Preparing the State of Michigan’s Budget for the Next ... · Preparing the State of Michigan’s Budget for the Next Recession In a Nutshell 1) Michigan’s rainy day fund is being

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November 2017 | State Budget Note 2017-01

Preparing the State of Michigan’s Budget for the Next Recession

In a Nutshell1) Michigan’srainydayfundisbeingrefilledaftersittingemptyformanyyearsattheendofthelast

recession.2) Currentdepositsareinsufficientforanythingbeyondaverymildeconomicdownturn.Michigan

shouldcontinueeffortstobuildupreservesinthatfund.3) Michigan’srainydayfundisdesignedverywelltoconservemoneythathasbeensavedfora

recession,butthesavingscapmightlimittheeffectivenessofthefund.Oncesavingsreachthefundcap,lawmakersshouldconsiderraisingtheamountthatcanbesavedintherainydayfund.

IntroductionNearlyadecadeaftertheGreatRecession,thenationisinthemidstofoneofthelongestnationalrecov-eriesinhistory.1However,somestategovernmentsarebeginningtofacethenextwaveofbudgetpres-sures. Thirtystatesareexperiencingorexpectedtoexperiencebudgetshortfallsbytheendof2018.2 WhileMichiganisnotfacingimmediatebudgetaryproblems,aseriesofpastpolicydecisionswillputincreasingpressuresonthestate’sbudgetoverthenextseveralyears.

Eventhoughanewrecessiondoesnotseemimmi-nent,itisaquestionofwhen,notif,thenationandthestatewillexperienceanothereconomicdown-turn.Inthefaceofbudgetproblemsandtheinevi-tabilityofthenexteconomicdownturn,policymakersshouldkeepacloseeyeonthemechanismsdesignedtostabilizethestatebudgetduringroughperiods.

Rainydayfunds,theprimarysavingsaccountsformoststates,serveasacommonlyemployedtooltoweatherrecessions.Forty-eightstateshavesomeformofrainydayfund,usuallyofficiallydesignatedasthebudgetstabilizationfund,tolessentheneedfor drastic program cuts or sizable tax increasesduringdownturns.

Recent history shows that these accounts play asignificantroleinstabilizingbudgets;morethan70percentofstatesusedtheirrainydayfundstosur-vivetheGreatRecession(December2007throughJune2009).3Michiganwasnotoneofthesestates.Michigan’srainydayfundwasemptiedinthestate’sstrugglestocopewithitsSingleStateRecession,a leavingnosavingstodealwithworseningeconomicconditionswhenthenationenteredintotheGreatRecession.Statebudgetmakerswerelefttodealwitha$2billiondecline inGeneralFundb revenuefromFY2008toFY2009withoutbudgetstabilizationfunds.

NowthatMichiganisseeingafewsunnydaysthattranslateintonewsavingsintoitsrainydayfund,andgiventhatupcomingchallengeswillrequireavarietyof tools for state policymakers tomanage futureeconomicpressures, it is importanttounderstandthecapacityofthestate’srainydayfund.

a WhiletherestofthenationsufferedfromarelativelyminorrecessionfromMarchtoNovember2001,thisperiodservedasthebeginningofwhatwastobecomeMichigan’sSingleStateRecessionwhichlastedformostofthenextdecade.b Inthispiece,whentheGeneralFundismentioned,wearereferencingtheGeneralFund/GeneralPurposeportionof thebudget.


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Official Research Paper

Lorem Ipsum Research Paper TitleLorem Ipsum Sub-Heading

115 West Allegan Suite 480 | Lansing, MI 48933 | crcmich.org pg. 1

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Citizens Research Council of Michigan Board of DirectorsALEKSANDRA A. MIZIOLEK, ChairMICHAEL P. MCGEE, Vice ChairLAURA APPEL, Treasurer

TODD ANDERSONBETH BIALYLAWRENCE N. BLUTHCHASE CANTRELLSTEPHAN W. CURRIEDANIEL DOMENICUCCI

TERENCE M. DONNELLYRANDALL W. EBERTSRICHARD A. FAVOR, JR.JOHN J. GASPAROVICJUNE SUMMERS HAASJIM HOLCOMB

MARYBETH S. HOWEWENDY LEWIS JACKSONHARRY KEMPWILLIAM J. LAWRENCE IIIANNE MERVENNEPAUL R. OBERMEYER

JAMES M. POLEHNAJULIE RIDENOURCAMILO SERNACAROLEE K. SMITHCHRISTINE MASON SONERALKATHLEEN WILBUR

The Current EconomyBoththeSingleStateRecessionandtheGreatRe-cessionhittheMichiganeconomyhard.Whilemoststatessawsizableexpansionsduringtheearly2000s,Michiganexperienced thebeginningsof a decadeofeconomicdecline,causingstate taxrevenuetostall.AfterGeneralFundrevenueincreasednearly50percentfrom$7.3billioninFY1990to$10.4billionin FY2000 (despite a reduction in the income taxrate),revenuegrowthcametoahalt.Infact,duringthefirstdecadeofthecentury,staterevenueonlytoppedFY2000revenuetotalsonce,andinFY2010theGeneralFundandSchoolAidFundcombinedtoraise$18.5billiondollars,$2.1billionlessthantheFY2000amount.Whenadjustedforinflation,thisbleak record for the state’s revenues seem evenworse.Inflation-adjustedrevenuetoMichigan’stwolargestfundsshrankinallbutoneyearfromFY2000toFY2010.Thisrepresentsa29percentdeclineininflation-adjustedrevenue.

