Gretchen Whitmer inherits a stable economy, but an unforgiving budget

Jan. 22, 2019: Whitmer administration changing tone around Michigan marijuana regulation

When she takes office in January, Gov.-elect Gretchen Whitmer will have the economic wind at her back — low unemployment, nearly $1 billion set aside for a rainy day, fiscal reforms to lower Michigan’s debt.

That should spell good news for a new Democratic governor who promises to invest more in road and water infrastructure and public schools.

Yet even before Whitmer lays out her spending priorities early next year, Michigan’s roughly $10 billion general fund — essentially, the state’s primary checking account — is under pressure. General fund tax revenue is forecast to grow modestly at best. And hundreds of millions of dollars are already spoken for, with past deals on funding roads and corporate tax credit payouts among the biggest takers.

Related: 5 places where Michigan’s governor and legislature can make deals

And that’s while the economy is still humming. No one can say with any certainty when that will stop, though economists note that recessions are cyclical, and inevitable. While it appears that outgoing Gov. Rick Snyder will leave Lansing without having to govern through a downturn, economists say Whitmer likely won’t be as lucky.

The U.S. is now in the second-longest economic expansion on record, dating to the official end of the Great Recession in June 2009.

“I really hope that it will be possible for the Whitmer administration to enact a lot of her proposals. If we’re lucky, we will be able to fund some of them from a growing economy,” said Charles Ballard, an economist at Michigan State University. “But I hope her team is also thinking about the more difficult choices that will inevitably have to be made if the economy doesn’t grow fast enough, or starts to shrink.”

Governing amid budget pressure

A year ago this month, Whitmer told Bridge that voters on the campaign trail were telling her they felt left behind in an uneven economic recovery. She said that’s why she wants to expand access to early education and to skills training to help people land jobs that employers are demanding and that may be less likely to disappear in a bad economy.

Whitmer has proposed a number of new investments, from college scholarships to help students attend at least two years of school without debt, to universal preschool for 4-year-olds, to $2 million in new state funds to fix Michigan’s crumbling roads.

She has said some of her proposals could be funded with higher tax revenue spurred by a growing economy, and from new tax revenue generated from legalization of recreational marijuana and online sales tax captures.

Related:

• 2019 priorities in Lansing: roads and schools, no-fault and clean water
• Michigan Democrats’ 2019 vows: safe roads, clean water, better schools
• Michigan Republicans’ 2019 to do’s: roads and auto insurance

Whitmer has not called for an increase to Michigan’s 4.25 percent income tax rate to pay for her priorities, though some fiscal experts have raised eyebrows at the notion that marijuana revenue or economic growth alone could fund some of her big-ticket items.

“Some folks will say the legalization of marijuana will lead to some future revenue increase. I think that’s true. I don’t think I would bank on that in the next budget,” said Al Pscholka, a former Republican chairman of the state House Appropriations Committee and Snyder’s budget director until this past February.

“If you’re thinking, ‘Let’s fix the roads,’ you’re probably going to need to have some sort of (new) revenue source to do that,” Pscholka said.

Whitmer has talked about issuing bonds if the Republican Legislature balks at raising transportation user fees, a tool that could spread payments out over years, Pscholka said, though, he added: “It’s not revenue, it’s debt.” (Whitmer’s campaign said bond revenue could be repaid as the state’s obligation to pay corporate tax credits expires, though that won’t happen for years.)

Other campaign promises would mean less revenue coming into the state, not more, raising additional questions about how the state would pay for Whitmer’s highest priorities. Whitmer proposed eliminating a tax on some retirement income, which Snyder signed into law in 2011 as part of a larger business tax overhaul; estimates suggest that could amount to as much as $300 million in lost state revenue if the so-called “pension tax” is repealed.

Whitmer voted against Snyder’s tax legislation in the Senate, citing the pension tax component and because it shifted more of the state’s tax burden from businesses to individuals. Ballard, who opposes repeal, said the state would lose more revenue as Michigan’s population continues to get older, and that doing so exempts one group of residents from paying income taxes but not another.

Whitmer also has vowed to stop funding community colleges and public universities from the nearly $14 billion School Aid Fund, a practice that former Democratic Gov. Jennifer Granholm started in the 2010 fiscal year because of general fund revenue shortfalls and later continued by Snyder, a Republican. The fund mostly pays for K-12 public schools, but more than $908 million this year is going toward higher education. Whitmer has opposed that diversion, saying she believes the School Aid Fund is intended to solely pay for K-12 schools and college funding needs to come from another source.  

Related: Truth Squad | Gretchen Whitmer says school aid money only meant for K-12

So far, though, she has offered few details on how she would make up the lost revenue for colleges and universities.

Through a spokesman, Whitmer declined to provide more details about her fiscal strategy, including how she would approach the state’s rainy-day fund, citing the early stages of building her transition team.

Abiding by past deals

Less revenue is potentially problematic given the state’s general fund already is under considerable strain. Chief among them is the 2015 legislative package to fund roads, Pscholka said.

In the fiscal year that starts Oct. 1, 2019 — Whitmer’s first budget — $325 million in state income tax revenue automatically will be diverted to pay for roads. That amount will climb to $600 million when fully phased in by 2021, a significant amount of money yet not close to the $4 billion in new spending experts say Michigan needs to devote annually to fix aging roads and infrastructure.

