ANN ARBOR – Senate Fiscal Agency Director Gary Olson said Friday that Governor-elect Rick Snyder and the incoming Legislature will have to make the massive, painful and necessary structural changes that are overdue for state government.

Olson, who is retiring at the end of the year after two decades at the helm of the fiscal agency, was appearing at his last economic outlook conference at the University of Michigan and got some laughs when he noted his pending departure would allow him to “speak freely about what I think.”

The data is incontrovertible that the state has a number of structural budgetary problems, Olson said, citing the level of its compensation to current and retired employees, an insufficient revenue base for transportation needs, the size of tax expenditures and the configuration of the sales tax.

“In my opinion, 2011 is likely the year in which the scope and purpose of Michigan state government are adjusted to reflect the economic realities of this state,” he said. “It’s going to be painful, but it could be a great accomplishment.”

Olson pointed to a variety of statistics, notably that tax expenditures – exemptions, credits and other tax breaks – totaled $26.2 billion in the 2009-10 fiscal year, compared to $14.1 billion in 1999-2000. The current figure is more than double revenues received from state sources. He also pointed to the state being $8.8 billion under the revenue limit set by the Headlee Amendment after it exceeded the limit by $159.7 million in 1999-2000.

“The size of the state budget in relation to the size of the Michigan economy has significantly declined in the last decade,” he said, adding that he tells legislators, “If your goal over the last decade has been to shrink the size of state government, consider it a remarkable success because it has occurred.”

State government salaries were 5 percent above average for all states in 2009, Olson said.

Olson said spending from state sources of revenue went up during the decade by $578 million, or 2.3 percent, while the Detroit Consumer Price Index went up 22.7 percent.

He questioned those who say the state needs to eliminate entire programs to eliminate the $1.58 billion gap between available revenues for the 2011-12 fiscal year and existing spending.

“I’ve heard it all before,” he said. “We’ve done a lot of downsizing over the last decade. I seriously doubt there’s a huge amount of money to be saved from eliminating state programs.”

The state also needs to broaden the base of the sales tax to service and could do so in a way that is revenue-neutral by reducing the rate of the sales tax, Olson said. But the 2007 debacle when the Legislature and Governor Jennifer Granholm threw together a services tax in the middle of the night may have crushed that issue for the long-term. The governor and Legislature swiftly repealed the tax, and Granholm’s attempt to revive a services tax this year went nowhere.

“That needs to be done,” he said. “I thought in 2007 after they botched that job it probably put that on the shelf for about 10 years.”

Olson also said he gives Granholm “high marks” for reducing the prison population every way she could without statutory changes. Granholm has supported parole for prisoners who have passed their minimum release date.

In response to an audience question, Olson warned that default by local governments and school districts is a “huge issue” facing the state. Hamtramck set off alarms this week when it asked the state about declaring bankruptcy.

“It is a huge problem,” he said. “Andy Dillon, who’s going to be the next state treasurer, better focus on this issue, pretty quickly, in my opinion.”

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