CRC Memorandum

Proposal 02-02

Proposal 02-02 was placed on the August 6, 2002, statewide ballot by the Michigan Legislature (Senate Joint Resolution T) and would amend Article IX of the 1963 Michigan Constitution to make three principal changes with respect to natural resource and state park funding:

1. Amend Section 35 to increase the overall cap on assets in the Natural Resources Trust Fund from $400 million to $500 million.

2. Amend Section 35 to permit 1/3 of revenues to the trust fund to be appropriated until the fund reaches $500 million in assets. When that amount is reached, only interest earnings may be appropriated. (The present limit is $200 million.)

3. Amend (and renumber) Section 36(1) to permit interest and earnings plus 50 percent of the annual revenues from the MNRTF to be appropriated from the Genevieve Gillette State Parks Endowment Fund. (The present limit is $5.0 million, adjusted for inflation.)

Proposal 02-02 would also amend Sections 19, 35, 36(1), and 37 of Article IX to remove the prohibition against ownership of stock by state permanent and endowment funds, specifically including the Natural Resources Trust Fund, the State Parks Endowment Fund, and the Veterans' Trust Fund.

Background

The Kammer Trust Fund. Public Act 204 of 1976 created the Recreational Land Acquisition ("Kammer") Trust Fund with revenues consisting of rents and royalties from private oil, gas, and mineral exploration on state-owned lands, together with bonuses resulting from bids for access to such lands. The purpose of the fund was to acquire land for hunting, fishing, or other recreational purposes, and for the payment of any local taxes owed by the state on the land. The basic concept was that of using revenues from non-renewable resources to purchase land for the benefit of future generations.

P. A. 204 structured the fund in a manner intended to make it self-perpetuating. However, diversions from the fund were made in 1979, 1980, 1981, and 1983, preventing the fund from achieving its target asset level of $150 million. Although the largest initial diversions were made to help balance the state budget during the recession of that period, the greatest long-term diversion was to the newly-formed Michigan Economic Development Authority (MEDA). Beginning in 1982, revenues that previously went into the Kammer fund were deposited in a new Heritage Fund from which appropriations to MEDA were made. The plan was to pay out $20 million per year from the fund to MEDA over a 50-year period, a total of $1 billion.

Proposal B of 1984: The Natural Resources Trust Fund. In November 1984, voters approved Proposal B, which added a Section 35 to Article IX of the Michigan Constitution. The new section established the Michigan Natural Resources Trust Fund (MNRTF) and restricted the uses to which the revenues of the fund could be put, thereby creating a constitutional successor to both the Kammer Fund and the Heritage Fund. Statutory provisions for the fund were adopted in Public Act 101 of 1985.

Under provisions of the amendment, the interest and earnings accruing to the trust fund were available to be expended in the following year. In addition, the Legislature was permitted to appropriate up to 1/3 of the oil and gas lease revenue received by the trust fund each year until the fund reached its principal cap of $200 million. Once the cap was reached, only interest earnings were to be available for appropriation. Those appropriations were limited to the purchase of land or rights in land for recreational uses because of "its environmental importance or its scenic beauty," the development of public recreation facilities, and the administration of the fund, including payment in lieu of taxes on state-owned land purchased through the fund.

The amendment also permitted the Legislature to authorize the diversion of a portion of the trust fund revenues each fiscal year to the Michigan Strategic Fund, which replaced MEDA and which was designed to leverage private sector investment with public funds and to protect the rights of MEDA bondholders who had purchased bonds backed by the Heritage Trust. Although P. A. 101 would have terminated the Strategic Fund diversion in 1994, after the debt had been retired, the Legislature could have voted to continue the transfers.

(CRC analysis of Proposal B can be found in Council Comments No. 950, October 1984.)

