On July 10, 2006, a ballot committee calling itself "Stop Overspending (SOS)" filed a ballot petition with the Michigan Bureau of Elections to place before the state’s voters a proposed constitutional amendment that would have, among other things, capped annual state spending increases. The state Board of Canvassers later rejected the petition because of insufficient signatures.

The proposal appears to have been modeled on a Colorado constitutional provision that has been in effect since 1993. Attempts were made to place similar proposals on ballots in several other states in 2006, and at the time of this writing, a spending cap had been successfully placed on the state ballot in Maine.

Given the breadth of the SOS proposal and the possibility that a comparable proposal might be put before Michigan voters on a future ballot, the study below reviews the proposal and considers what its impact would have been in Michigan.

The proposal sought to accomplish four objectives, which are explained in detail below.

1. Capping the Annual Increase in State Spending

The SOS proposal would have capped the annual increase in state spending. State revenue (as opposed to state spending) is already limited by a provision in the Michigan Constitution popularly known as the "Headlee amendment." The Headlee amendment also acts as a spending limit because of Michigan’s constitutional requirement that the annual state budget be balanced.

The Headlee amendment restricts the annual revenue raised from Michigan taxpayers to no more than 9.49 percent of their combined annual personal income. If tax revenues exceed this dollar amount by more than 1 percent, the amendment requires state government to send refunds to income and business taxpayers in proportion to the taxes they paid. Exceptions to this refund requirement are permitted in certain emergency circumstances, but these are narrowly defined and have never been invoked.†

Federal funds are not counted when calculating the Headlee amendment’s revenue limit; they would also have been exempt from the spending limit in the SOS proposal. Federal aid represented 32 percent of the fiscal 2006 state budget, largely for a variety of restricted spending purposes.

For fiscal 2006, the estimated Headlee limit is $30.76 billion. State spending subject to the Headlee limit is expected to be $25.97 billion — about $4.79 billion less than the cap.[1]

If enacted, the SOS proposal would have constitutionally capped the annual increase in state spending to the sum of the percentage increases in inflation and in state population for the previous year. If, for instance, the previous year’s inflation rate had been 3 percent and the increase in Michigan’s population had been 2 percent, then state spending could not have increased by more than 5 percent from the previous year. In instances of deflation or falling state population, the declining component would not have been used to calculate the allowable spending limit for the following year.

Thus, the SOS proposal’s limit on state spending increases would have adjusted state spending upward or, in the exceptional case of deflation and no state population growth, kept state spending constant. The proposal would not have ratcheted state spending down to a lower spending limit.

Whenever state revenue, together with withdrawals from the state budget stabilization fund, did permit state spending to match the SOS spending limit, the current SOS spending limit would have become the spending limit for the next year and for each succeeding year thereafter until revenues again reached the limit.‡ At that point, the spending limit for the following year would have again increased by the sum of the percentage increases in population and inflation.

The SOS spending limit would have been an addition to, not a replacement of, the existing Headlee revenue limit. However, because the Headlee revenue limit is adjusted for the state’s aggregate personal income, which traditionally has grown faster than population and inflation combined, the likely practical effect of the SOS proposal would have been a spending limit that was more strict than the Headlee revenue limit.

†  Article 9, Section 27, of the Michigan Constitution states: “The revenue limit of Section 26 of this Article may be exceeded only if all of the following conditions are met: (1) The governor requests the legislature to declare an emergency; (2) the request is specific as to the nature of the emergency, the dollar amount of the emergency, and the method by which the emergency will be funded; and (3) the legislature thereafter declares an emergency in accordance with the specific [sic] of the governor’s request by a two-thirds vote of the members elected to and serving in each house. The emergency must be declared in accordance with this section prior to incurring any of the expenses which constitute the emergency request. The revenue limit may be exceeded only during the fiscal year for which the emergency is declared. In no event shall any part of the amount representing a refund under Section 26 of this Article be the subject of an emergency request.”


‡  Because of the SOS proposal’s budget stabilization fund provision (described under “Refunds to Taxpayers and Payments to the Budget Stabilization Fund”), the cap would always have been met and reset for the following year whenever state revenues and state budget stabilization monies were sufficient to meet the spending cap. This appeared to be true regardless of lawmakers’ spending decisions.

Refunds to Taxpayers and Payments to the Budget Stabilization Fund

In any year in which revenue exceeded the proposed spending limit, the SOS proposal would have returned at least 50 percent of the surplus to taxpayers, with each receiving an amount proportional to the personal income taxes he or she paid. The SOS proposal would have removed the Headlee provision granting refunds to business taxpayers.

The remainder of any revenue surplus — but never more than 50 percent for any given year — would have been deposited in the state budget stabilization fund. If the stabilization fund’s balance had reached 10 percent of the current year spending limit, any remaining tax revenue surplus would have been rebated back to the taxpayers according to the formula detailed above.

