Michigan’s recovery dangles from ‘fiscal cliff’

By Mitch Bean

While the action over the “fiscal cliff” tax and budget decisions will occur on Capitol Hill, the consequences of whatever course is chosen will ripple across the Great Lakes State. Bridge asked Mitch Bean, a longtime head of the House Fiscal Agency, to explain the details of the national situation and, most importantly, the stakes for Michigan.

The ‘cliff’ ahead

There are two parts to the “fiscal cliff”: budget cuts that occur through the sequestration process and tax increases as the Bush tax cuts expire. In Michigan, sequestration would mean cuts to non-defense spending, defense spending and NIH grants of about $860 million in 2013. These impacts are primarily pass-through to locals, reduced spending for defense contractors through procurements, or NIH grants that would affect research. Repeal of the Bush era tax cuts and the increased payroll tax rates would reduce total state disposable income about $14 billion and reduce state consumption tax collections.

The Budget Control Act of 2011 will cut $109 billion from the federal budget in 2013 unless Congress is able to figure out how to either reduce the deficit or cut another deal by January. Fifty percent ($54.7 billion) will come from non-defense sequestration and 50 percent will come from defense.

The Congressional Budget Office estimated that fiscal year savings will range from $68 billion in 2013 to $148 billion in 2021. The goal of the sequestration process is to reduce spending by $1.2 trillion from 2013 to 2021. Savings goals include $216 billion from reduced debt service, and $492 billion each from reduced defense and nondefense spending.

The $54.7 billion in non-defense cuts will come from both mandatory (entitlement) and discretionary (non-entitlement) programs. The mandatory cuts will include:

* Cuts in Medicare payments to providers and insurance plans. Those cuts are limited to 2 percent of such payments in any year, or $11 billion in 2013.  (Medicare providers will be reimbursed at a rate of 98 cents on the dollar).

* About $5.2 billion in cuts in the other mandatory programs, including farm price supports, student loans and dozens of smaller programs.

All in all, in 2013, about $16.2 billion of the $54.7 billion in non-defense cuts will come from mandatory programs.

Mitch Bean was the long-time director of the Michigan House Fiscal Agency which provides non-partisan information and analysis for members of the Michigan House of Representatives. He is one of the most knowledgeable financial and policy figures in Lansing and serves on the Bridge Board of Advisers.

The remaining non-defense cuts — about $38.5 billion in 2013 — will come from discretionary programs. Cuts would occur through across-the-board, proportional reductions in the new funding provided for each discretionary program.

Cutting defense

The $54.7 billion in 2013 defense cuts will occur through across-the-board, proportional reductions in the funding provided for defense accounts. War costs are subject to sequestration.

In 2013, the president can exempt some or all military personnel funding from the sequestration. To the extent he chooses that option, the cuts in other defense funding would increase.

If the president chooses to exempt some military personnel, the percentage cut on the other defense accounts would rise, to 9.5 percent if all military personnel accounts are fully exempted and are funded at the level he has requested.

The taxman cometh

The other side of the “cliff” equation is the change in the federal tax code. Among the major alterations looming:

All of the Bush tax cuts are set to expire on Dec. 31. As a result, income tax rates rise to percentage rates of 15, 28, 31, 36 and 39.6, up from 10, 15, 25, 28, 33 and 35.

The capital gains rate would rise to 20 percent, from 15 percent, for most filers.

The child tax credit falls to $500 per child from $1,000. The refundable portion also reduced.

The marriage penalty relief expires, which effectively means a low- or middle-income two-earner-couple will owe more to the IRS than they would if they were single making the same income.

The estate tax reverts to pre-2001 levels.

The “patch” on the alternative minimum tax disappears, which would extend its impact from 4 million people to 30 million.

Finally, the payroll tax holiday is set to expire, so the Social Security tax rate reverts to 6.2 percent, up from 4.2 percent, on the first $110,100 in wages.

According to an analysis from the Tax Policy Center, American households face an average tax increase of $3,500 if Congress doesn't act to avert the fiscal cliff, and 88 percent of households would end up with higher taxes.

If lawmakers cannot agree on how to address the situation, about $7 trillion worth of tax increases and spending cuts over the next 10 years will begin to go into effect in January. The U.S. economy will most likely go into recession in 2013. We will probably lose about 2 percentage points of GDP, and lose about 1 percent of jobs.

About 155.6 million people were employed in October, so about 1.5 million jobs would be lost. That also means that state and federal costs would increase, and revenues would go down.

Impact for Michigan: economic regression

Here in Michigan, cuts to non-defense spending would be about $244.4 million; and cuts to defense spending would be about $562.7 million.

Higher personal income tax rates would reduce disposable income and reduce state consumption tax collections. Repeal of certain business tax provisions concerning accelerated depreciation and higher rates on pass-through entities would have a negative impact on businesses.

So the state would probably lose all the net jobs we’ve created in the last year to 18 months -- and state revenues could easily take a $300 million to $400 million hit in 2013l, necessitating budget changes.