As revenues slid, a number of circumstances andpoliciescreatedastructuraldeficitofmorethanhalfabilliondollarsannually,including:

• ThestatewaswindingdownthelevyoftheSingleBusinessTax;

• Theeconomyenteredarecession;• Untaxedservicesweregrowingatafaster

raterelativetotaxedgoods,suppressingthegrowthofsalestaxrevenue;

• Medicaidandhighereducationspendingwereincreasing;

• DemandforaidprogramslikeMedicaidbegantoincreaseasunemploymentrose.4

Astheeconomyimproved,staterevenuestabilizedandMichiganwasabletoresolveitsstructuraldeficitissues.Chart 1showsstaterevenuesreboundedafterFY2010,butgrowthhasbeennowherenearasstrongasitwasinthe1990s.InFY2016,General

FundandSchoolAidFundrevenuewas$22.1billion,a20percent increase fromFY2010 levels. Whenadjustedforinflation,combinedGeneralFundandSchoolAidFundrevenuehasincreased8.7percentsinceFY2010,butremainmorethan20percentlowerthanthepeakinFY2000.

Chart 1 General Fund and School Aid Fund Revenue

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Source: House Fiscal Agency

Note: Consensus Revenue Estimating Conference projections are used for FY2017 data.

Alongwithimprovementsintheeconomy,budgetproblemsthatplaguedthestatewereresolvedandMichiganwasabletopassmorestablebudgets,andevenstartstashingmoneyaway.SincetheendofFY2010,Michigan’sbudgethasnothadastructuraldeficit.

Despite these positive developments, turbulentwaters appear to be likely in Michigan’s future.Slowrevenuegrowthduringthecurrenteconomicexpansionisstartingtotakeatollonthebudget.TheCitizensResearchCouncil recentlynotedthatnearly$2billioninrevenuereductionsandspendingincreases are built into the future of theGeneralFundbudget,andotherfactorsoutsideofthestate’s























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Balancing Competing InterestsAsthestatemovestowardsthenextwaveofbudgetchallenges,it isimportanttoknowtherisksofaneconomicdownturnandmonitortheoptionsthatthestatehastomanagethebudgetwhenit isoutofbalance.Staterevenuesaresusceptibletotheef-fectsofrecessionsbecauseofthenatureofeconomicactivityuponwhichthestate’slargestsourcesoftaxrevenuesarelevied–consumptionandincome.AsChart 1 shows,thedeclineinrevenuecausedbytheGreatRecessionwassubstantial,andwhenadjustingforinflation,thedeclineinfundinglevelsthroughoutthe2000swasevenmoresevere.However,thispic-turemissestheideathatsomespendingdemands,likeMedicaid,typicallyseeanincreaseindemandduringeconomicdownturnsasmorepeoplelosetheirjobandneedtemporaryrelief.6Thismeansthatasrevenuesaredeclining,costsassociatedwithsomeprograms can increase, putting pressure on bothsidesofthebudgetequation.

Anothercomplicatingfactoristhestate’sbalancedbudget requirement. Article V, Section 18 of the1963MichiganConstitutionrequiresthelegislaturetoadoptandthegovernortosignabalancedbud-get.Whilethestatemayborrowtocoverexpenseswithinafiscalyear,thestateisnotallowedtoborrowtocovergeneralexpendituresfromoneyeartothenext.c Thisalsomeans thatprograms function inazero-sumnature inthebudget, i.e.everydollarspentonMedicaidisadollarthatcannotbespentfundingprisons.

Tomaintainabalancedbudgetduringadownturn,Michiganhasthreeprimarymechanisms:

1) theabilitytoincreaserevenues (i.e.taxincreases),

2) thelatitudetoreducespending,and3) thecapacitytorelyonexistingreserves.

c Capitalexpendituresandinfrastructureprojectsareexceptionstothisrule,buthavespecificprocedures.

control could increase the pressure on the statebudget.5SowhileMichiganisgrowinginthemidstofoneofthelongesteconomicexpansionsinthena-tion’shistory,thecombinationofincreasedrevenuediversionsandspending,slowrevenuegrowth,and

aneconomicdownturncouldcreatemoreproblemsforMichigan.Furthermore,naturaleconomiccyclesmakethenextdownturnaquestionofwhen,notif.

Obviously,Michigancanonlyrelyonreservestotheextentthatthestatehassavedpriortoarecession.Each option has its benefits and drawbacks, but,particularlyduringtimesofgrowth,moreattentionisgiventotherevenueandspendingquestions,asthosedebatesarefueledbypoliticalconcernsandorganizedinterests.SavingsinMichigan’srainydayfunddonothaveaprimaryconstituencyoranorga-nizedgroupofinterestsprovidingadvocacy,despitethefuturevalueandsecuritytheybringtothestate.