In sum, the SOS proposal would have restricted the percentage increase in state government spending to the combination of inflation and state population growth. It would have mandated that up to 50 percent of any state revenue exceeding the proposal’s spending limit be placed in a budget stabilization fund that would have been allowed to grow to 10 percent of that year’s state spending limit.∂ The proposal would also have required that at least 50 percent of all annual revenue surpluses be rebated to taxpayers, and that up to 100 percent of the surplus be rebated to taxpayers whenever the budget stabilization fund had reached its maximum mandated annual size.

∂ The SOS proposal did not stipulate how the substantial monies that could have accumulated in the budget stabilization fund might have been invested.

Definition of "Revenue"

From 2000 through 2005, the state received more than $1.8 billion from a lawsuit settlement against the U.S. tobacco industry. Annual payments from this suit have ranged from a low of $261 million to a high of more than $350 million. This tobacco money and some other recent sources of nontax state revenue are not counted as part of the Headlee revenue limit. The Headlee limit therefore does not curb state expenditures as much as it would if these other sources of state income were considered.[2]

The SOS proposal would have altered the existing Headlee language so that the definition of "total state revenues" specifically included the tobacco settlement money and "any (revenue) source now in existence, or created or identified in the future." As noted earlier, federal funds would have been exempt from the SOS proposal’s spending cap, just as they are under the Headlee revenue cap. Several other exceptions to the Headlee cap would also have been kept by the SOS proposal,¶ such as revenue from voter-approved bonds for capital construction projects and monies for state-administered pension and insurance plans. The state treasurer’s mandatory transfers from the budget stabilization fund (detailed below) also would not have counted toward the calculation of "total state revenues" under the SOS proposal.

¶  The list of exceptions is lengthy and specialized. Article 9, Section 33, of the Michigan Constitution stipulates, “‘Total State Revenues’ includes all general and special revenues, excluding federal aid, as defined in the budget message of the governor for fiscal year 1978-1979.”  Thus, the exceptions include the line items in that gubernatorial budget message, as well as a variety of state funds detailed in Article 9.  

Exceptions to the Spending Limit

The Headlee revenue limit may be exceeded for one year, provided that the governor declares an emergency, states a specific reason for exceeding the limit, specifies the specific amount needed and proposes a specific means of raising the additional money (such as a tax increase). The Legislature must then approve this request by an affirmative vote of two-thirds of each chamber. To date, no governor has ever made such a request. The SOS proposal would have narrowed the constitutional definition of "emergency" in both the Headlee and SOS limits to include only instances involving "an imminent threat to public health or safety."

The SOS proposal would also have added a new mechanism for exceeding both the revenue limit and the proposed spending limit. With a two-thirds vote from both the state House and the state Senate, a request to collect and spend above the Headlee revenue and SOS spending limits could have been submitted to the voters for their approval at a November general election. While the request would not have required a reason or purpose for the additional spending, such as an "emergency," the following statement would have had to appear in the ballot language presented to voters: "A ‘yes’ vote on this measure will authorize the state to retain extra taxes and spend them in excess of constitutional limits by [insert amount of predetermined maximum additional spending]."

It is important to note that if such a request had been granted by voters on an election day for either president or governor, the approved additional spending would have been counted as a permanent upward adjustment to the spending limit, regardless of the inflation and population adjustment for that year. Alternatively, if voters had approved the request in another general election (i.e., odd-year November elections), the resulting upward adjustment in spending would have counted only for that particular year — a one-time source of additional revenue that would not have affected the spending limit of subsequent years.

2. The "Budget Stabilization Fund"

The state budget stabilization fund, popularly known as the "rainy day fund," is a state budget account that is discussed in the Michigan Constitution. The fund is like a savings account in which state government can deposit surplus revenues during favorable economic times. The fund is intended to provide additional monies during declines in state revenue, though the Legislature and the governor have sometimes changed the law governing the fund to allow withdrawals for reasons other than this original purpose.

The SOS proposal not only would have mandated that a fixed percentage of surplus revenue be dedicated to the fund (described above in "Refunds to Taxpayers and Payments to the Budget Stabilization Fund"), but also would have eliminated the Legislature’s political authority to withdraw money from it. Only the state treasurer would have been constitutionally permitted to withdraw money from the fund. He or she would have been allowed to do so when, and only when, total state revenues for the year had not proved sufficient to allow state spending to match the spending limit; moreover, in these circumstances, he or she would have been required to remove enough money to meet the cap (if possible), but to withdraw no more than that amount.

3. Local Tax Provisions

Taxpayers and local governments have had several legal battles over the meaning of the Headlee amendment’s restrictions on the taxation authority of government.** A number of the SOS proposal’s modifications appear to be efforts to clarify Headlee language.