Proposal P of 1994: Termination of the Strategic Fund Diversion; Creation of the State Parks Endowment Fund. By 1993, the principal balance in the MNRTF had reached only $70.3 million, far short of the principal cap of $200 million established by Proposal B of 1984. As long as funds were permitted to be appropriated to the Strategic Fund, reaching the cap would take a very long time, so in November 1994, the Legislature submitted Proposal P to the voters. Proposal P, which was approved, did three things: 1) amended Article IX, Section 35, to eliminate the diversion of revenue from the MNRTF to the Strategic Fund; 2) amended Section 35 to increase the principal balance limit of the MNRTF from $200 million to $400 million, thereby providing more interest income with which to purchase land; and 3) added a Section 36 (actually, a second Section 361) to establish, fund, and provide for the use of the Genevieve Gillette State Parks Endowment Fund (SPEF), created by Public Act 79 of 1994.

The SPEF was created to address the volatile funding and gradual deterioration of the state park system. Although supported by general fund appropriations for much of their history, beginning in 1980, state parks became more and more dependent on user fees for funding. Under Proposal P, the SPEF was to receive up to $10 million annually from the MNRTF. In addition, if the State Accident Fund were to be sold (it subsequently was), $40 million would be appropriated to the SPEF as seed money. When the MNRTF reached its principal cap of $400 million, all revenues otherwise dedicated to it would be deposited in the SPEF. When the SPEF reached a principal balance of $800 million, all MNRTF revenues, exclusive of interest, would be distributed as provided by law.

Finally, Proposal P provided that until the SPEF reached $800 million, the Legislature could make annual appropriations of $5 million, adjusted annually for inflation, from the fund to the state park system. Once the SPEF reached its cap, only the interest in excess of the amount required to maintain the fund at its principal limit would be available for appropriation.

(CRC analysis of Proposal P can be found in Council Comments No. 1030, September 1994.)

Fund Finances Since 1994. The MNRTF principal balance (currently capped at $400 million) doubled from 1995 to 2001 as shown in Table 1.

Proposal 02-02 of 2002

Provisions. Proposal 02-02 would amend Article IX to do three things regarding the MNRTF and SPEF:

1. Increase the principal cap in the Michigan Natural Resources Trust Fund from $400 million to $500 million. Under current provisions, when the MNRTF accumulated principal reaches $400 million, all fund revenues (which come from rentals and royalties derived from mineral, coal, oil, and gas interests on state-owned land) will be deposited in the State Parks Endowment Fund. Section 35 would be amended to increase this cap to $500 million, permitting the fund to earn somewhat greater amounts than under the existing cap.

2. Permit annual appropriation of 1/3 of royalty earnings (plus interest) until MNRTF accumulated principal reaches the overall cap of $500 million. Currently, when MNTRF accumulated principal reaches $200 million, the Legislature will no longer be able to appropriate 1/3 of the royalties each year to fund grants to local units of government as well as state agencies to acquire or develop public recreation areas. Only interest earnings of the fund would then be available for appropriation. Proposal 02-02 would amend Section 35 to increase the cap to $500 million.

3. Permit annual appropriation from the State Parks Endowment Fund of interest and earnings plus 50 percent of the annual revenues from the MNRTF. Current provisions limit annual appropriations from the SPEF to $5.0 million, adjusted annually for inflation. Proposal 02-02 would amend Section 36(1) by increasing this cap to interest and earnings plus 50 percent of the annual revenues from the MNRTF. In FY2001, expenditures of $7.0 million were made from the SPEF. (Proposal 02-02 would also renumber Section 36(1) as Section 35a, thereby remedying an oversight in Proposal P of 1994. See footnote 1)

Statutory Nature. Sections 35 and 36(1) are among the longest and most complicated sections in the Michigan Constitution, principally because Proposal B of 1984 was essentially an importation of a state statute, P. A. 204 of 1976, into the Constitution. This approach was taken in large part to insulate the Kammer fund from the diversions that were preventing it from reaching its asset goal. In 1994, the same constitutional protection was accorded the SPEF and in 1996, the Michigan Veterans' Trust Fund, created by statute in 1946, was given constitutional status to circumscribe the uses to which it could be put.