The Difficulties of Spending ReductionsDuringeconomicdownturns,manyservicesthatthestateoffers,particularlypovertyreliefprograms,likeMedicaidorWelfare,mayseeincreasesindemand.Cuttingprogrambudgetswhiletheyseeanupswingindemandcouldmeanthatarecessionhitsharderon lower income families (and previouslymiddleincomefamiliesaffectedbyjoblossorreductionsinpayandbenefits).Thiscanhavenegativeeffectsonconsumptionaswell,asfamiliesreliantoncoreserviceswillhaveevenlesstospendbeyondbasicneeds.Cutstootherservicescanhavemorelong-termeffects.Reductionsinschoolfundingdonothaveasstrongofashort-termimpact,butcanhaveamuch larger cumulative economic impact if thequalityofeducation in thestatedeclines. Fallingbehind on infrastructure can also have long-termdamagingeffects.Raisingtaxesduringacrisiscanallowthestatetomaintainservicelevelsifdemandincreasesorrevenuesdecline.

The Difficulties of Generating RevenueWhilethereseemtobealotofproblemsreducingspendingduringadownturn,findingnewrevenuetomatchdeclinescanbesomewhattricky.Whenrevenuefallsbybillionsofdollars,asitdidduringtheGreatRecession,largescaletaxincreaseswouldbenecessarytomaintainspending.Inasluggish
























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economy,alargeincreaseintaxesrunstheriskofmaking the currentdownturn longerandharsher.Increasingtaxesongoodsandservicesoronindi-vidualincomewilllowerconsumption,whichcoulddeepenthecrisisandharmthosemostatrisk,whileincreasingtaxesonbusinessesthatarestrugglingtosurvivecouldmagnifytheeffectsoftherecessiononemploymentandinvestment,eitherofwhichcouldlengtheneconomictroubles.

The Case for Rainy Day Savings While neither increasing revenues nor cuttingspendinginarecessionareideal,athirdalternativeisMichigan’sabilitytorelyonsavings.Bybuildingrainydayreservescapableofbalancingthebudgetduringadownturn,Michigancanavoidthepotentiallyeconomy-stallingeffectsof increasingtaxrevenuewhilealsomaintainingservicestopreventthelong-term effects of cuts. Devoting additional surplusrevenuetostatesavingsmayalsoprovideastrategytoconstrainstatespendingandgrowthofgovern-ment,preventingprogramspendingtogrowbeyonditsmeansduringperiodsoflargeeconomicgrowth.

Savingsservetoprotectagainstavarietyofuncer-taintiesinstaterevenuesources.ThelawcreatingMichigan’srainydayfundoutlinesthatitspurposeis “toassistinstabilizingrevenueandemploymentduring periods of economic recession and highunemployment.”7ThisdirectshowthelegislaturecanauthorizerainydayfundmoneytotheGeneralFundandSchoolAidFund tomeet shortfalls andattempt to improvehighunemploymentnumbers.Aseconomiccyclesnaturallyseeperiodsofupswingsand downswings, savingmoney in the rainy dayfundallowsthestatetomovesomerevenuefromaboomingeconomytoaslumpingone.Savingscanthus prevent either steep cuts or revenue spikesduringadownturn,limitingthenegativeeffectsofaneconomiccrisis.

Whilesavingsseemlikeagreatsolutiononcethestate is ina recession,actuallysaving themoneyduringtimesofeconomicexpansioncancreateeco-nomictradeoffsthatthelegislaturemustconsider.Inaboomingeconomy,policymakersoftenarefocusedon other battles,whether it be tax reductions orfundingnewprograms.Thiseither-orpropositioncreatesazero-sumbudgetsituationwheresaving

moneyisleftonthesideline.Reducingtaxesandincreasingspendingtendtohavestrongerpoliticalandconstituentsupport.

Further,duringperiodsofeconomicgrowth,savingmoneymightnotbethebestthingfortheecono-my.Advocatesoftaxcutswouldsaythatputtingmoneyintherainydayfundcouldlowereconomicproductivitybytakingmoneyoutoftheeconomytokeepinthestate’sbankaccount,whilethosewhosupportincreasedspendingwouldarguethatsavingsleavefewerresourcesforprogramsthatcoulduseincreasedfundingtosetthestateupforlong-termsuccess.

WhileMichigan’s rainyday funddoes leave fewerresourcesforpossiblerevenuereductionsorincreas-esinspending,thesesavingsserveotherpurposesthathelpMichiganinthelongrun,independentofbuildingabulwarkforthenextrecession.Therainydayfundbalanceisapartofthestate’sManageableCommon Cash.d This cash is pooled together tomanage state investments inoneaccount, and isusedtopaystatecostsonaday-to-daybasis.Thisallowsthestate tomanagecashflowsduringtheyearwhencollectionsarenotevenlydistributedtocoincidewiththeperiodswhenthestateneedstospendcash.Bydoingso,thestatecanpreventtheneedtotakeoutshort-termloanstopayday-to-dayexpenses.Ineffect,evenwhennotdirectlyallocat-ed, the rainyday fundhelps smoothout revenuecyclesfortheGeneralFundandSchoolAidFund.

