Michigan revenues soar amid risk of recession

Economists said they are betting on slowing growth

LANSING – In what is becoming a habit, state officials revised upwards by several billion dollars Friday how much tax revenue the state is expected to receive over the next three years.

Economists said they are betting on continued but slowing economic growth in Michigan, but they warned there also are significant risks of a recession as early as this year.

The uncertain forecasts came at a revenue estimating conference at the Capitol, one day after state lawmakers voted to cut taxes by about $2.5 billion annually. Republicans, joined by some Democrats, cited an upward boom in state tax revenues that experts say is largely a short-term phenomenon resulting from aggressive but temporary federal stimulus measures and a shift in consumer behavior during the coronavirus pandemic.

Gov. Gretchen Whitmer, who in March vetoed an earlier $2.5-billion tax cut proposal from the Republican-controlled Legislature, is pushing more modest election-year proposals to repeal taxes on retirement income and boost the Earned Income Tax Credit, which together could cost less than $800 million a year. On Thursday, she also called for $500 tax rebate checks for “working Michigan families,” while saying eligibility and cost details should be negotiated with lawmakers.

Though the economic outlook is uncertain, the fact that state coffers are bursting with cash is not. State officials on Friday revised upward their estimates of how much net General Fund and School Aid Fund revenue the state will receive by nearly $3 billion for the 2022 fiscal year and by about $2 billion for 2023. The discarded estimates were made just four months ago. Those revisions mean state lawmakers will have about $6 billion more General Fund and School Aid Fund money to work with as they finalize the budget for the 2023 fiscal year that begins Oct. 1, though much of that is considered “one-time” money, said state Budget Director Christopher Harkins.

Soaring state tax revenues continue to shock forecasters from Michigan’s two legislative fiscal agencies. After record income and sales tax revenues in 2021, analysts expected declines in 2022, but taxes continue to pour in well above forecast.

“In terms of revenue, we’ve had a lot of surprises,” said David Zin of the Senate Fiscal Agency.

During the pandemic, consumers who received federal stimulus checks and sweetened unemployment insurance benefits shifted their spending away from services, which mostly are not subject to the 6% sales tax, to the purchase of goods like home entertainment systems, which are taxed. The experts still expect consumer spending to revert to the former pattern, but say that so far demand for taxable goods has remained strong, despite inflation.

Exactly when spending returns to more normal patterns — and how quickly it happens — is the great unknown. If spending suddenly returned to the former trend, it could reduce short-term sales and use tax revenue forecasts by about $2 billion, said Eric Bussis of the state Treasury Department.

“This was one of the most difficult deliberations that we’ve had,” said Michigan Treasurer Rachael Eubanks. “We are trying to pinpoint a turnaround point. There are many wellfounded but differing viewpoints on when that will occur.”

Friday’s conference made history as the first time all three state officials who voted on the revenue estimates were women. Eubanks was joined by Mary Ann Cleary, director of the House Fiscal Agency, and Kathryn Summers, director of the Senate Fiscal Agency.

Daniil Manaenkov, a U.S. forecasting specialist with U-M’s Research Seminar in Quantitative Economics, said it is going to be “very, very challenging” for the U.S. Federal Reserve to drive down inflation through higher interest rates without sending the nation into a recession. “Our forecast assumes that the Fed successfully lands the economy,” though “there are likely scenarios where we hit a recession later this year.”

The U.S. economy, measured by gross domestic product, shrank by 1.4% in the first quarter of 2022. Many economists define a recession as two consecutive quarters of negative growth.

Gabriel Ehrlich, director of the RSQE, said the main reasons his agency is forecasting continued Michigan growth include continued resiliency in the construction and manufacturing sectors, expected improvements in supply chains and continued strong labor demand. But the fact the construction and manufacturing sectors are sensitive to higher interest rates is a concern, he said.

Payroll employment in Michigan is now at about 88% of what it was in February 2020, before the pandemic started, which is below the national recovery rate of about 95%, Ehrlich said. Labor force participation in Michigan, those who are working or say they are available to work, is about 1.3 percentage points below the pre-pandemic level.

State Rep. Thomas Albert, R-Lowell, called for caution, despite voting in favor of Thursday’s massive tax cut, which is expected to soon be sent to Whitmer’s desk.

“Keep in mind these are simply revenue projections — not actual money in the bank,” Albert said.

“With all of the uncertainty in the economy, we must be careful. It would be a mistake to make plans for spending this new estimated surplus right now. We are seeing warning signs of a recession and we might not actually have that much tax revenue coming in as time goes on.”

Though both state officials and economists at Friday’s conference agreed on the need for caution, some of the upward estimates are, in fact, money in the bank. Officials have a high level of confidence in the revised 2022 numbers, because that fiscal year is more than half over.