Overview

On Nov. 7, 2006, Michigan voters will be asked to consider a proposed new law that would, if passed, require annual state spending to increase at no less than the inflation rate for the following state budget areas: public school districts and charter schools; certain specific budget items in state spending on public school districts and charter schools; and state universities and community colleges. The proposal also contains new requirements for state payments to districts with declining enrollment and places liability for school employee pension cost increases on state government, rather than school districts. The proposed new law will appear as "Proposal 5"on the ballot, and its mandates would take effect in the 2006-2007 school year.

Past Spending on Public School Districts

During the recessionary period from 2001 to 2005, Michigan state government’s spending on primary and secondary education did not keep pace with inflation.* Nevertheless, it did increase slightly during this period. Moreover, state school aid fund spending in 2005 was more than 40 percent higher than in 1995 — about $1 billion above the 27 percent total inflationary growth for that period. State school aid spending easily remained the single largest expenditure of state government.

Michigan is still one of the nation’s leaders in school spending. According to the federal government’s National Center for Education Statistics, Michigan’s per-pupil spending in 2003 was ninth in the nation, and according to the National Education Association, the average salary for Michigan instructional staff was eighth. In 2004, the average compensation for instructional staff at Michigan public schools was more than $54,000. If one of Proposal 5’s main goals is to ensure high and rising primary and secondary school spending over the long term, it would seem that goal has already been met.

* Sources for the findings cited in the “Executive Summary” are provided in endnotes to the main text of the Policy Brief.

Past Spending on State Universities and Community Colleges

State appropriations for community colleges and universities were nearly 37 percent higher in 2001 than in 1995, compared to 15 percent total inflationary growth. State higher education expenditures dropped nearly 10 percent between 2001 and 2005. Yet Michigan’s public universities and community colleges were able to raise money from tuition and other sources; total expenditures from the general funds of the four-year universities increased every year from 2001 through 2005. Spending per capita by Michigan’s public institutions of higher education was ninth in the nation in 2002 — nearly 33 percent above the national average.

It is also worth noting that even as the growth in state appropriations for universities exceeded the inflation rate between 1995 and 2001, the average undergraduate in-state tuition at Michigan universities rose more than 28 percent — an increase of nearly twice the inflation rate. Thus, while Proposal 5 might ameliorate tuition hikes, it is unlikely to solve the problem of rapidly rising tuition.

Pension and Retirement Health Care Costs

The pension and retirement health care provision of Proposal 5 involves a state-administered retirement plan primarily for employees of Michigan public school districts. A recent, credible estimate suggests that the cost of the retirement plan will increase more than 94 percent by 2016. In contrast, the cost increase from 1996 to 2006 was about 50 percent. The total retirement fund contribution increases from 2004 through 2006 cost the average school district an additional $178 per pupil, exceeding the state’s per-pupil foundation allowance increase during the period by $3 per pupil.

The major factors driving the hike in retirement costs are a growing imbalance in the number of workers supporting retirees, the need to recover recent stock market losses, and a substantial projected payment increase for the retirement health care benefit. While the cost of the health insurance benefit represented less than 45 percent of retirement fund contributions in 2005, it is projected to reach more than 62 percent in 2020.

The proposal does not change the retirement fund cost structure, even though the substantial majority of private-sector employers do not offer any retirement health care benefit at all. Instead, Proposal 5 would shift nearly all of the future retirement fund cost increases from the budgets of school districts to the state. If Proposal 5 were to pass, the state general fund budget would assume responsibility for $386.3 million of an estimated $1.9 billion total retirement fund cost in fiscal 2007 alone. This $386.3 million figure is in fact larger than 16 of the 26 state departmental budgets from fiscal 2006.

By putting the financial pressure of rising retirement contributions on state government, Proposal 5 would make local budgeting easier, but would also subsidize school districts’ personnel budgets by reducing the local cost of payroll. This subsidy could lead districts to make otherwise unsustainable staffing decisions and drive overall retirement liabilities even higher.

Likely Budget Effects of Proposal 5

State lawmakers had the discretion to cut some programs more than others during the current recession. Proposal 5 would leave lawmakers with less flexibility during future declines in state revenue growth. State spending on education at all levels represents 54 percent of the state budget that depends on state revenues. Proposal 5 would mandate that this spending rise with inflation regardless of the funds available for the remaining 46 percent.

Proposal 5 would provide lawmakers an incentive to cut state spending on certain primary and secondary education programs, such as adult and vocational education, by an estimated $141.7 million in fiscal 2007. Indeed, the Michigan Senate Fiscal Agency has assumed such cuts would take place, and these cuts lower the first-year cost estimate for Proposal 5 to $566.6 million. Without the cuts, the estimated first-year cost would reach $708.3 million. Assuming no increase in taxes, legislators could meet Proposal 5’s 2007 spending requirements in one of two ways: by making 9.8 percent cuts to noneducation general fund spending, such as human services, corrections or veterans services; or by making 7.9 percent cuts to this spending and $141.7 million in cuts to the "unprotected" primary and secondary education spending noted above.

Tax increases could also be used to raise some or all of the first-year spending required by Proposal 5. In the case of the income tax, $708.3 million would represent about 11.1 percent of current revenue, while $566.6 million would represent 8.9 percent. Raising taxes on Michigan households, however, would decrease their disposable income and raise the effective cost of such things as higher education.

Colorado’s experience with a similar state education spending mandate suggests that tax increases, spending cuts to noneducation programs, or both are reasonably likely to occur if Proposal 5 is passed.

Proposal 5’s Potential Effects on Education and the Economy

There is no apparent correlation between Michigan’s high spending for education on the one hand and brighter kids and more jobs on the other. Despite the relatively high level of Michigan’s spending on education, Michigan students have posted mediocre standardized test scores, and Michigan’s economy is now one of the nation’s worst. Economist Richard Vedder recently found no association between state spending on higher education and economic growth.

Proposal 5 could produce unintended educational effects. Granting additional money to districts with declining enrollment could insulate poorly performing districts from the financial consequences of their failures. This reduced penalty, along with the proposal’s spending increases regardless of academic performance, could lower poorly performing districts’ incentives to reform.