SB 248: New Reforms to Michigan’s No-fault Auto Insurance

On Thursday, April 16, Michigan’s Senate passed Senate Bill 248, a bill that proposes major changes to Michigan’s no-fault auto insurance system.  The bill includes reforms that would generally create more transparency in a new association created to replace the Catastrophic Claims Association (who calculates the annual per vehicle catastrophic claims assessment paid by insured car owners), create an auto insurance fraud authority, set attendant care pay limits, and potentially reduce the prices paid for auto accident claims to medical providers.  New language also strives to ensure that rates for automobile insurance are not “excessive,” but it is probable that consumers will only see insurance rate and vehicle assessment relief if savings from changes to medical spending are passed to consumers by auto insurers and by the new association that handles catastrophic claims.

In 2013, Citizens Research Council issued a report, Medical Costs of No-fault Automobile Insurance, which analyzes the medical costs associated with the state’s auto insurance system.  Medical costs typically make up 30 percent of nationwide auto insurance premiums. The CRC report identifies some reasons why Michigan’s medical costs associated with auto insurance may be higher than necessary; several of the reforms in SB 248 address the points raised in CRC’s report.

Michigan is one of 12 states with either mandatory or optional no-fault insurance.  As part of Michigan’s no-fault insurance, drivers are required to purchase personal injury protection (PIP).  PIP provides coverage for unlimited medical costs of an injured party in an accident, regardless of fault.  These include direct medical care, but may also pay for facility or in-home attendant care if medically necessary. Michigan’s coverage also pays up to 85 percent of the income the injured party would have earned had the driver not sustained an injury in the accident and injured parties are entitled to up to $20 per day in replacement household services (such as housekeeping and yard work) if they are unable to perform these services themselves.

These features of Michigan’s auto insurance law remain intact in SB 248.  What SB 248 does address is the reimbursement prices paid for medical and hourly attendant care services for injured parties.

Reimbursements to Medical Providers

In regards to prices charged for medical services, the Michigan Insurance Code currently states that providers “…may charge a reasonable amount for the products, services and accommodations rendered. The charge shall not exceed the amount the person or institution customarily charges for like products, services and accommodations in cases not involving insurance.”  This language, which is retained in SB 248, has been held to mean that auto insurers must pay the amount customarily charged and not the amount customarily received.  This distinction is important because some payers (but not all) for medical services do pay, or are able to negotiate, discounted rates- namely Medicaid, Medicare, and private health insurers.

The impact that this language has on the amount auto insurers and the Michigan Catastrophic Claims Association (MCCA) pays for medical services on behalf of parties injured in auto accidents may be quite significant.  CRC’s report includes a medical fee comparison showing that for the 15 most common charges, Detroit’s no-fault reimbursement exceeds workers’ compensation reimbursements by anywhere from 13% for a 25-minute office visit to 335% for a neck CT scan.

The language and legal interpretation of the Insurance Code may explain why providers’ claims for reimbursement for medical care related to auto accidents are 24 percent higher in Michigan than in other states, when holding the amount of care constant.  CRC’s report outlines a number of policy options that would reduce medical costs related to no-fault, many of which could be implemented without impacting the quality or quantity of care provided to those injured in auto accidents.  Some of these options include: introducing a fee schedule for auto insurers, similar to that required for workers’ compensation; designating the health insurer as primary payer for auto accident related medical expenses and the auto insurer as the secondary payer; and allowing auto insurers to pay the amount customarily received or allowing auto insurers to pay the same prices as health insurers.

Senate Bill 248 implements one of these policy options: allowing auto insurers and the catastrophic claims association to pay the same amount that the provider receives from other payers (excluding Medicare and Medicaid) for similar services.  While maintaining the language allowing providers to charge the amount they customarily charge for similar services, new language follows that effectively allows insurers and the association paying for catastrophic claims to pay similar rates as private health insurers.  Regarding the charge, new language states: “If parties are unable to reach an agreement, the insurer or corporation…is not required to pay an amount that exceeds the average amount the person or institution accepts from all sources for like products, services, and accommodations.”  It goes on to exclude from the average other cases involving PIP, as well as Medicaid and Medicare rates.

Attendant Care Pay Limits

Senate Bill 248 also addresses spending related to in-home attendant care.  Of major note is a limitation on the payment for in-home attendant care provided by a family or household member to $15.00 per hour, regardless of the care provided or licensure of the attendant.  CRC’s report identified attendant care as an expense driving spending by the MCCA, the association that currently pays for catastrophic claims.  For the period covering July 1, 2010 through June 20, 2012, roughly 21.8 percent of MCCA loss payments were for family attendant care.  Providers of these services have the same legal right as other providers to receive the entire amount they bill.  As such, prices for attendant care vary widely.  The current statute only requires that that charges be “reasonable.”

Analysis of Proposed Law

The changes to auto insurance proposed in SB 248 represent a significant departure from the current law which sets no specific rates and generally leaves it to providers to charge reasonable rates for services.  The reduced spending for medical care related to auto injuries that would undoubtedly occur should SB 248 be passed by the House and signed into law, would be significant mostly for the new association that would handle catastrophic claims in excess of $545,000.  Reduced spending here could reduce the per vehicle assessment charged to insured motorists by the association.  This amount is currently $186 per vehicle.  Auto insurers would also see savings but there are currently no provisions in the bill that ensure those savings are passed on to consumers through lower premiums.

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Eroding Tax Bases in Wayne County

A recent press conference held by Wayne County Executive, Warren Evans, has confirmed the dismal outlook for the county’s financial situation and cites a $70 million budget deficit. What is more, Evan’s administration anticipates that the county will run out of cash by May 2016 without any kind of intervention. While discussions to identify contributing factors cannot omit exploring criticisms of financial management and other administrative shortcomings, these alone cannot account for the full story.

The tax base of a county government is only as strong as the tax bases of the local governments that lie within it.  Michigan Department of Treasury data reveals that local governments within Wayne County have seen an average 17.6 percent loss of taxable value in real dollars since 2000. Indeed, no local government in Wayne County, as of 2014, has been able to return to the taxable values seen prior to the collapse of the housing bubble in 2008. On average, these municipalities have been able to recapture approximately 67 percent of peak values by 2014. A valid reply to this may be to suggest that the figures just prior to the recession are an inappropriate point of comparison due to the artificial pricing that is characteristic of any commodity experiencing bubble price rises. However, even when comparing to the taxable values seen in 2000, 40 percent (17 of 43) of local governments in Wayne County have yet to recapture those figures in terms of nominal dollars and only 19 percent (8 of 43, which, with the exception of the cities of Plymouth and Northville, are all fringe townships) have been able to recapture these values when adjusting for inflation.

The first losses in terms of both nominal and real taxable value for the county as a whole were observed in 2008. Wayne County’s taxable value decline in real dollars from 2007 to 2014 was over $14.8 billion. Nevertheless, as Graph 1 below indicates, year to year losses in taxable values in some Wayne County local governments were seen even before the events of 2008. Furthermore, the Graph 2 indicates that local governments in Wayne County were experiencing taxable values below levels of inflation prior to 2008 as well. Stated otherwise, communities were experiencing year to year losses of potential purchasing power. This decline in taxable value may be explained by the rapid decline of Michigan’s manufacturing base observed during this time period and the subsequent erosion of housing values.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year. *Out of a total of 43 local governments.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year. *Out of a total of 43 local governments.

The devastating subsequent effect of the housing market crash on the most populous local governments in Wayne County cannot be emphasized enough. In 2008, of the 43 local governments in the county, only three (Riverview, Hamtramck, and Sumpter Township) did not experience losses in real (or inflation-adjusted) taxable value, despite only a 0.05 percent increase in the rate of inflation from the year before. Overall, the county as a whole experienced a 3.2 percent loss in taxable value. In 2009, an extremely low inflation rate assured that further losses were slightly less severe in terms of real dollars compared to the year before, with ten local governments experiencing modest gains in inflation adjusted taxable values. This, however, was short lived. From 2010 through 2012, all local governments in Wayne County except Northville Township (which experienced a modest gain from 2011 to 2012) saw losses in real taxable value. In terms of unadjusted dollars, Sumpter Township had a modest gain in 2010, while the same was true in 2012 for Northville Township, the cities of Northville and River Rouge. Average decreases over this 36 month period in real dollars were 8.1 percent.

Since 2012, only a handful of local governments (Northville, Canton, and Sumpter Townships, and the cities of Northville, Melvindale, River Rouge, Grosse Pointe, Rockwood, Plymouth, and Grosse Pointe Farms) have seen real taxable value increases from one year to the next, and even in these limited cases, on an inconsistent basis. The graphs below illustrate the losses at the county level and show that signs of trouble appeared early, in the form of decelerated year to year growths in taxable values, even in nominal dollars.

The greatest percentage losses from peak to current real values have been experienced by built out, working class communities in Wayne County. The cities of Harper Woods, Wayne, Dearborn, Westland, Romulus, Flat Rock, Lincoln Park, and Wyandotte and Redford Township, all currently have between 61 percent (Dearborn) and 47 percent (Harper Woods) of the real dollar taxable values they possessed prior to 2008. The anomaly here is the City of the Village of Grosse Pointe Shores, incorporated as a city in 2009, which has lost 57 percent of its real dollar taxable value capacity, compared to its peak in 2004. Some cities have done better than one would expect. Notably, Detroit and Hamtramck have been able to maintain 64 and 67 percent, respectively, of their peak inflation adjusted taxable values. Unexpectedly perhaps, the cities of Livonia, Dearborn Heights and Belleville find themselves between these two ranges of percentages. Wayne County’s taxable value is 66.8 percent of the peak value in 2007. Slightly over 51 percent of the local governments in the county are positioned below this figure in terms of inflation-adjusted capacity compared to peak years.

While the last two years indicate that the rate of “bleeding” may have eased, any significant resurgence is unlikely. Recent federal revenue projections from the Congressional Budgeting Office indicate that the economy will at best see only modest rates of expansion for the next decade. In Michigan, these modest gains will prove even weaker due to Headlee rollbacks and Proposal A caps. This does not bode well for Wayne County local governments that find themselves needing to provide services to residents with significantly less purchasing power than they had a decade-and-a-half ago. Other issues aside, in light of the aforementioned, it is of little surprise that Wayne County finds itself in dire financial straits.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

Source: Taxable Values collected from Michigan Department of Treasury. Calculations by Citizens Research Council of Michigan. Calculations for inflation set to the year 2000 as the base year.

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The Road Funding Debate: Is a Compromise Coming?

With just a week remaining in the legislative session, both the House and the Senate have now passed competing plans aimed at raising revenue to shore up Michigan’s deteriorating road system.

On November 13, the Senate passed a plan that would convert Michigan’s current 19-cents per gallon gasoline tax and 15-cents per gallon diesel fuel tax to a new tax based on the wholesale price of these fuels. The Senate proposed tax rate would start at 9.5 percent of the wholesale price on April 1, 2015 and incrementally rise to 15.5 percent of the wholesale price in 2018.

Then, on December 4, the House passed legislation that would revise the gasoline and diesel fuel taxes to 8.5 percent of their wholesale prices effective January 1, 2016 and incrementally increase that rate to 13.5 percent by 2021. However, the House package also phases out the state’s sales tax on motor fuel over this time period – thus, consumers will pay additional motor fuel tax but will have offsetting savings by not incurring the traditional 6 percent sales tax.

Lawmakers now have four session days to work on ironing out the differences in the two plans. While both packages raise significant revenues for roads, they differ significantly in terms of (a) the amount of new road funding generated and how quickly they raise this new revenue; and (b) who effectively pays for the increased investment in the road system.

Revenue Differences: How Much and How Quickly?
By implementing a steeper and more immediate increase in the motor fuel taxes, the Senate’s plan will generate more revenue in both the short term and the long term. The chart below illustrates projected growth in transportation revenues under both plans as estimated by the House Fiscal Agency.

New Transportation RevenuesSource: House Fiscal Agency analyses of House Bill 5477

Recent reports from stakeholders suggest that anywhere between $1.2 billion to $2.0 billion in new annual revenue is needed to help prevent continued significant deterioration in Michigan’s road infrastructure. The Senate plan is estimated to generate almost $1.2 billion in new annual revenue by FY2018 and more than $1.7 billion by FY2023. Since the fuel tax increase is phased in slower under the House plan, it generates less revenue. In FY2018, estimates suggest the House plan will generate $360 million in new road revenues – $824 million less than the Senate plan and significantly below the suggested annual need. Once the fuel tax increase and the accompanying sales tax reduction are fully phased in, that gap shrinks. But even in FY2023, the House’s plan generates about $1.4 million in new revenue, still $375 million below the Senate.

Who Foots the Bill?
Beyond the revenues, the plans also differ significantly on who ultimately pays for the fuel tax increase. The Senate plan raises the fuel tax rate with no offsetting reduction in other taxes affecting consumers. As a result, motorists will feel the effect of the Senate plan in what they pay at the pump.

But by how much? As with any change in fuel taxes, the added burden of the tax increase for any motorist will depend on: (a) how much they drive; and (b) their vehicle’s fuel efficiency. Since the Senate’s plan would impose the new tax rate on the wholesale price of fuel, changes in those wholesale prices will also affect the future tax burden.

The chart below helps illustrate how much more motorists will pay on an annual basis under the Senate plan assuming that gasoline prices stay close to today’s levels. The Senate’s initial rate of 9.5 percent (effective in April 2015) equates to about a 26-cents per gallon gasoline tax rate at today’s prices. At that rate, for example, a motorist who drives 15,000 miles per year in a vehicle with a fuel efficiency of 26 miles/gallon would pay about $151 in additional gasoline tax. Most motorists would pay between $100 and $300 more per year at the pump. Once the rate reached 15.5 percent in 2018 (equivalent to about 43-cents per gallon at today’s prices), that burden would increase to between $150 and $450 per year for most motorists if wholesale prices remain stable.

Tax BurdenNote:  Figures assume an underlying wholesale gasoline price of $2.75/gallon.

Conversely, the House plans shifts the burden of the tax increase from motorists to other elements of the state budget. The House plan’s phase-out of the 6 percent sales tax on motor fuel should largely offset the accompanying fuel tax increase from the motorist’s standpoint (although diesel fuel users will feel a bite).

That phase-out, however, will pinch revenues currently earmarked elsewhere. About 73 percent of sales tax revenue currently goes to public education. Another 10 percent goes to local governments through constitutionally-dedicated revenue sharing payments. A smaller portion (about 4.6 percent) is dedicated to public transportation programs, with the remaining 12 percent falling to the state’s general fund. The loss of the motor fuel-related sales tax revenue will have an impact on each of these groups. The charts below highlight these impacts for public schools and local governments.

The state’s School Aid Fund provides much of the financing on which local school districts depend for their operations. The sales tax contribution to the School Aid Fund – currently at around $5.3 billion – would be $621 million lower in FY2020 under the House plan due to the phase-out of sales tax on motor fuels according to House Fiscal Agency estimates. By FY2023, the sales tax would contribute an estimated $889 million less to the School Aid Fund than it would under current law. Effectively, the House plan diverts much of the growth in this revenue stream to pay for the increased investment in roads.

Sales tax estimatesSource:  CRC calculations based on May 2014 consensus revenue estimates and House Fiscal Agency legislative analysis.  Graph assumes 3% long-run growth in sales tax revenues.

Similarly, the House’s proposed phase out of the sales tax on motor fuels also affects state revenue sharing. About 10 percent of current sales tax revenue is dedicated by the Constitution for distribution to Michigan cities, villages, and townships on a per capita basis. Some municipalities also receive revenue sharing payments from additional monies authorized in the budget beyond the constitutional allocation. For FY2015, just over $1 billion is appropriated for revenue sharing payments to cities, villages, and townships: $758 million from the constitutional earmark and $249 million from other appropriated funding. These revenue sharing allocations are a significant component of many municipal budgets. It’s also worth noting here that state statute actually earmarks an additional 14.2 percent of sales tax revenue to statutory state revenue sharing to supplement the constitutional designation. However, appropriations have fallen well short of this earmark for many years. Currently, only about one quarter of the earmark is actually paid out to local governments, so this statutory sales tax earmark is not a factor in the analysis that follows.

Under the House plan, sales tax revenue that would have been distributed to these local governments would no longer be realized. Projections suggest that revenue sharing allocations would be $88 million lower in FY2020 and $121 million lower in FY2012 if the House transportation plan is enacted. Again, this effectively eliminates much of the projected growth in the constitutional revenue sharing component.

Revenue sharingSource:  CRC calculations based on May 2014 consensus revenue estimates and House Fiscal Agency legislative analysis.  Graph assumes 3% long-run growth in sales tax revenues.

Can Lawmakers Reach a Compromise?
Stakeholders suggest that the state needs to find an additional $1.2 billion to $2 billion in new annual revenue to stabilize Michigan’s roads.  Neither plan hits this target range for a number of years; the Senate in FY2018 and the House in FY2022. As the legislature enters its final week of the 2013-14 session, lawmakers will seek to reach a compromise on this critical policy issue. But to do so, they will need to find consensus on the significant differences that exist between the House and Senate road plans. Keys to that consensus will be answering the key policy questions discussed above: How much new revenue should be generated for roads, how soon should those revenues be realized, and who ultimately should bear the burden of paying for them?

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Another Wrinkle in the State’s Plan to Dissolve the Buena Vista School District

Since the summer of 2013, CRC has been following the implementation of Michigan’s new school district dissolution policy.  On November 4, voters in the dissolved Buena Vista School District rejected the renewal of a tax dedicated to pay off the district’s accumulated deficit.  Failure to get voter authorization to levy the tax raises the question of who will pay to eliminate the district’s deficit.  Also, this vote reveals some of the unintended consequences inherent in the district dissolution policy

Repurposing the 18-mill School Operating Tax

The state adopted a new law (Public Act 96) in the summer of 2013 to allow for the dissolution of school districts that are not deemed “financially viable.”  Almost immediately after its enactment, state officials determined that the factors were met for dissolution and steps were taken to dissolve Buena Vista School District (Saginaw County) and Inkster Public Schools (Wayne County), the two districts that precipitated the development of Public Act 96.  The districts ceased educating students at the end of the 2012-13 school year and their students were assigned to neighboring school districts effective with the 2013-14 school year.

Due to years of overspending, Buena Vista School District had amassed a $4 million accumulated operating deficit by the end of 2012-13.  In addition, the district had outstanding long-term debt totaling $2.6 million backed by a dedicated tax.

The new law requires a dissolved school district to continue to exist solely for the purposes of satisfying its debts, including any accumulated deficit.  A dissolved district continues levying all authorized taxes until its debts are settled.  Most importantly, in order to enable a district to eliminate its operating deficit without a direct state bailout, the law effectively repurposes a school operating tax for deficit reduction.

By law, the 18-mill school operating tax on non-homestead property is used to finance the local portion of a school district’s per-pupil foundation allowance.  Because a dissolved district no longer educates students, it does not receive the state foundation allowance funding that accompanies each student.  This makes the 18-mill tax proceeds available for debt repayment.  However, if, as was the case for Buena Vista School District, authorization to levy the 18-mill tax expires before the debt is fully repaid, voter approval is necessary to continue levying the tax.

State Plan Hits a Snag

The expiration of authority to levy the 18-mill operating millage created a snag in the state’s use of the school district dissolution law.  Voter authorization to levy school operating taxes is provided for a set number of years.  At the completion of that term, school districts must seek voter approval to continue levying a school operating tax.  Experience has shown that requests for voter approval for these taxes have been somewhat perfunctory since passage of Proposal A of 1994 because primary residences (people’s homes) are usually exempt from the tax.

Buena Vista School District levied the 18-mill tax in 2013 and 2014, generating about $1.5 million annually, and directed the proceeds to deficit reduction.  According to the state’s original plan, these revenues should have been sufficient to eliminate the district’s deficit by the end of 2014, when authorization to levy the tax was scheduled to expire.  However, the district’s 2012-13 audit, released in early 2014, revealed that at least a portion of the 2015 tax levy would be needed to eliminate the deficit as the final deficit figure was larger than originally estimated.

The state’s plan to pay off the Buena Vista School District’s debts hit a snag with the November 2014 general election.  At the election, voters were asked to renew the authorization to levy the tax for another three years to pay off the district’s deficit.  It was estimated that the district would eliminate the tax with the 2015 levy and likely at a rate below the full 18 mills.  Voters rejected the tax renewal question.

It is of little surprise that Buena Vista’s tax renewal question was not approved.  First, the tax is generally not well understood by voters because most people don’t pay it.  The tax is levied on business and second home properties, while most homeowners are not subject to it.  Second, voters were asked to approve a school operating tax for district that no longer is educating students.  While the district exists on paper, it was dissolved over a year ago and its former schools remain vacant and unused.  Finally, the request for voter approval for a longer duration than was previously stated as necessary to retire the debt may have bred distrust in this tax question.

What Happens Next?

Regardless of the reasons behind recent voter behavior, the November election result raises the question:  Now what?  The district, which exists only on paper, has no funds to liquidate the remainder of its deficit, estimated at $800,000.

There appears to be three possible paths forward at this time, each with its own set of considerations.  First, the district could take another shot at gaining voter approval for the 18-mill tax.  This would likely have to take place in early 2015, as the millage has traditionally appeared on the summer tax bill.  This response would require the Saginaw Intermediate School District to shoulder the costs of running the millage election, including any voter education efforts involved.  Passage of the millage request the second time is not be guaranteed, although other districts have successfully gained approval of the tax after an initial defeat.

A second course of action would be for state policymakers to provide a direct appropriation for the express purpose of satisfying the remainder of Buena Vista’s deficit.  The state has already provided $5 million to assist with the dissolution of this district and Inkster Public Schools, so a similar response would not be precedent-setting.  Like the earlier appropriations, this response would result in other school districts bearing the costs, as there would be fewer state resources to distribute to schools.

Finally, the state could pursue a judgment levy to raise the needed funds.  As opposed to the state appropriation approach, this would localize the cost of debt repayment by forcing taxpayers in Buena Vista School District to share in the burden of resolving the remainder of the district’s deficit.  Whereas the 18-mill tax is levied only on non-homestead property, a judgment levy is spread across the entire tax roll.  In CRC’s assessment, a number of factors suggest that this is the least attractive option.

Unintended Consequences

In previous writings, CRC highlighted some of the unintended consequences arising from the state’s school district dissolution policy.  Others have surfaced based on the Buena Vista experience.  Of immediate concern is the fact that the new law does not contemplate what happens if a situation like the one in Buena Vista School District arises.  There is no “Plan B” should the 18-mill tax not be available for debt repayment.  This creates uncertainty for many entities that are potentially impacted, including taxpayers, state officials, intermediate school district administrators, and local assessors.

The inequitable treatment of taxpayers has arisen as another consequence.  With the expiration of the 18-mill tax in Buena Vista School District, district taxpayers (primarily business) are going to enjoy a tax advantage over their competitors in other parts of the state.  Under the new dissolution law, the tax base in a dissolved district is not transferred to a receiving district until all the debts are repaid.  This means that business property will not be subject to the taxes levied in a nearby district (i.e., where the 18-mill tax is levied) until the Buena Vista deficit is eliminated.

Finally, the experience in Buena Vista School District reveals the problems with ad-hoc policy responses.   The new state law allowing for school district dissolutions was initiated as a policy response to address severe fiscal stress in a limited number of cases because policymakers believed that the state’s primary, long-standing tool (i.e., the emergency manager law) was not a workable solution.  In enacting this “made-to-order” policy, however, lawmakers bypassed the deliberative processes outlined in the state’s emergency manager law in favor of one that promised a more speedy and expeditious resolution to school financial problems.  Based on what has happened in Buena Vista School District, a speedy and clean resolution is not guaranteed under the new policy.

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Funding State Mandates a Zero-Sum Game for School Districts

The Michigan Constitution (Section 29 of Article IX) prohibits the state from mandating new programs or activities of local governments (including school districts) without providing state funding.  Despite this voter-approved provision in the constitution, Michigan’s current method of funding public schools and previous Michigan Supreme Court decisions convey to local school districts that it is unlikely that they will receive any sort of financial reprieve in efforts to implement new state-mandated programs or activities.

The Michigan Supreme Court recently heard oral arguments in the next installment in the long-running school finance Adair case. While a plaintiff win would indicate that the state legislature did indeed underfund a set of state-mandated activities, specifically the maintenance and transmission of data to the Center for Educational Performance and Information (CEPI), previous state government responses to Section 29 violations dealing with school funding indicate that, even with a favorable ruling, school districts may not be in for a financial windfall.

How, exactly, has this political process previously played out and what can we learn from this?

Michigan’s School Funding System and Guarantee

Prior to 1994, public education in Michigan was largely funded at the local level through property taxes with state aid playing a minor role in the overall finances of schools. With the adoption of Proposal A, school funding was centralized: state taxes are now responsible for the majority of school funding and state lawmakers annually set the per-pupil foundation allowance that each district receives.

In addition to a largely state-controlled school finance system, Proposal A also established a constitutional funding guarantee via a per-pupil funding floor for every school district. Section 11 of Article IX of the Michigan Constitution specifically states that each district will receive at least the same amount of combined state and local per-pupil revenue for school operating purposes that it did in 1994-95, the year when the constitutional amendment was enacted.

According to the Michigan Senate Fiscal Agency, the legislature appropriated $3.5 billion more than the Proposal A funding guarantee in Fiscal Year 2014. To whom and for what these additional funds can be used is at the discretion of state lawmakers, which means that it is up to them to determine the portion that will go to fund state-mandated services.

Responding by Reallocating, Rather Than Increasing Funding

The initial chapter in the Adair saga alleged that the State of Michigan violated Section 29 by mandating new data collection, maintenance, and reporting activities of school districts.  In the summer of 2010, the Supreme Court ruled in favor of the plaintiff districts that the requirements constituted an unfunded mandate for which the state did not provide funding to cover the necessary costs.

State policymakers responded to the Michigan Supreme Court’s Adair I ruling by appropriating $25.6 million in the FY2011 state budget specifically for the data maintenance and transmission requirements that were at issue in Adair I. While these appropriations were a new line item in the School Aid budget, they were not new dollars to schools. Instead, the Michigan Legislature enacted a supplemental appropriations bill that required $25.6 million of the appropriated state school aid fund money – money that originally would have gone toward per-pupil funding – be used solely for the purpose of paying districts for the cost of the state-mandated collection, maintenance, and reporting of data. The state effectively honored its constitutional requirement to fund its mandate by redirecting existing school funding and earmarking the funds for a specific purpose.