Rainydaysavingsalsohelpthestate’screditposition.Ratingagenciespayattentiontothestate’savailablecashonhand,payingacloseeyetotherainydayfundandstatecashreserves.Whenmakingratingsdecisions, credit agencies see the state’s savingpatternsasanimportantwaytoguardagainstthevolatilityofrevenuesduringaneconomiccontrac-tion,whilecashonhandisanimportantmeasureforthestate’sabilitytopaybillsontimeintheshortterm.8TheratingbenefitsofMichigan’srainyday

d Michigan’sManageable Common Cash pool is a groupingofreservesincludingtheGeneralFund,theSchoolAidFund,theSpecialRevenueandEnterpriseFund,theInternalServiceFund,andtheTrustandAgencyFund.Formoreonthestate’sManageableCommonCash, see Stabilized State Budget andRainyDayFundDepositsImproveState’sCashPosition,crcmich.org/mi-state-budget/state-cash-position/























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fundwereondisplayinSeptemberwhenStandardandPoor’supgradedMichigan’seconomicoutlookfrom“stable”to“positive”,citing improvements inboththestate’scashpositionandreservesaspartofthereasonforimprovement.9Whilecreditratingsdonothaveadirectimpactonstatefinances,they

canhaveasignificantimpactonlong-termspendingdecisions.Stateswithbettercreditratingsareabletoborrowmoneyatlowerinterestrates,whichcansavemillionsofdollarsoverthelifetimeofcapitalexpenditureprojects.10

Table 1 Guidelines for Rainy Day Fund Deposits and Withdrawals

Deposits WithdrawalsCondition Amount Condition Amount

Adjusted Personal Income

Ifinflation-adjustedpersonalincomeisgreaterthan2percent

1percentofGeneralFundrevenuesperpercentagepointgrowthabove2percent

Ifinflation-adjustedpersonalincomeisnegative

1percentofGeneralFundrevenuesperpercentdecline

Economic Factors

Staterevenueexceedsconstitutionalrevenuelimitsby1percentorless

Theamountinexcessoftherevenuelimit

Stateunemploymentrateishigherthan8percent

Ifunemploymentisbetween8and12percent,withdrawalupto2.5percentofthefund;ifunemploymentisgreaterthan12percent,upto5percentofthefund

Legislative Appropriation

Budgetedbythelegislature

Determinedbythelegislature,uptotherainydayfundlimit

Needforanemergencyappropriation

Supermajorityvoteinbothchambers

Source:PA431of1984(M.C.L.18.1351)

Michigan’s Rainy Day Fund

What is the Rainy Day Fund?Michigan’s Counter-Cyclical Budget and EconomicStabilizationFund(sometimesdenotedastheBudgetStabilizationFundorBSF)wascreated in1977 inresponsetoaseriesofeconomicchallengesthestatehadfaced.Arecession,whichcauseddeepdeclinesintaxrevenuesandhittheautoindustryparticularlyhard,sentthestateintoascrambletokeepthebudgetbalanced. After thestate recovered,policymakerscreatedtherainydayfundtoeasefuturedeclinesinrevenue.In1984,thestatuteconcerningtherainydayfundwasre-codifiedwithotherlawsintheMan-agementandBudgetAct,wheretheauthorizationfortherainydayfundcurrentlyexists.11

Therainydayfund’soutlineddirectiveisto“reservefundsduringpositiveeconomictimesandthenhavethefundsavailabletouseduringtimesofhighun-employmentandeconomicdownturns.”12The lawoutlines three conditions that allow for deposits

intoandwithdrawalsfromtherainydayfund(seeTable 1):

1) changesinpersonalincomeinthestate;2) revenueandemploymentfactors;and3) legislativediscretion.

Theadjustedpersonalincomeguidelineisthepri-marymechanismthatcontrolstheflowofrainydayfunds. Under theManagement and Budget Act,fundsaredeposited intotherainydayfundwheninflation-adjustedpersonal income inthestate in-creasesbymorethantwopercentandarewithdrawnwhen inflation-adjustedpersonal incomedeclines.For each percentage point adjusted personal in-comegrowthsurpassestwopercent,thelegislatureisdirectedtodepositonepercentofGeneralFundrevenuesintotherainydayfund.

BasedonprojectedFY2017revenues,athreepercentincreaseinadjustedpersonalincomewouldrequirea
























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$101.1millionrainydayfunddeposit(oronepercentofprojectedGeneralFundrevenue).Withdrawalsfunctionsimilarly,witheachpercentagepointdeclineinadjustedpersonalincomeresultinginawithdraw-alofonepercentofGeneralFundrevenue.BasedontheConsensusRevenueEstimatingConference(CREC)projections,adjustedpersonalincomeinthestateisexpectedtoremainonanupwardtrajectory.CRECprojectsrainydayfunddepositsof$52millioninbothFY2018andFY2019,duetoaprojected2.5percentincreaseinadjustedpersonalincomeeachyear.13

Thesecondsetofrulesthatallowmovingfundsinandoutoftherainydayfundisbasedoneconom-ic factors. Article IX, Section 26 of theMichiganConstitutioncapsstaterevenuesat9.49percentofpersonalincome;ifrevenueexceedsthislimitbyonepercentormore, theexcess revenue is supposedtobedepositedintotherainydayfund,thoughthelegislatureinpracticemustappropriateit.Inprac-tice,thestateisunlikelytoseerevenuesurpassthelimitationintheforeseeablefuture.FY2000wasthelasttimerevenuesexceededthelimit,andFY2016revenuewas$8.13billionbelowthelimitation.

Economic-basedwithdrawalsaretiedtoincreasesintheunemploymentrate.Whentheunemploymentrateexceedseightpercent,thelegislatureisabletoappropriatemoneyfromtherainydayfundtosup-plementGeneralFundandSchoolAidFundspending;however,thatspendingislimitedtoprojectsintendedtoimprovethestate’semploymentclimate.Whenunemploymentisinexcessofeightpercentbutlowerthan12percent,thelegislaturecanappropriateupto2.5percentoftherainydayfundbalance.Ifun-employmentis12percentorgreater,thewithdrawallimitincreasestofivepercentofthebalance.

Finally, the legislature is able tomake appropria-tions toandwithdrawals from the rainyday fundatitsdiscretion.Appropriationsinexcessofthoseoutlinedabovehaverelativelyfewrestrictions;gen-erally the legislaturemay appropriatemore thanrequiredinthebudgettoincreasethetotalamountinsavings,aslongasthebalancedoesnotexceed10percentofcombinedGeneralFundandSchoolAidFundrevenue(seeRainyDayFundBalancebelow).Withdrawalsbeyondemploymentandincome-based

withdrawals,whicharedeemedtobeanemergencyappropriation,requireasupermajorityvoteapprovalfrombothchambers.

Rainy Day Fund BalanceAttheendofFY2017,thestate’srainydayfundsatat$711million,oraboutthreepercentofcombinedGeneralFundandSchoolAidFundrevenues.Withthe$167.5millionindepositsslatedforFY2018andinterestexpectedtoaccumulateoverthenextyear,thefundisexpectedtoreach$890millionbytheendofFY2018.14

AsChart 2shows,whenthestateusesrainydayfundrevenuesduringdownturnsthebalancehasnotlastedlong.Thestate’sinitialfundbalanceofjustover$200millionevaporated inasingleyearduetothenationalrecessionin1980,leavingthetankonemptyforfiveyearsbeforethestatestartedtorefuelitinthemid-1980s.

While therainyday fundreached$400millionby1989,theturnofthe1990ssawaquickdeclineinthefundbalancewiththeeconomicslowdownthatstarted the decade. Immediately after the fundnearlybottomedoutin1992,thestatesavedmoneyatarateithadnotcomeclosetobefore;withtheexpansionthatbeganin1992,thestatewasabletosavemorethan$1billionoverthreeyears.

Chart 2 Rainy Day Fund Year-End Balance FY1978 to FY2017

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Source:MichiganDepartmentofTreasury

Note:The gray lines represent the start of national recessions based on National Bureau of Economic Research classification.























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However,thatmoneywasusedupjustasfastasitwassaved—attheturnofthemillennia,thestateemptied the nearly $1.3 billion in reserves overthreeyearsofdownturn.AsthestatemovedfromtheSingleStateRecessionintheearlypartofthedecadeintotheGreatRecessionin2008,reservesstayedclosetoempty.

Whilerecoveryfromconsecutivedownturnsledtoaslowrebuildfortherainydayfund,Michiganisfinallybeginningaddtoitsmainsavingsaccount.

Rainy Day Funds and Economic ConditionsTherateatwhichtrendsintherainydayfundtrackwithbroadeconomicfactorsdetermineiffundsare

beingsavedduringeconomicexpansionsandusedduringeconomicdownturns. Chart 3 shows therainy day fund balance and per unit Income Taxcollections (the amount of revenue collected foreachpercentagepointleviedthroughthePersonalIncomeTax).Usingperunittaxrevenuesprovidesatrendofincometaxrevenue,whileadjustingforchangesinthetaxrate.

Asseen inChart 3, therelationshipbetweenthetwoisquitestrong;inperiodsofgrowthinincometaxcollections,Michiganhasexperiencedmoderatetosignificantgrowthintherainydayfund;whenin-cometaxcollectionsdecline,Michiganisquicktouseexistingfundbalancestostabilizethestatebudget.

Chart 3 Rainy Day Fund Balance Compared to Inflation-Adjusted Per-Unit Income Tax Collections

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Sources:MichiganDepartment of Treasury, State ofMichigan Comprehensive AnnualFinancial Reports fromVarious Years, Department of Commerce, and calculations byCitizensResearchCouncil.
























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Similartrendsareseenintherelationshipbetweenunem-ploymentandtherainydayfundbalance. When therearespikesinunemployment,rainydayfunddollarsevap-oratequickly,andtheygrowwhenunemploymentexpe-riences a steep downwardtrend(seeChart 4).Theseshow the use of rainy dayfund dollars typically occurduringperiodsofincreasingunemployment, which fol-lowstheintentofthefund.

Rainy Day Fund Balance CapWhen initially created in1978, the rainy day fundbalancewascappedat25percentofGeneralFundrevenue.Atthetime,schoolaidfundingwaslessthanaquarterofthesizeoftheGeneralFund.Pro-posalAin1994revampedschoolfinancingfromthestatewithincreasesintheSalesTax(fromfourtosixpercent)andotherstatetaxincreases.Becauseofthesechanges,theSchoolAidFundmorethandoubledinsizeandcametobeapproximatelythesamesizeastheGeneralFund.Thisleadthestatetochangetherainydayfundcapfrom25percentofGeneralFundrevenuesto10percentofcombinedGeneralFundandSchoolAidFundrevenues.