Although these funds are now largely protected from being used for other than their original purposes, that protection entailed the placement of detailed material in the Constitution that would normally be found only in statute. Among the reasons for calling the Michigan Constitutional Convention of 1961-62 were the length to which the 1908 Constitution had grown, largely through adding amendments that might have been accomplished through statute, and the constitutional dedication, or "earmarking" of state revenues. Proposal B of 1984 did both and Proposal 02-02, with the exception of the repeal of the prohibition against stock ownership, asks the voters to approve amendments to the law that, before 1984, could have been made by the Legislature.

Investing Public Funds in Stocks

The Internal Improvements Debacle. The success of the Erie Canal in New York in the 1820s led a number of states to the conclusion that economic development would come only through massive subsidization of "internal improvements," principally canals and railroads. In the 1830s and 1840s, these projects were enthusiastically undertaken, but, in state after state, whether by corruption, poor planning, or excessively optimistic economic assessments, they failed, resulting in the creation of state debt that in many cases persisted into the late 19th century, with little to show for it. Illinois, Indiana, and Michigan were among the hardest hit of the states that were caught up in the internal improvement debacles.

Some of the failed projects were privately financed, but many involved public participation in private railroad and canal companies, such as the Michigan Central and Michigan Southern railroads and the Clinton-Kalamazoo Canal. The reaction to this ill-starred participation was to adopt constitutional prohibitions against public ownership of stock. Article XIV, Section 8, of the Michigan Constitution of 1850 provided that

The state shall not subscribe to, or be interested in the stock of any company, association or corporation.

This provision was retained virtually unaltered in the Constitution of 1908, but the Constitution of 1963 significantly eased the prohibition by exempting public employee pension funds and endowment funds created for educational or charitable purposes.

Provisions of Proposal 02-02. Proposal 02-02 would amend Article IX, Section 19, to extend the exemption from the prohibition against stock ownership to other permanent or endowment funds. The proposal would amend Sections 35, 36(1), and 37 to specifically permit the State Treasurer to invest the assets of the Michigan Natural Resources Trust Fund, the State Parks Endowment Fund and the Michigan Veterans' Trust Fund in the same manner as the investment of the Public Employees Retirement Fund.2 Current law permits up to 70 percent of retirement fund assets to be invested in stocks. No more than 5 percent of stock ownership may be in one company and the fund may not own more than 5 percent of any company.

Most of the assets of these funds currently consist of bonds. Stocks are riskier than bonds in the sense that the deviation of the rate of return in any one year from the long-term average annual rate of return is greater for stocks. Numerous studies have shown, however, that, over the long term, stocks outperform virtually all other investments and more rapid growth in the assets of these funds may be expected if they are permitted to hold stocks. A 2002 study by Wilshire Associates, for example, shows that over the 75-year period 1926-2001 the annual average rate of return for stocks exceeded that of bonds by 5.0 percentage points (10.7 percent vs. 5.7 percent). Clearly, funding public employee retirement benefits in Michigan would have been much costlier to taxpayers if the assets of the retirement funds could not have been invested in stocks.

Moreover, the current prohibition prevents these funds from fully diversifying their investment portfolios. By diversifying and creating the opportunity for offsetting losses and gains, it is actually possible to reduce the risk for the entire portfolio by adding a riskier investment class, such as stocks.

1 In March 1994, voters approved Proposal A, which made major changes in constitutional provisions regarding Michigan education funding and taxation. Proposal A had added a Section 36 to Article IX, providing a dedication of 6 percent of tobacco tax proceeds to health care. Through an oversight, the Legislature submitted Proposal P to the voters with its own Section 36 in November 1994 and, since it received voter approval, the Legislature could not subsequently renumber the section on its own.