Another $400 million in future spending is earmarked for other commitments: an expanded homestead property tax credit, and a state match to federal funding for Michigan’s Medicaid expansion program.

All of which means Whitmer is unlikely to find the funding she needs for her ambitious programs without finding a new source of revenue or cutting back elsewhere, said Jordon Newton, a research associate at the nonpartisan Citizens Research Council of Michigan, which studies state budget pressures.

“Depending on how much in total spending her priorities have and what she wants to prioritize,” Newton said, “finding the money within the budget is going to be probably challenge No. 1.”

Adding to the challenge will be aligning her budget priorities with Republican majorities in the state House and Senate. Whitmer has said she wants to meet regularly with GOP leaders, including incoming Senate Majority Leader Mike Shirkey (Clarklake) and House Speaker-elect Lee Chatfield (Levering).

Both sides have talked at length, for instance, about finding solutions for road funding. Though Chatfield recently told reporters: “No one in the House Republican chamber ran on raising taxes.”

Related: 5 places where Michigan’s governor and legislature can make deals

That doesn’t mean, however, that Whitmer won’t be able to accomplish her goals. With a Republican Legislature, several business leaders say they are optimistic that divided government could force both sides to meet in the middle.

Bipartisanship also could help preserve fiscal reforms the Snyder administration achieved, from building up the state’s rainy day fund to paying down debt, said Sandy Baruah, president and CEO of the Detroit Regional Chamber.

“This is where I'm hoping this split government will work in our favor; I’m hoping that the Republican Legislature will actually put the brakes on a Democratic governor’s inclination to spend down the fiscal gains that we’ve made,” Baruah said.

What about a recession?

Recessions can’t be predicted. They’re often triggered by factors that extend beyond Michigan, like the dotcom bubble bust in the early 2000s or the world financial crisis in 2007-09.

Economists tell Bridge they don’t see imminent signs of danger. The state has made progress in diversifying its economy so it doesn’t rely as heavily on manufacturing and the auto industry, and unemployment is low. But the state is vulnerable should another downturn hit, in part because Michigan hasn’t yet recovered all of the jobs lost during the Great Recession and many residents have given up looking for work.

Related: Demand for Michigan workers is very high, but many have given up looking

Making it through Whitmer’s four-year term without another recession would be “a historical aberration,” Ballard said, since at that point the economic expansion would be the longest in history.

“If we are lucky, we will be able to pay for things through a growth dividend for a few years, and maybe for more than a few years,” he said. “But there is a good chance that economic growth will slow or stop.”

Should a recession happen, said Newton of the Citizens Research Council, “any plan for increased spending is going to have to contend with the inevitable decline in revenues.”

Are Snyder reforms enough?

Whitmer will inherit a state government that has worked to position itself to withstand another downturn. It has set aside more money in its reserves, though some experts say Michigan should consider saving more.

The general fund would be vulnerable in a recession because its largest source of revenue is the state income tax, which is tied to employment. Cities also would be vulnerable, both because of state revenue sharing cuts and falling property values.

The state has slashed $8.6 billion in statutory revenue sharing since 2002. That includes a $1.4 billion reduction in what Lansing sends Detroit, $128 million to Grand Rapids and about $100 million for both Lansing and for Flint, according to the Michigan Municipal League.

Related: In Michigan, more than 150 communities are financially distressed

That in turn has forced communities across the state to slash budgets for everything from police and fire to park maintenance and local roads. In Lansing, for example, the percentage of major streets that were in poor condition soared from 4 percent in 2004 to 40 percent in 2013.

A recession also most likely would mean a drop in property values, which in turn would cut a primary source of revenue for cities and townships. If the state is forced to fill in budget holes of its own, that could leave cities out in the cold.

Tony Minghine, chief operating officer for the Michigan Municipal League, considers the state’s current funding model for cities broken. Municipal advocates want to revisit Proposal A, which limits annual growth of an individual property’s taxable value to the lesser of the inflation rate or 5 percent.

While Prop A has slashed tax bills for Michigan residents, it also caps property tax growth because revenue doesn’t grow as fast as the economy. Minghine said such legislative reforms would be “no easy lift” even with a new administration.

“We need to have a serious conversation about restoring funding that would be healthy for cities,” he said. “Absent that, a recession would be catastrophic.”

What else should the new governor be thinking about?

Everything from continuing to fund pension and retirement health care liabilities, to following Snyder’s path on adopting budgets months before Oct. 1, when the state starts its new fiscal year, Pscholka said.

In addition, several experts said Whitmer should avoid drawing from the rainy-day fund unless it’s absolutely necessary. When Snyder took office in 2011, Michigan had just $2.2 million set aside, enough to run state government for barely 30 minutes. Short-term spending and one-time funding are low-hanging fruit when it comes to cuts.

One of Pscholka’s last bills as a state legislator was to cap the amount of money that could be withdrawn from the state’s reserves in a single year at 25 percent. The bill passed the House but died in the Senate at the end of the two-year term in 2016.

“I thought it was a good, common-sense piece of legislation so you weren’t using that as a crutch,” he said. “The last thing you want to do is start to tap that rainy day fund. You want to avoid that. That really does send a message to funders and bondholders and all that you really don’t have your financial house in order.”

Bridge reporter Ted Roelofs contributed to this report.