COVID-19 Impacts State Budget: Prepare for Cuts to Local Government Programs

The University of Michigan Research Seminar in Quantitative Economics just released their economic forecast for the nation and the state. The forecast was presented at a recent SEMCOG webinar focusing on the economic impacts of COVID-19. Contained in the forecast is a projection of revenues for the State of Michigan for the current fiscal year as well as for fiscal years 2021 and 2022. The forecast is projecting significant revenue drops at the state level and, as such, will undoubtedly mean budget cuts for programs that aid local governments at all levels in the state.

U of M is projecting that state General Fund revenues will fall short of January’s official state estimate by $1.65 billion; School-Aid Fund revenues will fall short by more than $900 million. The analysis further projects a shortfall in the projected revenue for the combined General Funds and School-Aid Fund of $2.85 billion for 2021 and $1.65 billion for 2022, compared to projections currently being used by the state to develop next year’s budget. For perspective, the state’s General Fund expenditures for this year were appropriated at $10.8 billion; the School-Aid Fund was expected to total $13.3 billion.

Of course, there is more to the state budget than just the General Fund and School-Aid Fund. More than a third of the state budget is derived from federal funds and another $10 billion of the state’s revenues are restricted in their use by either the state constitution or law. However, when the state has a budget deficit, all eyes turn to the General Fund, which is comprised of revenues that can be used for any purpose.

How are local governments impacted?

How will this loss of state revenue impact local governments? Some budget items will automatically change with the falling revenues. Constitutional revenue sharing is based 100 percent on sales-tax collections. With many of the retailers closed, sales-tax collections are down. Way down. This means constitutional revenue sharing distributions will be significantly below normal until stores, restaurants, and car dealerships reopen. Not much gasoline is being sold either. This will impact the amount of money available for distribution under Public Act 51. These are examples of reduced state revenues that have nothing to do with legislative actions.

If the U of M numbers are shown to be correct, and no one has consistently better numbers, then the legislature will need to adjust the current state General Fund budget by $1.65 billion. Cutting that much money out of a $10.8 billion budget is a huge fiscal problem over the course of a year, but more than half of the fiscal year has already come and gone. The legislature will have only about $5 billion that remains unspent. Currently, the state has a fund balance or “rainy day fund” of approximately $1.2 billion. This will offset part of the problem for this year and next, but it still leaves many issues to resolve.

Historically, big cuts in the state budget usually mean big cuts in state appropriations to local programs. The most notable example is that two-thirds of the statutory revenue sharing program has been absorbed back into the state budget since 2002; $444 million was appropriated to support county, city, village, and township operations under this program in the current year. In the past, the legislature has shifted general funds out of higher education budgets and into the state budget, and then diverted school-aid funds out of the K-12 budget and into higher education fill the general fund hole. (See “Whatever happened to the lottery money?” blog.) Governor Whitmer has called this a “shell game.” Hopefully, it is not a game that is repeated. When the legislature increased road funding in 2015, they dedicated income-tax revenues – normally considered general-fund revenues – to roads. Many voiced concerns that the new funds would disappear when the state budget got tight. This situation will test to see if the skeptics were right.

The state has already started taking steps to curtail spending. A hiring freeze is in place. All discretionary spending not related to COVID-19 has stopped. Many grant programs are on hold. The Chairperson of the Senate Appropriations Committee wants to lay off all nonessential state personnel.

How can local governments prepare for these impacts?

Local officials should look closely at all revenues that come from the state. Any programs or grants that are based on General-Fund revenues will be highly susceptible to legislative budget cuts. Other programs that are formula based on revenue collections are virtually guaranteed to see distributions below previous estimates. Hopefully, federally based distributions will remain solid.

SEMCOG will be communicating with the legislature as budget plans evolve, but this is also the time for local officials to talk with their legislators. Remind them that local governments are already seeing revenue issues of their own, and that the COVID-19 outbreak has created new needs that may or may not be covered under the federal CARES Act. Also remind them that, while the state only has months before the end of their fiscal year, cities and school districts only have weeks. Finally, remind them that your local government’s main revenue source was not allowed to rebound from the financial disaster that occurred during the Great Recession because of constitutional limitations, unlike state revenue sources.

As we are often hearing; we are all in this together. All of us will need to be watching out for each other as the second part of the COVID-19 crisis hits – the economic crisis.