**  In 1994, the “Headlee Blue Ribbon Commission Report,” requested by Michigan Gov. John Engler, examined many of these disputes. The Headlee Blue Ribbon Commission had members representing taxpayers, state government and local government. The commission’s opinion regarding local government disputes with taxpayers was not always unanimous. The official report of the commission states all sides of these disputes and issues conclusions from both the majority and minority perspectives. A copy of the “Report of the Blue Ribbon Commission on the Headlee Amendment” may be obtained from the Michigan Department of Treasury. Substantial excerpts of the report have been posted online by the Anderson Economic Group at http://www.andersoneconomicgroup.com/modules.php?name=Content&pa=display_aeg&doc_ID=1537.

Limited Tax General Obligation Bonds

The Headlee amendment allows an exception to its revenue limitation in the case of voter-approved bond sales. The purpose of this exception is to allow taxpayers a chance to vote on any local government proposal that obligates them to pay for future spending.

Some local governments have adopted the practice of selling a particular type of bond — "limited tax general obligation bonds" — without the consent of the voters. These bonds are repaid out of tax revenue that local governments already have the authority to levy. The sale of these bonds does not violate the Headlee restriction for the current year or necessarily even create a tax increase for that year, but the bonds nonetheless create a long-term payment obligation for taxpayers, just as voter-approved bonds do.[3]

The SOS proposal would have prohibited this practice and require that this type of long-term borrowing be subject to voter approval.

Special Assessments and User Fees

The Headlee amendment requires voter approval before a local government can create a new tax or increase the maximum allowable rate of an existing tax. The definition of a "tax" has thus been a matter of legal dispute, particularly on the question of distinguishing "user fees" and "special assessments" from "taxes."

A pivotal court case involved the Lansing city government’s creation of a system to separate the city’s storm water runoff from the city’s sewer water. To pay for this system, Lansing implemented a charge against property owners without seeking voter approval.

City officials argued that the charge was a "user fee," rather than a tax. The levy entered popular understanding as the "rain tax," however, and following a lawsuit by a Lansing taxpayer, the Michigan Supreme Court in 1999 agreed that the charge was a tax requiring voter approval, in part because "users" had no ability to cease receipt of the service or control the amount that they used.[4]

The SOS proposal would have placed the following definition of the term "mandatory user fee" in the state constitution: "‘Mandatory user fee’ means a compulsory obligation to pay for goods or services under circumstances where the user does not have the absolute discretion to choose how much of the good or service to use, or whether to use it or buy it at all, without giving up common law rights incidental to private property ownership." The proposal would have required voter approval for these fees, while the decision to increase voluntary user fees would have remained with local officials.

The SOS proposal would also have added "special assessments" to the list of government levies that would have needed voter approval. "Special assessments," unlike the general property taxes charged on the value of a property, are levied proportional to a specific benefit provided to a property. For example, a special assessment for new streetlights might bill each nearby store owner based on the number of lights in front of his or her building. Properties that are not located near the lights and not receiving a direct benefit from them would not be taxed.

Headlee "Rollbacks" and "Preapproval"

The Headlee amendment requires an automatic reduction in the rate of local taxation when property values increase faster than inflation (this automatic tax reduction does not apply to state education property taxes).[5] This automatic reduction is commonly known as a "Headlee rollback" and has the effect of limiting the growth of local government tax revenues to only the value of new construction and the growth in inflation. However, with voter approval, commonly known as a "Headlee override," local governments are permitted to forgo the rollback and continue levying the current tax rate.

In advance of this automatic tax rate reduction, some taxing jurisdictions have been requesting "preapproval" from voters for tax rates that exceed what is presently allowed by law, but that exactly equal an impending Headlee rollback. Although the higher tax rate cannot be levied right away, the local government institutes the new tax after the Headlee rollback takes effect, thereby keeping the tax rate constant. The SOS proposal would have no longer permitted this "preapproval" practice.

Statute of Limitations to Challenge Headlee Violations

The Michigan Constitution does not currently specify how much time taxpayers have to challenge an alleged violation of the Headlee amendment. In the absence of constitutional language, courts have imposed a one-year statute of limitations on Headlee-based lawsuits. The SOS proposal would have instituted a three-year statute of limitations for challenging Headlee and SOS violations, giving taxpayers two additional years in which to sue.

4. Lawmaker Pension Prohibition

Michigan lawmakers currently receive a taxpayer-funded matching contribution for the money they place in a state-administered 401(k) retirement fund. The SOS proposal would have prohibited state lawmakers elected after January 31, 2007, from receiving any pension or other retirement benefits that are financed by Michigan taxpayers or other state revenues.