In the FY2012 budget, an additional $8.4 million was added to pay for Adair compliance, bringing the total to $34.0 million.  As was the case with the initial amount, the additional funding was not new; lawmakers moved funding from the CEPI line item into the Adair compliance line item. In effect, the state’s response to Adair has been to create a new categorical funding stream for schools while, at the same time, reducing the amount of resources districts receive for other purposes.

Different Case, Same State Response Likely

While the specific legal issues arising from the current iteration of Adair may vary, it is unlikely that a legislative response would vary from past precedent even if the Supreme Court rules in the plaintiffs’ favor.  A win for the school districts in this Section 29 challenge, or any other future challenge for that matter, is not likely to result in the state providing schools with additional overall funding.

In its oral arguments presented to the Court, the State of Michigan signaled that it allocates in excess of $3 billion annually above what is constitutionally required under the Proposal A funding guarantee. Thus, even if the state were found to be deficient in its funding responsibility, as is alleged in Adair II, it would be well within its authority to tap into this pot of money and redirect funds to meet a constitutional requirement.  Doing so would not result in additional new money for schools, but another reallocation of existing funds schools already receive.

Future Headlee Challenges

Given the state legislature’s response to the Adair I ruling, it would appear that funding future Headlee requirements will result in a financial zero-sum game for school districts.  Because the state is funding schools well above the Proposal A funding floor, it can tap into these resources as a fiscal response to court decisions related to both un- and underfunded mandates. The bottom line is that Michigan’s highly centralized school finance system allows the state to require schools to implement new programs or activities and subsequently shift resources within the bigger school funding pot without increasing the overall state funding provided to schools to finance programs or activities. In effect, rendering moot the Headlee Amendment’s prohibition against unfunded state mandates.

A version of this post also appears on the Green & Write Education Policy Insights Blog.

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Comments re: Making Sense of K-12 Funding Report

CRC recently received an email message containing a few comments about our recent report on K-12 education funding, Making Sense of K-12 Funding, issued on October 16. Below is the message along with the response provided.


“In your recent article, “Making Sense of K-12 Funding​,” you [CRC] repeatedly made the claim that, “While total state funding is up over $1 billion from FY2011 to FY2015, the increase is almost exclusively earmarked to satisfy school employee retirement costs, specifically legacy costs arising from the financial market downturn and state retirement system reforms.” You say that the fund imbalance in MPSERS is the result of “market downturn,” portraying it as an unfortunate set of circumstances that is nobody’s fault. You fail to point out the many, many years that the state has manipulated and “dipped into” that fund, leaving it depleted (far more than any “market downturn” could have) so that it no longer had the ability to support the retired teachers WHO PAID THEIR OWN HARD EARNED MONEY to build the fun in the first place. The result is that your article makes teachers who have spent their lives serving their communities and schools appear to be the villains in this whole debate, rather than the victims.

Furthermore, you refer to “state retirement system reforms” as if to represent that the courts haven’t already found that legislation on state employee retirement systems to be unconstitutional. What about the 3% of each and every public school teacher’s paycheck that is still sitting in an escrow account while the State Supreme Court is stalling (for years) in taking up the appealed case, wherein the unconstitutionality of the “reform” will most assuredly be upheld? I would think that as an “unbiased” institution, you would seek to better represent the WHOLE story so as not to mislead the public.”

Note:  CRC withheld the name of the author.

CRC Response:

State and local government contributions to defined benefit retirement systems have been growing for a number of years.  Increasing retirement contributions are not unique to Michigan.  States and localities across the country are dealing with this fiscal problem.

Nationally, the Pew Center on the States estimates that the gap between pension system liabilities and assets across all states and local governments was $1 trillion in 2012.  This gap grew 14 percent from 2010 to 2012 in inflation-adjusted dollars.

In Michigan, all traditional public school districts and some charter schools participate in the Michigan Public School Employees’ Retirement System (MPSERS).  This system provides both financial pension benefits and subsidized health insurance benefits to covered employees.  The cost of providing these benefits is shared by school districts, school employees, and the State of Michigan.  State law caps the amount that employees pay towards future benefits (generally as a percent of their salary).  Also, state law caps the amount that school districts have to pay towards financing these benefits (expressed as a percent of covered payroll).  Specifically, districts’ contributions to meet annual unfunded accrued liability payments are capped at 20.96 percent of payroll.  Since 2012, unfunded accrued liability contributions above this cap are covered by the State of Michigan.

In a detailed 2013 report, CRC examined the escalating MPSERS costs and the impact that they have had on school funding.  The report identified unfunded accrued pension liabilities as the primary driver behind the growth in employer contributions and state contributions to MPSERS.

Combined, employer contributions for pension normal costs and retiree health benefits hovered around 12 percent of payroll each year between 2004 and 2012.  In contrast, contributions to meet unfunded accrued pension liabilities increased significantly; from 1 percent of payroll in 2004 to nearly 13 percent of payroll in 2012.  Overall, unfunded liabilities increased from $7.7 billion in 2004 to $25.8 billion in 2013.

In a separate analysis, our report identified and quantified the underlying factors behind the increased contributions for unfunded liabilities since 2004.  We examined the official MPSERS actuarial valuation reports issued by the Office of Retirement Systems to reveal that the primary cause was investment gains falling short of actuarial assumptions.  Of the cumulative $16.6 billion actuarial loss between 2001 and 2012, $14.7 billion (89 percent) was due to poor market performance relative to assumptions (i.e., 8 percent annual gain).  Specifically, the market losses of 2008 and 2009 resulting from the worldwide financial crisis were identified as the primary culprits.  Because MPSERS uses a five-year smoothing method to spread the market losses across a number of years, 20 percent of the total 2009 market loss is reflected in the 2014 valuation.

Other minor factors contributing to pension liability growth include greater pay raises than assumed by the actuaries as well as people living longer than originally assumed.  Additionally, decisions my state lawmakers in the past to make interest-only payments towards the unfunded liabilities or “mark to market” the value of the investment portfolio have helped school districts meet their MPSERS obligations in the short-term, but had longer-term consequences for the unfunded pension liabilities (e.g., extend amortization period).   The official financial statements for MPSERS do not reflect any instances where funding was diverted from the trust fund for non-pension/retiree health care costs.

As a result of the growing costs of MPSERS retirement liabilities to public schools, legislation aimed at mitigating some of the upward cost pressure was enacted in 2007, 2010, and 2012.  These reforms primarily rely on increased employee contributions, reductions in retiree health care subsidies, and/or reductions in pension benefits to offset the need for employer contributions to cover liabilities.