BasedoncurrentGeneralFundandSchoolAidFundrevenues, the 10 percent cap equates to roughly$2.2billion.AnyrevenueinexcessofthecapwouldhavetobereturnedtotaxpayersintheformofIn-comeTaxrefunds.Thestatehasneverbeenclosetoreachingthiscap(seeChart 5).Whilerainydayfundbalancesseemedtooutpacegrowthinrevenuesduringthemid-1990s,thefund-to-capratiopeakedat61percentinFY2000,theyearthechangeincal-culationforthefundcaptookplace.EstimatesforFY2018wouldleaverainydayfundreservesbelow45percentofthefundcap.

Chart 4 Rainy Day Fund Balance Compared to the Unemployment Rate

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Sources: Michigan Department of Treasury and FRED Economic Data

Adequacy of ReservesBecausethestatewouldneedtorelyonsavingsintheeventofarecessiontoavoidbudgetcutsortaxincreases,it’simportanttounderstandtheamountofresourcesthatwouldtypicallybeneededtostabilizethebudgetinthecaseofarecession.However,thelackofgeneralagreementonthelevelofsavingsastateshouldholdmakesitdifficulttoestimatehowlarge rainy day funds need to be tomitigate theeffectsofarecession.

Expertsrecommendthatstatessaveanywherefromfive15tofifteenpercent16ofGeneralFund(and,forthe case ofMichigan, School Aid Fund) spendingintherainydayfund.However,inresponsetotheGreatRecessionmanyorganizationshaveincreasedtheir savings recommendation. TheGovernmentFinanceOfficersAssociation,forexample,increasedtheirtargetedsavingsfromonetotwomonthsofoperatingcostsinresponsetotheGreatRecession.

ItisuncertainifMichigan’scurrent10percentlimitwouldallowforasufficientrainydayfundbalance.AsChart 5shows,Michigan’s rainyday fundhas























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neverbeenclosetothelimit,makingitdifficulttojudgeifthereisaneedtoraisethecapbasedonrecenthistory.However,Michigan’sexperiencewiththeSingleStateRecessionshowssomeconcernforthestate’sabilitytoweatheranotherdownturn.Atjustover60percentofthesavingslimit,therainydayfundbalancewasexhaustedearlyintheSingleStateRecession,withsavingsalmostentirelydepletedinjust a single year. Current reserves,which sit atabout35percentofthefundcap,arelowerthantheywereinFY2000whenthebalancewasatitspeak.

Togetabetterunderstandingoftheadequacyofbothreservesandtherainydayfundbalancelimit,someorganizations have conducted research intowhatindividualstatesmightneedtopreventspend-ing cuts or revenue increasesduringa recession.ThePewCharitableTrustsfoundthatspecificbalancetargetstendtobearbitrary,andarenotsetbasedonindividualstate’sneeds.Theyrecommendlook-ingatarangeoffactorsincludingastate’srevenuevolatility,thesizeofthestatebudget,andthetype

of revenuesources the staterelies on to determine howmuchstatesshouldsave.17

An analysis by Moody’s An-alytics utilizes these factorsto determine the sufficiencyof state rainy day funds forstateGeneralFundspending.18 Their simulation found thatMichigan’srainydayfundwasinsufficient to cover the de-clineinrevenueandincreaseinMedicaid spending in theGeneralFundforamoderaterecession,oronethatissimilartotypicalrecessions.Moody’sestimatestheneteffectofrev-enuereductionsandspendingincreases would be a $1.54billion need in the GeneralFund. While their reportdidnotestimatetheneedsoftheSchoolAidFund,theGeneralFundwould needmore thantwice the current rainy day

fundbalancetoweathertherecessionwithoutrev-enueincreasesorspendingcuts.

TheMercatus Center at GeorgeMasonUniversityconductedasimilaranalysisusingdatafromFY2015andpredictedthatinanaverage-severityrecession,Michigan’sGeneralFundwouldrequire$1.4billioninrainydayfunddollarstoweatheradownturnwithoutcuttingspendingorincreasingrevenue.19

Whilethereissomelevelofvariationbetweenthetwoestimates,bothMoody’sandtheMercatusCen-terpredictthatGeneralFundneedsduringatypicalrecessionwould require double the current rainydayfundbalance,andthatisbeforeaccountingfortheSchoolAidFund.Thecombinationofthestate’srelativelyweakcashpositionandpotentialupcomingbudgetissuesmakeitunlikelythatcurrentrainydayfundreserveswillbesufficienttosmoothoutrevenuedeclinesinanaveragerecessionwithoutsteepcutsorlargerevenueincreases.

Chart 5 Rainy Day Fund Balance Relative to Fund Cap

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The cap calculation changed after 1999

Sources:Department of Treasury and Senate Fiscal Agency

Note:The gray lines represent the start of national recessions based on National Bureau of Economic Research classification.
























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National ComparisonWhileahistoricalanalysisshowssomepossibleissueswiththestate’srainydayfund,thecontextoftherecovery from theGreatRecession isabsent. AnanalysisofwhereMichiganstandsrelativetootherstatescangiveanideaofhowtherecoveryofMich-igan’srainydayfundisfairinginthecurrentcontext.

Asof2016,48stateshavesomesortofrainydayfund. Colorado and Illinois are the only stateswithoutanofficialrainydayfund(thoughtheyhaveotheraccountsforsavings).KansasandMontanaestablishedtheirrainydayfundswithinthelastfewyears,whichlimitsinformationthatcanbeinferredfromcomparingthemwithMichigan.

