and proposed providing seniors with relief through tax credits.  Republicans also cautioned over new spending.

“Fiscally conservative leadership in the Legislature over the previous years has resulted in a fiscally sound state budget,” Sen. Jon Bumstead, R-North Muskegon, the Senate Appropriations vice chair, said in a statement. “This is not the time to grow the size of state government in unsustainable ways. The hardworking people of our great state do not need more government bureaucracy, they need to keep more of what they earn — after all it is their money in the first place.”

The state’s current $76 billion budget package struck by Whitmer and the Republican leadership in place last summer boosted the rainy day fund to its new high and sent $2.6 billion to public pension plans.

Spending rose from the original $70 billion fiscal 2022 budget due to receipt of federal COVID-19 pandemic relief and surplus tax collections. Local governments received an additional fiscal benefit from a 5% ongoing and 1% one-time increase in the state’s revenue sharing program.

On the education front, the budget raised by $610 million the per-pupil school aid allotment to $450 per student, the highest ever for the state while providing hundreds of millions more for other education-related programs.

The budget also earmarked $475 million for the creation of a school infrastructure and consolidation fund to help districts build or refurbish classrooms, labs, and libraries, and aid in the voluntary consolidation of school districts. Community colleges received a 5% increase in operational funding while public universities saw a 2% to 5% or $55 million increase in operating aid.

The Department of Transportation budget was raised to $6 billion from $5.4 billion. Much of the new spending is directed toward one-time items to avoid creating a structural gap, Harkins said at the time.

The state’s brighter economic prospects and COVID-19 rebound drew two rating outlook boosts in June 2021 when Fitch Ratings lifted the outlook on its AA rating to positive from stable and S&P Global Ratings raised the outlook on its AA rating to stable from negative.

Fitch last July followed with an upgrade to AA-plus and a stable outlook. “Michigan’s combined cash, governmental reserves, and rainy-day fund balance are nearing or have surpassed their historic highs as a result of conservative budgeting both during and prior to the pandemic, coupled with solid revenue over-performance,” Fitch said.

Moody’s Investors Service rates Michigan Aa1 with a stable outlook.