One aspect of the reforms enacted in 2010 included a mandatory employee three percent salary contribution towards retiree health care benefits.  This contribution was challenged in court by school employee groups and the Court of Appeals ruled in August 2012 that the contribution was unconstitutional.  The funds collected from school employees for about two years are being held in escrow until the issue is settled by the Supreme Court.  As a result, the employer contribution for retiree health was increased by three percent of covered payroll.

The Supreme Court recently heard oral arguments regarding the employee three percent contribution being held in escrow.  It is unknown, at this time, how the Court will rule.  If the Court rules in favor of the employees, the money will be returned, with interest.  However, if the contribution is ruled constitutional, then the escrowed funds will be used to reduce the amount of unfunded liabilities.

It should be noted that the three percent contribution was modified through legislation in 2012, soon after the Court of Appeals ruled.  Specifically, the law now requires that an employee’s contributions will be reserved for retiree health benefits received by the employee, as opposed to others.  This change effectively guarantees that employees will get a certain level of subsidized health care insurance in retirement.

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Today’s Student Count will Provide Districts with a Clearer Picture of Their Finances

Although school districts across the state approved spending plans for the current school year (2014-15) back in June, the October 2014 student count will reveal how much money they will have to operate this year.  This, despite the fact, that schools have been open for one month already.  For many districts, especially those battling declining enrollment, a lot is riding on the result of the student count.  Districts that overestimated enrollment gains (or underestimated enrollment losses) when preparing budgets last spring will likely have to take corrective action in the coming months to ensure budget balance.  Failure to do so will exacerbate the financial problem and cause, or add to, district fiscal stress.

By law, the first of two student count days occurs on the first Wednesday in October (October 1, 2014 for the 2014-15 school year).  The other count will take place on February 11, 2015.  The two counts (each with different weights) are blended to arrive at a total enrollment figure for purposes of distributing state aid to school districts.

The total amount of funding a district has to operate each year is a function of its student enrollment and its per-pupil foundation grant, which is $7,126 for the 55 percent of all districts that receive the minimum grant.  Because the October student count carries the heaviest weight (90 percent), much will be revealed about school district finances for 2014-15 with the result of the today’s count.

By law, school districts are required to adopt their budgets for the coming school year by July 1.  Districts base their initial budgets on estimates of student enrollment and their per-pupil foundation grant, which is set annually by Lansing lawmakers as part of the state budget process.  In recent years, lawmakers have completed the state budget in advance of the July 1 deadline, providing districts with certainty for the foundation grant portion of the funding equation.

With respect to the other half of the total funding equation, districts have to make estimates about student enrollment for the coming year.  In doing so, districts consider a number of factors, including past enrollment experience, birth rates, migration patterns, and competition from other public schools, both traditional public schools and charter schools.  Missing the mark on these estimates can have profound fiscal consequences for districts, especially for those that previously have had to cut programs, reduce staff, and find alternative service delivery models in response to declining enrollment.  Fewer students this year means further budget adjustments.

For many districts, budgeting for declining student enrollment is the new norm.  Two thirds of all traditional public school districts (360 of 543 districts) saw their enrollment decline from 2012-13 to 2013-14.  Overall, approximately 19,000 fewer students (a 1.4 percent decline) enrolled in traditional public schools in 2013-14 compared to 2012-13.

The statewide decline masks considerable variation among individual districts.  Enrollment declines among traditional districts topped out at nearly 50 percent (Bendle Public Schools in Genesee County), while many large, central city districts experienced declines well above 10 percent (e.g., Education Achievement Authority – 20 percent, Flint – 15 percent, Pontiac – 19 percent).

Looking at the five-year period from 2009-10 to 2013-14 reveals that over 70 percent of all districts saw some amount of enrollment decline.  Over one-quarter of all districts had declines of 10 percent or more, which is equivalent to 2.6 percent per year on average.  The causes of decline are many, including fewer births, net out-migration, and competition from other K-12 schools.

Enrollment Changes in Traditional Public School Districts and Charter Schools, 2009-10 to 2013-14*
  Traditional Public School Districts Charter Schools

Enrollment Change:  2009-10 to 2013-14

Number Share of Total Number

Share of Total

Enrollment Gain 153 28% 126 63%
Enrollment Loss
  Greater than 50% 1 0% 5 3%
  25% to 50% 16 3% 13 7%
  10% to 25% 137 25% 27 14%
  0 to 10% 235 43% 28 14%
Source:  Center for Educational Performance and Information* Enrollment data is total full-time equivalency (FTE) K-12 student count in fall of each year.

Declining enrollment has not been as pervasive in the charter school sector.  In fact, over the last five years, the opposite is true.  Nearly two-thirds of all charter schools have experienced annual jumps in student enrollment between 2009-10 and 2013-14.

Fewer students mean fewer total resources for districts, which can lead to increased fiscal stress.  Managing in an environment of declining resources, at least in the short term, can be difficult, especially when the funding reduction is sizeable.  All schools face some fixed (or semi-fixed) costs for building operations (i.e., lighting, heating), employing teachers, and staffing various non-instructional positions.  When students leave a district, many of these costs remain with the district.  The reality is that the relationship between enrollment and district costs is not completely linear, at least in the near term.

Over time, districts are able to “right size” their budget to accommodate a significantly smaller student body, for instance, by closing buildings or reducing staff.  But, in the short run, declining enrollment can increase fiscal stress associated with meeting the “sticky” fixed/semi-fixed costs.  The bottom line is that declining enrollment will continue to be a challenge requiring affected districts to think long term to effectively manage their resources without incurring undue stress.

Hopefully, as the results of the October 2014 student count become known, school officials will revisit their original budgets to see where things stand.  If the original student enrollment estimates were too optimistic, steps must be taken sooner rather than later to adjust spending to meet the new revenue projections or tap into reserves to make sure budgets are balanced.

Delaying corrective actions that are necessary to meet the new enrollment figures can contribute to fiscal stress and exacerbate financial problems.  Taking action earlier provides district officials with more time to implement requisite spending reductions and/or program adjustments.  Based on recent trends, many districts will be re-visiting their budgets to address declining enrollment revealed in the October student count.

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Revisiting Certificate of Need

On Tuesday, September 16, Michigan’s Senate Majority Leader Randy Richardville introduced a new bill that once again addresses the controversial Certificate of Need (CON) program.  Senate Bill 1073 proposes some reforms to the CON Commission, while also creating opportunities for new hospital projects that meet very specific guidelines.  The conversations around this bill are bringing to light the underlying purpose and value of Michigan’s CON program, a topic CRC thoroughly explored in a 2005 report, The Michigan Certificate of Need Program.  Although this report is nearly a decade old, the bulk of the report provides context and background for the issue, including a discussion on CON’s effectiveness in addressing health care costs, quality and access, and is still relevant to issues introduced in Tuesday’s bill.

