The newspapers are full of frightful headlines reporting yet another "$1 billion state budget deficit." Gov. Jennifer Granholm has included proposed (but unlikely) federal cuts in order to claim that the gap is $1.2 billion, and to push for $400 million in tax hikes. But a closer look at the numbers reveals a different story.

According to the Senate Fiscal Agency’s January projections, Michigan will finish this year with $16 million in its combined General Fund/School Aid Fund checkbook. In 2005, the Agency estimates that phased-in tax cuts will slice $44.6 million from this year’s General Fund revenue. However, School Aid Fund revenue will increase by $348 million.

So where’s the "$1 billion deficit"? Headlines make it appear that the state will take in a billion dollars less next year. It might be more accurate to say that legislators want to spend a billion more than they know they will have. It’s like someone who earns $30,000 declaring a $10,000 "deficit" because he wants to spend $40,000.

Not that there aren’t real budget challenges. The actual 2005 General Fund "deficit" figure is $894 million, not $1 billion. This assumes the slightly lower revenues cited above, the loss of additional "one-time" revenue sources, and a spending freeze at 2004 levels. It also assumes a $298 million "hit" to make up reduced federal Medicaid money.

OK so far. But the number also includes a $154 million "rainy day fund" deposit, and $160 million for state employee pay raises. The first item is required under a 2002 cigarette tax hike statute. It can be changed with a vote of the Legislature and the signature of the governor.

The pay raises can also be changed, but this will require intestinal fortitude and tough negotiating by the governor. She should not hesitate — Michigan state employees historically have been very well paid compared to private sector and other state government workers, according to an Office of the State Employer survey. Private sector workers often make concessions in hard times. Taxpayers should expect no less from public servants.

Without these two items the General Fund "deficit" falls to $580 million.

In the School Aid Fund, the picture becomes positively rosy. At current spending levels, 2005 will end with a $252.6 million surplus. The schools will be quick to note that they took a $55 per-pupil cut this year. But 338 school districts have a total of $1.84 billion in their own rainy day funds, and Intermediate School Districts sit on another $112 million. Both figures are far above the 15 percent reserve considered prudent. Plus, schools could put employee health insurance out for bids and save $400 million, while still providing "Cadillac" health plans instead of the "Rolls Royce" coverage most now enjoy.

Subtract the $252.6 million school surplus from the $580 million real General Fund deficit, and the real 2005 deficit is less than a third of the publicly touted $1 billion figure — just $327.4 million. This can be easily cut without robbing any widows or orphans.

How? Gov. Granholm herself has proposed cuts. Her plan to save $65 million by reducing Merit Scholarship Awards was defeated, and her proposed $27 million cut from the MSU agriculture extension program was stillborn. Rep. Judy Emmons, R-Ionia, sought to save an income tax rate cut by slicing $25 million from adult education for prisoners, $16 million from mass transit, and $10 million from the Detroit Medical Center. These cuts weren’t adopted, but they could be.

But better still, Mackinac Center Director of Fiscal Policy Michael LaFaive has specified $1 billion that could be saved by returning many government functions back to civil society institutions from whence they came. Much of the $90 million in annual casino taxes are squandered on corporate welfare. Arts funding should be left to the private sector, saving $11.8 million. Potential prison sentence and parole reforms could save a bundle. Also, Senate Appropriations Committee Chair Shirley Johnson, R-Royal Oak, plans to "unroll" the contents of individual budget line items, which will help separate wants from genuine needs.

These overall budget numbers are good news for Michigan. There is still plenty of fat to trim, and the monstrous deficit numbers are an illusion. We are closing the much-feared "structural imbalance" in state government. The challenges are political, not fiscal. It is time to resume changing Michigan’s reputation as a relatively high tax state to one that attracts business and jobs with lower taxes.

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Jack McHugh is legislative policy analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich.