CHICAGO - Gov. John Engler of Michigan and a state senator who sponsored a measure to eliminate school operating property taxes last month are calling for a Dec. 31 deadline to come up with an alternative funding plan for schools.

In an Aug. 2 letter to newspapers in the state, Engler said the Legislature should complete work on funding schools and designing new and better schools" by the end of December "so everyone will get six months next year to prepare for the phase-in."

Engler said that finding replacement revenues for schools is "the easy part, " and that reforming schools will be more difficult. He said his reform agenda calls for quality education, school choice, less bureaucracy, and more competition among schools.

The letter did not recommend alternate funding sources for schools.

Meanwhile, state Sen. Debbie Stabenow, D-Lansing, has identified a number of funding options to replace about $6 billion of property tax revenues for secondary and elementary schools that is slated to be eliminated. Engler is scheduled to sign the legislation, which would become effective July 1, on Aug. 19.

Stabenow, who is planning to run for governor in 1994, outlined more than $6 billion of funding alternatives, including raising the state personal income tax to 6.6% from 4.6%, extending the 4% state sales tax to some services, increasing taxes on cigarettes and other tobacco products, and raising taxes on businesses by hiking the state's single business tax by 1.5% or instituting a 25-mill property tax on industrial and commercial property.

Melissa Kaltenbach. an aide to Stabenow, said that the options are merely part of a framework that the senator has laid out for discussion. Kaltenbach said that the funding options would not need voter approval and could be put in place by the Legislature.

However, the. state constitution limits the total amount of revenues Michigan can raise based on a percentage of the state's personal income. A state official has said that under that formula, the state can raise only $3.8 billion more than it already does.

Another Stabenow staff member said that creating an education finance authority to levy the taxes may be a way to avoid the constitutional limitation. Kaltenbach said that the senator hopes to equalize annual per pupil funding in the state, which currently ranges from $2,800 to $10,000, and make sure that outstanding tax increment finance debt is taken care of under any reforms.

Rating agency and public finance officials have raised concerns that the elimination of the school operating property tax could impair both tax increment bonds supported in part by school taxes and limited tax general obligation bonds paid off with school operating property tax revenues. The legislation left the property tax millage for unlimited tax GO debt intact.

Moody's Investors Service said the ratings of 60 school districts in Michigan are at risk because of the elimination of the operating levy. Standard & Poor's Corp. officials have said the effects on credits they rate will depend on what action the Legislature takes to replace funding.

Meanwhile, a taxpayers watch-dog group has sent a letter to both rating agencies that states the elimination of the school property tax highlights the group's claim that limited tax GO debt has been unconstitutional since the passage of the so-called Headlee Amendment in 1978. The group. Taxpayers United for the Michigan Constitution, is led by Richard Headlee, who sponsored the amendment.

The letter, written by Patrick Anderson, a director of Taxpayers United, says that governments have been skirting the amendment's requirement of voter approval for certain bonded indebtedness" by issuing limited tax GO bonds.

"The theory was that [limited tax debt] would carry the full faith and credit of the local taxing authority. but only up to limits that had been approved by the people for operating purposes," the letter says.

"This is attempting to have your cake and eat it, too: receiving full faith and credit without having to obtain voter approval. "

Now, with the elimination of the operating property tax levy, Anderson said that "the lack of a guaranteed source" for limited tax GO bonds is exposed.

Because such bonds have "never been approved by the voters, the constitution will not allow the same unlimited debt millage it grants voter approved debt," Anderson wrote. "Without both a source of operating revenue and a school board willing and able to divert it to the repayment of limited debt, principal and interest payments cannot be made on limited tax bonds."

The group said while the ratings on voter-approved unlimited tax GO debt should be maintained or upgraded based on the "positive economic impact" the property tax cut will have on the state, a downgrade of the ratings on limited tax debt "is justified. and indeed overdue."

Paul Devine, a vice president and manager of the Great Lakes region at Moody's, said issues "regarding the legality and constitutionality of debt are matters to be discussed and debated by bond counsel and the courts." He added, however, that the taxpayers group's point about the "vulnerability" of limited tax debt is appropriate, pointing out that Moody's has identified ratings on six limited tax issues that face the most risk "due to the absence of a pledged debt millage."

The taxpayers group has been unsuccessful in the past in posing legal challenges to limited tax debt, which has been defended by bond attorneys and issuers in Michigan as constitutional because it does not result in a property tax increase.

Claire Cohen, executive vice president of public finance at Fitch Investors Service, said that while Fitch does not rate any limited tax school debt in Michigan, it hoped any plan for school funding would accommodate that debt.

Officials from Standard & Poor's did not return phone calls.

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