Michigan is one of 36 states with CON laws, but the stringency and scope of the laws vary by state. Michigan’s CON program was enacted in 1972, is governed by Part 222 of Public Act 368 of 1978, and is administered by the Department of Community Health. With the legislated purpose of assuring availability and access to quality health care at reasonable prices, the overall approach of Michigan’s CON program has been to regulate the utilization of facilities and equipment and the location of services. Applicants for health care service expansions, upgrades, relocations, or equipment purchases are required to demonstrate that the service is needed, that it is not duplicative, and that explorations have been made of the ways that the need can be met at the least cost. If a Michigan health care provider can effectively demonstrate need, then the CON Commission will issue a certificate.  Generally a dollar threshold is set for facility upgrades and renovations so that smaller projects do not require a CON.

The issue of how excess capacity in the health care market impacts health care costs has been long debated and is heavily tied to the discussion of regulating facility costs through CON programs.  Research on this topic dates back to at least the 1960s when states began adopting CON regulations and the federal government toyed with (and eventually mandated, then repealed) requirements for states to regulate health care facility costs.  States, which are large health care spenders because of the Medicaid program, are incentivized to reduce overall health and medical costs; CON laws are one policy mechanism states may use to achieve this.

Rationale For and Against CON Programs
Proponents of CON programs argue that traditional supply and demand theory does not work in health care because providers, typically doctors and other health care professionals through their diagnosis and treatment decisions, have the predominant role in determining the demand for medical services. These providers are also paid for supplying the services they determine people need.  Further, consumers often do not have sufficient information to make decisions based on cost and quality.  Thus, there is a market failure and government intervention is thought necessary to limit competition and spending that would lead to artificially high demand for unnecessary services.

Opponents of CON programs argue that they artificially increase costs and shield health care providers from making costly investments that they might be more inclined to make in a more competitive environment.  Some researchers and health care stakeholders believe that by shielding existing hospitals from new competitors, health care service supply is reduced to below competitive levels, thus increasing costs.  Additionally, because CON programs block entry of new hospitals, incumbent hospitals may delay the adoption of new and improved technology or treatments because they may be more costly.  New, higher quality service providers are locked out of the market which reduces competitive incentive to improve service quality.

Another argument deals with health care access.  Without CON, health care providers can choose to reduce or eliminate health care service facilities in poorer, high need areas that may be less profitable because of higher rates of both uninsured patients and patients covered by insurance with low reimbursement rates such as Medicaid.  Instead, health care service supply will move to low need areas with a higher number of patients insured by higher paying private insurance.  If this occurs, then health care services will be available based on ability and willingness to pay and rather than the likelihood of medical need.

CRC’s report, The Michigan Certificate of Need Program, provides a state, national, and historical context for CON programs and details the coverage and scope of Michigan’s program, application process, and review standards.  Finally, it discusses the issues of costs, quality, access, and other highly pertinent issues of the CON program, all of which are still being discussed today.

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Solving Michigan’s Obesity Problem with Physical Education Programs

In 2013, just over one-quarter of Michigan children ages 6 to 17 participated in vigorous physical activity every day, despite the federal recommendation for 60 minutes of physical activity daily.   Not only are children not engaging in vigorous physical activity, but they are engaging in high amounts of sedentary activity.  Over one-third of Michigan high school students played video or computer games or were on a computer for three or more hours per day.  Over one-quarter of high school students watched television for at least three hours per day.  And while these figures are at or below national averages, they are not exactly worth bragging about.

Physical inactivity is a risk factor for obesity and regular physical activity is linked to improved student concentration, cognitive functioning, and classroom behavior as well as improved academic and standardized test performance.  If public policy is to be used to effectively prevent obesity and treat it in children, it needs to address both diet and physical activity, as both of these factors influence health.  Schools have a long history of providing health and physical education curricula and now, more than ever, these two subjects are needed.

The Revised School Code mandates that, “Health and physical education for pupils of both sexes shall be established and provided in all public schools of this state. . . .Each pupil attending public school in this state who is physically fit and capable of doing so shall take the course in physical education.”  When the school code was first drafted in 1976, authors understood the importance of health and physical education, though obesity was not yet a looming issue.

While this statute is specific about the need for health and physical education, it does not specify how this mandate must be carried out.  The Michigan Merit Curriculum requires that high school students complete 0.5 credits in each physical education and health education in order to graduate.  However, state statute allows for several exemptions for this requirement, including an allowance of credit for participation in extracurricular activities.  This unfortunately waters down much of the benefit of the original requirement since students are better off if they engage in physical activity both during the school day and afterward.

While some health and physical education criteria is spelled out for high school students, Michigan statute does not similarly provide companion law or rules for grades K-8.  The Grade Level Content Expectations developed by the Michigan Department of Education and approved by the State Board of Education set out learning and activity objectives but do not specify how much time children must spend in physical activity. Importantly, the content and frequency are recommendations, not requirements.

Schools are also not required to provide a recess, though the State Board of Education recommends that public schools provide opportunity for 30 minutes of physical activity outside of physical education, including at least 20 minutes of scheduled recess.

According to a 2012 nationwide survey, fewer than 60 percent of school districts required that elementary schools provide students with regularly scheduled recess and only 11 percent required middle schools to provide physical activity breaks outside of physical education class.  To help Michigan’s children develop to the fullness of their potential, these statistics are just not good enough.  While school, state, and local leaders are engaged in this process, more still needs to be done to generate noticeable results that improve individuals’ quality of life and the economic status of families and communities.

For more information about Michigan’s health and physical education programs and how public policy can improve these courses, see Citizens Research Council’s new report Addressing Michigan’s Obesity Problem.

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The IBM Ruling: Could the State Have Avoided a Potential $1 Billion Problem?

The state’s budget outlook just got significantly cloudier with a July ruling by the Michigan Supreme Court that the state must refund to the IBM Corporation around $4.7 million in Michigan Business Tax (MBT) payments made in 2008. The court agreed with IBM that the corporation had the legal authority to calculate its liability under the MBT using a three-factor formula as allowed for within the state’s Multistate Tax Compact Act.

Compared to a $53 billion state budget, $4.7 million is little more than a rounding error. However, IBM is not the only out-of-state corporation standing in line for a refund. According to court documents, the state is involved in 134 other open cases regarding this same issue and acknowledges the potential for many other claims. Extrapolating the IBM settlement to a few other multistate corporations easily gets us to a number that represents a very significant one-time hit to the state budget. The Department of Treasury’s Office of Revenue and Tax Analysis currently estimates the potential revenue impact on the state to be around $1.1 billion plus interest.