Rainy Day Fund BalancesInterstatecomparisonsarebestperformedwhen normalized toreflect differences in size andeconomic abilities. Just know-ing that the average rainy dayfundbalanceacrossthestatesinFY2016wasjustover$1billionandthatthenationalmedianwas$477million does not help tounderstandthe levelofsavingsrelative to the size of thebud-gets.AveragesandrangesareskewedbystateswithsignificantbalancessuchasCalifornia,witha balance above $7 billion, orAlaska and Texas, which havesignificant reservesbuiltmostlydue toeachstates’vastsupplyofoilreserves.

Wh i le the med ian makesMichigan’s FY2016 balance of $612million seemrelativelylarge,ranking17thamongallstates,theutility ofMichigan’s rainy day fund actually rankstowardsthebottom.Whenmeasuringrainydayfundbalancesagainstbudgetsize,e5 Michigan’s rainy day e5 For all states other thanMichigan this is General Fundspending.ForMichigan, it ismeasuredagainstGeneralFundandSchoolAidFundSpending.MichiganisuniquenationallyforhavingaseparateSchoolAidFund.ActivityintheSAFisreflectedintheGeneralFundinotherstates;thus,weadjusteddatain

fundbalanceranks36thamongthe48stateswitharainydayfund,andmanyofthosebelowiteitherhaverelativelynewrainydayfunds(suchasKansas),orhaveverylittleinthebank(Pennsylvania).

As of 2016,Michigan’s rainy day fund could onlyoperate state accounts for 10 days, compared tothenationalmedianofjustunder19days.Chart 6 showsthat,whileMichigan’srainydayfundstartedthemillennia above themedian and close to thenationalaverage,therainydayfundwashithardbytheSingle-StateRecessionandbecauseofthis,Michigan’srainydayfundhasyettocatchuptothenationalaverageormedian.

Partofthis isbecauseMichigan’s largerrole infi-nancingK-12publiceducation;Michiganprovidesthe

ninthlargestshareofK-12educationcosts,repre-sentingnearlythreetimesthemedianstateshare.20 Thismeansalargerportionofspendingfallsonthestate budget inMichigan relative tomost states,increasingtherangeofservicestherainydayfundmusthelpcoverduringadownturn.

thissectiontoaccountfortheSAFbecauseRainyDayFundsareusedtooffsetspendinginbothaccounts,andignoringthatdatawouldoverstatetheutilityofRainyDayFundbalances.

Chart 6 Days of Operation Using Rainy Day Fund Balance, FY2000-FY2016

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Michigan 50 State Median 50 State Average

Sources: NationalAssociationofStateBudgetOfficers,thePewCharitableTrusts, andcalculationsbyCRC























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Disbursement of Rainy Day FundsMichiganhasoneofthetightestsetsofcontrolsonits rainyday fund,as itsuse is limited tospecificeconomicandincomebasedconditions,orbyuseofalegislativesupermajorityvote.Infact,Michiganisoneofonly19statesthathaveanexplicitpur-poseforthefundsthatisdirectlyoutlinedinlaw.21 ThePewCharitableTrustslistthisassignificantforstatesavingsbecauseitallowsstatestomakemoreinformeddecisionswhenpreparingforandexperi-encingadownturn.

Michiganisalsooneofonly11statestolinkrainydayfundwithdrawalstoeconomicvolatility,andisoneof14statesthatrequiresasupermajorityvoteinthelegislaturetomakediscretionarywithdrawals.22 ThecombinationoftheseleavesMichiganwithsomeof themostpointed rules for rainyday funduse,whichensuresthatsavingsareusedduringeconomicdownturns.Savingsarethuswellsafeguardedwhilesimultaneouslybeingaccessibleduringaneconomicdownturn.

Rainy Day Fund CapsMichigan’scapontherainydayfundishigherthanthemedianat10percent;10otherstateshavetheircapsetat10percentofrevenues,whilesevenstateshaveacaphigherthanMichiganandanothersevendonotcaprainydayfundbalances.23PriortotheGreatRecession,21stateshadhittheirrevenuelimit.

Giventhat22statesexhaustedmorethantwo-thirdsof their rainyday fundbalancesduring theGreatRecession, thedirenatureofmanystatebudgetsraisedseveralquestionsaboutthesufficiencyofbothrainyday fundbalancesandrainyday fundcaps.Asdiscussedabove, the lastdecadehaschangedwhat isseenasasufficientbalance;modernbestpracticeswouldputanythingbelow10percentasalikelyinsufficientlevelofoverallsavings.So,whileMichiganhasoneofthehigherrevenuecapsnation-ally,evidencefromthelastrecessionshowthatanincreasedlimitwouldimproveoutcomes.

ConclusionThe current economic expansion has allowed thestatetostabilizeaftertheone-twopunchofMichi-gan’sSingleStateRecessionandtheGreatReces-sion,buttheeffectsofsuchaprolongedeconomicstagnation andagrowing list of demandson thestatebudgetdemonstratetheimportanceofusingthisexpansiontoprepareforthenextdownturn.

