Bolema: Michigan’s fiscal health is not strong

Ted Bolema

Michigan has struggled to emerge from the Great Recession, just like so much of the rest of the nation — and it still has a great deal of work to do. The latest evidence is a new report published by the Mercatus Center at George Mason University, which shows the state’s “fiscal health” ranking is slipping.

Until recently, assessing the fiscal health of states was difficult because of the lack of standardized data. Now, however, all states prepare audited Comprehensive Annual Financial Reports, which can be compared across states. Using this data, my Mercatus Center colleague Eileen Norcross calculated the fiscal health rankings for all 50 states. This report, “Ranking the States by Fiscal Condition,” puts Michigan in 34th place, based on its solvency in five categories.

This project takes the extensive data in these reports, as well as little-known data like trust fund solvency measures that are often overlooked by state regulators and watchdog groups, and puts them into context so that anyone can see a snapshot of how his or her state is doing. For Michigan, the snapshot is not very flattering.

Michigan scores better than average in only one category. We rank 22nd in budget solvency, which measures whether a state can cover its fiscal year spending out of current revenues. Fortunately, Michigan is meeting its current year fiscal commitments better than most states.

Unfortunately, Michigan ranks lower in the categories that measure its fiscal condition in the long run. In particular, our low overall ranking is due to poor rankings in two categories: trust fund solvency and service-level solvency.

Michigan’s lowest ranking is for trust fund solvency, which measures the size of pension liabilities and state debt as compared to state income. The biggest problem is our unfunded pension liabilities. Michigan’s audited financial statement finds that future pension liabilities are 63 percent funded, but that funding ratio is based on discounting future liabilities with unrealistic future pension fund returns.

Norcross’ report recalculates the actual market value of these liabilities using a more appropriate risk-adjusted discount rate, revealing that Michigan’s pensions are only 32 percent funded, well below the average for other states. This severe underfunding should be especially troubling for a state with recent experience with underfunded pensions in Detroit and with General Motors.

Michigan’s other poor ranking is for service-level solvency, or “fiscal slack.” This measures the state’s ability to raise taxes if spending commitments demand more revenues. In other words, it measures the state’s ability to increase taxes without harming the economy. The report ranks Michigan 33rd in service-level solvency, indicating that we are in a worse position than most states, due to a high ratio of current taxes to personal income.

These fiscal rankings are based on the most recent data available (from the 2013 fiscal year), and build upon the methodology in an earlier Mercatus Center report in which Michigan fared somewhat better, with an overall ranking of 30th in the nation. So Michigan’s fiscal condition is deteriorating relative to other states.

The report finds that nearly all states have unfunded pension liabilities that are large relative to state personal income, indicating we all need to take a closer look at unfunded pensions. Another financial crisis could mean serious trouble for states that are fiscally stable in other areas.

Michigan policymakers are debating many important fiscal matters, including road funding and tax reform. While these issues are important, the message from Michigan’s relatively poor fiscal ranking is that we must take better stock of our long-term fiscal health before making future public policy decisions.

Ted Bolema is director of policy research editing with the Mercatus Center at George Mason University.