However, the state has appealed to the Supreme Court to rehear the case, a request that is still pending. A review of the legislative history of the related legislation, however, raises another question: Could the Legislature have avoided this problem altogether back in 2011? It appears an 11th-hour language change may have contributed to the current problem.

Background on Tax Apportionment: the MBT and the Multistate Tax Compact
In 2008, the state legislature made sweeping changes to Michigan’s system of business taxation by replacing the often-criticized Single Business Tax with a new Michigan Business Tax, which itself was composed of separate taxes on both business income and on gross receipts.

All forms of state business taxation have to deal with an important question: How should tax liability be allocated to a firm that operates across many states? For instance, IBM is an international corporation with both physical offices and product sales spread across the globe. What portion of their business activity should be subject to taxes in Michigan? Typically, this question is addressed through the establishment of an “apportionment” formula contained in state law.

The new Michigan Business Tax created its own apportionment formula. Businesses were required under the new law to apportion both their income and gross receipts to Michigan based on a single factor: their gross sales within Michigan. So, if 10 percent of a firm’s gross sales were within Michigan, 10 percent of their income and gross receipts were to be apportioned to Michigan for the purposes of paying the MBT.

However, while enacting the MBT changes in 2008, the legislature made no changes to another state law relevant to business taxation – the Multistate Tax Compact (MTC) Act. Michigan established the MTC Act in 1969 as part of a joint effort by states to coordinate their tax policies and fend off federal efforts to preempt some state control over business tax provisions that were the subject of debate at that time. Michigan is one of 16 states and the District of Columbia that are currently members of the compact – all of these jurisdictions having enacted a MTC Act into their state laws.

Significantly, the MTC Act has its own provision regarding apportionment. The act allows multi-state firms that operate in two or more compact states to elect, at the firm’s discretion, to apportion any “income tax” imposed by the state according to a three-factor apportionment that includes sales, property, and payroll. Clearly, this holds an advantage over the sales-only approach of the MBT to any firm that sells in Michigan but does not retain a significant business presence in terms of offices, equipment, and employees.

This advantage was not lost on IBM as the corporation in 2008 asserted its authority under the MTC Act to apportion its income and gross receipts using the three-factor approach rather than the MBT Act’s sales-only approach when it filed its first MBT return. The Michigan Department of Treasury, however, rejected IBM’s election, asserting that the newly enacted MBT Act precluded the firm from this option by specifically requiring the one-factor method under the MBT. This dispute precipitated the court action on which the Supreme Court issued its July ruling.

Michigan Supreme Court’s Finding: IBM Prevails
After losing in the lower courts, IBM’s contention prevailed before Michigan’s Supreme Court. In a split 4-3 ruling, the court agreed that both the income and gross receipts components of the MBT represented an “income tax” subject to the apportionment option under the state’s MTC Act and that the elective three-factor apportionment was available to IBM. The lead opinion in the case rejected the state’s arguments that the strict one-factor apportionment language contained in the MBT Act effectively repealed the MTC’s apportionment provisions by implication.

The swing vote in the court’s decision was Justice Brian Zahra. In a separate concurring opinion, Justice Zahra indicated the question of whether the new MBT law repealed the MTC’s elective apportionment provision was “a very close question” but one that he did not have to reach. His opinion was based specifically on actions taken by the legislature in 2011 when the Michigan Business Tax itself was repealed and replaced by the state’s new Corporate Income Tax – part of major tax restructuring that also involved changes to the treatment of pension and retirement income under the state’s Personal Income Tax.

As part of that package, changes were made to the MTC Act to eliminate the three-factor apportionment option for businesses subject to either the MBT or the new Corporate Income Tax. However, the legislation did not apply this change retroactively. Instead, it specifically eliminated the option “beginning January 1, 2011”. Justice Zahra’s opinion points to that language from Article III of the MTC Act:

“…except that beginning January 1, 2011 any taxpayer subject to the Michigan business tax act, 2007 PA 36, MCL 208.1101 to 208.1601, or the income tax act of 1967, 1967 PA 281, MCL 206.1 to 206.697, shall, for purposes of that act, apportion and allocate in accordance with the provisions of that act and shall not apportion or allocate in accordance with article IV.” (Emphasis added)

Thus, the inclusion of this date in the MTC Act appears to have played a very significant role in Justice Zahra’s legal thinking on the matter. In effect, he states the legislature intended to create a window from the initiation of the MBT in tax year 2008 through tax year 2010 during which the election provision would still apply; otherwise, the legislature would not have included this specific starting date.

But, what prompted the legislature to include the date? That’s not clear. What is clear is that this date was added very late in the legislative process. House Bill 4479 was introduced on March 23, 2011, was reported from the House Tax Policy Committee on April 27, and was passed by the Michigan House on April 28. At no time during the House’s consideration of the bill did Article III include the date reference pointed to in the court opinions. The bill moved to the Senate and was reported favorably without amendment by the Senate Reforms, Restructuring, and Reinventing Committee on May 12, 2011 – again, with no date reference. Later that same day, during Senate floor deliberations, the Senate adopted a substitute bill, and that substitute was the first instance in which House Bill 4479 contained the January 1, 2011 starting date for the elimination of this tax apportionment option. Neither the analysis of the bill nor the record of the debate elaborate on the rationale for this new language. Shortly thereafter, the bill was passed by the Senate. It was then re-transmitted to the House, where it was concurred in on the same day. The bill was enrolled, and Governor Snyder signed it into law on May 25, 2011.

Is there a remedy?
Attorney General Bill Schuette has already filed a motion with the Supreme Court to stay the July 14 decision and to grant a re-hearing of the case, citing the potentially significant revenue implications. In the meantime, the legislature is pondering its own next steps.

Media reports suggest the legislature may move to undo what the legislature did in 2011 and strip away the January 1, 2011 starting date on the statutory elimination of the elective apportionment provision in the MTC Act. That would appear to address a key concern of Justice Zahra, perhaps in a manner which would cause him to rule in favor of the state in a future hearing on this issue. Still, his opinion called the broader question of whether the new apportionment language of the MBT Act implied a repeal of the MTC provisions a “very close” – but not a settled – question.

Even if this legislative fix succeeded with the Michigan Supreme Court, it may not put an end to the legal wranglings. The California Court of Appeals in a similar case involving the Gillette Corporation found that the Multistate Tax Compact represented a binding contract to states; in their opinion, only a withdrawal from the compact would negate issues such as the MTC’s apportionment option. That case is now pending before California’s Supreme Court. So, in the end, a favorable decision for the state by the Michigan Supreme Court on re-hearing may simply move the question into the federal courts.

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