Therainydayfund,ascurrentlyconstituted,hasthepotentialtoprovideasomewhatstrongfoundationforMichiganinadownturn,butcanbeimprovedinsomeclearareas tomitigate thepotential effectsofdownturns.Thestringentrequirementsforuseoffundsandeconomy-basedwithdrawalarestrongstandardsthatcanmakethefundeffective,butthehistoricallylowrateofdepositshavelimiteditsutility,whilethelowcaponfundscouldfurthershrinktheroleitplaysinmoderatetoseveredownturns.

While$890millionhasbeensavedforthenextdown-turn,moresavingscouldbenecessary;MichiganhassavedlessmoneythanithadpriortotheSingleStateRecession,andlessthantheamountprojectedtobeneededtopreventcutsduringanaveragerecession.Whilethe$2.2billionrevenuelimitunderthecurrentcapmight be sufficient for an average recession,manyorganizationsbest practices recommendupto twomonths-worth of savings; and projectionsbasedonMichigan’sGeneralFundaloneplacestateneedsatmorethan$1.5billiontoavoidcutsandrevenueincreases.Whileincreasingthesavingcapmightbenecessaryforthefundtofunctionatpeakcapacityinthelongrun,themostpressingissueforthestate’sreservesisaneedtoputmoreawayforthenexteconomicdownturn.
























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Endnotes1 Goldmansaysthismaybecomethelongesteconomicexpansioninhistory,CNBC,www.cnbc.com/2017/05/08/goldman-says-u-s-economy-may-be-slowly-growing-into-the-longest-expansion-in-history.html2 StatesFacedRevenueShortfallsin2017DespiteGrowingEconomy,CenteronBudgetandPolicyPriorities,www.cbpp.org/research/state-budget-and-tax/states-faced-revenue-shortfalls-in-2017-despite-growing-economy3 WhyandHowStatesShouldStrengthenTheirRainyDayFunds,CenteronBudgetandPolicyPriorities,www.cbpp.org/research/why-and-how-states-should-strengthen-their-rainy-day-funds4 TheProspectsforaLong-TermSolutiontoMichigan’sGeneralFundStructuralDeficit,CitizensResearchCouncilofMichiganStateBudgetNote2002-04,http://crcmich.org/PUB-LICAT/2000s/2002/sbn0204.pdf

5 ChallengesAheadinBalancingtheStateBudget,CitizensResearchCouncilofMichiganReport397,August2017,http://crcmich.org/challenges-ahead-in-balancing-the-state-budget/

6 Stress-TestingStates,Moody’sAnalytics,https://www.economy.com/getlocal?q=91a42834-85af-4773-b408-5da811028c00&app=eccafile

7 PA431of1984(M.C.L.18.1351)

8 StatesAddtoReserves,EspeciallyRainyDayFunds,ThePewCharitableTrusts,www.pewtrusts.org/en/re-search-and-analysis/analysis/2017/08/04/states-add-to-re-serves-especially-rainy-day-funds

9 CreditagenciesmaintainMichiganbondratings,Crain’sDetroitBusiness,www.crainsdetroit.com/article/20170906/news/638296/credit-agencies-maintain-michigan-bond-ratings

10 RainyDayFundsandStateCreditRatings,ThePewCharitableTrusts,www.brookings.edu/wp-content/up-loads/2017/04/pew_full.pdf

11 PA431of1984(M.C.L.18.1351-1359)12 PA431of1984(M.C.L.18.1351)13 Memorandum:ConsensusRevenueAgreement–May17,2017,HouseFiscalAgency,http://www.house.mi.gov/hfa/PDF/Revenue_Forecast/CREC_Final_Memo_May17.pdf

14 StateofMichiganFiscalYear2017-18AppropriationsSummaryandAnalysis,HouseFiscalAgency,house.michigan.gov/hfa/PDF/Revenue_Forecast/Summ_analy_fy17-18.pdf

15 Rainydayfundsprovednomatchagainstrecession-erabudgetgaps,NationalConferenceofStateLegislatures,www.ncsl.org/research/fiscal-policy/a-drop-in-the-bucket.aspx

16 WhenandHowStatesShouldStrengthenTheirRainyDayFunds,CenteronBudgetandPolicyPriorities,www.cbpp.org/research/state-budget-and-tax/when-and-how-states-should-strengthen-their-rainy-day-funds

17 WhyStatesSave,ThePewCharitableTrusts,www.pewtrusts.org/~/media/assets/2017/02/why_states_save.pdf

18 Stress-TestingStates,Moody’sAnalytics19 WeatheringtheNextRecession:HowPreparedArethe50States?,TheMercatusCenteratGeorgeMasonUniversity,www.mercatus.org/publication/weathering-next-recession-how-prepared-are-50-states

20 NationalPublicEducationFinancialSurveyData,NationalCenterforEducationStatistics,nces.ed.gov/ccd/stfis.asp

21 WhyStatesSave,ThePewCharitableTrusts22 WhentoUseStateRainyDayFunds,ThePewCharitableTrusts,www.pewtrusts.org/~/media/assets/2017/04/when-to-use-state-rainy-day-funds.pdf

23 WhyStatesSave,ThePewCharitableTrusts























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Documents

Preparing the State of Michigan’s Budget for the Next ... · Preparing the State of Michigan’s Budget for the Next Recession In a Nutshell 1) Michigan’s rainy day fund is being