A look at the economic and political landscape shaping the forthcoming budget session.
Legislative sessions are shaped by two forces – resources and power – which is why November is always a noteworthy month. The recently-released November economic forecast foreshadowed what may be available with respect to crafting the budget while the November elections determined who has the clout in the crafting. Put them together and they offer a glimpse at what we might expect in the new year – as the hunt for the elusive signed tax bill potentially enters year three.
State officials appeared rather satisfied during their presentation of the state’s November economic forecast for good reason – a respectably performing economy, intragovernmental borrowing completely paid off, a sizeable surplus, and a healthy budget reserve has that kind of an effect. The forecast estimates a $1.4 billion surplus for the upcoming biennium, which excludes the additional $334 million dedicated to the budget reserve bringing it within a whisker of the target (now $2.052 billion) that MMB sets based on economic factors, including revenue volatility.
However, some rather unusual circumstances surround this surplus forecast, largely concerning the 2016 tax bill that was torpedoed by the infamous “conjunction of doom.” If that bill had been enacted, tax cuts would have reduced projected FY 2018-19 revenues by $375 million (including property tax relief for business property owners and farm owners) and an additional $169 million would have been spent on aids and credits (including additional money for Local Government Aid and an enhanced Working Family Credit). Those changes would have left lawmakers with about $850 million to work with next year as they craft the FY 18-19 budget.
As of this writing, odds seem to favor teeing up a special session before Christmas to deal with the health insurance premium crisis, although Lucy has pulled that football away from Charlie Brown in the past. The cost of premium subsidies has been ballparked in excess of $300 million, which, if enacted and paid for from the general fund, would put a dent in next biennium ambitions. But it is also possible the tax bill would be resurrected as part of any special session agenda. The price tag of that bill this time around could be higher depending on where effective dates for the various provisions end up being set. The fate of the $266 million general fund appropriation for transportation, which was part of the last minute package of the 2016 session, is also in question. Depending on what parameters and details a special session agreement includes, the money available for additional FY 18-19 spending could be cut by over half.
Then there are the “off the books” biennial expenses that the forecast estimate does not formally recognize. The item that gets all the attention is projected spending inflation, which is included in the forecast estimate for informational purposes. As always, the state’s Council of Economic Advisors’ statement on the forecast is highly critical of this practice, arguing the projected cost of services as provided by current law for FY 18-19 is understated by roughly $1.7 billion. The other expense – which is completely ignored – is the cost of unmet public pension contribution requirements, which a recent study by the Boston College Center for Retirement Research has estimated conservatively at $590 million annually for the state. Why the Council of Economic Advisors’ mini-lecture on fiscal responsibility always harps on this highly debatable and grossly overstated projection of cost inflation while completely ignoring the really dangerous chicanery and budgetary self-deception occurring in public pensions is truly one of the great mysteries of state finance.
Looking at the big picture (see Table 1), FY 18-19 spending is expected to grow by just over $3 billion (7.4%) relative to FY 16-17. Many of the biennial reductions across spending areas likely reflect the one time nature of the supplemental spending bill passed in 2016. Of particular interest is the continuing ability of health and human services to suck up most of the new fiscal oxygen in the budget room. Many have touted the $173 million decline this forecast projects for the health and human service area relative to previous estimates for FY 18-19. The reduction includes $146 million of savings in the area of long-term care. While reforms in this area are yielding important and positive results, health and human service general fund spending is expected to grow 14.4% over the next biennium, or $1.64 billion1. In short, health and human services, which currently constitutes 28.5% of general fund spending, is projected to consume almost 60% of all new general fund revenues in the next biennium. Regardless of what size of biennial surplus actually materializes next year, that trend is alarming.
The forecast has ratcheted back revenue growth expectations a bit since the end of the 2016 session. On a biennium over biennium basis, revenues are now forecasted to grow 6.9% or just over $2.9 billion. Notably, individual income tax receipts account for nearly 80% ($2.3 billion) of that growth. The good news is that the economic forecasters foresee respectable growth in both wage/salary income and non-wage income in the range of 4.7% to 5.1% in both FY18 and FY19. The concern is dependency and accompanying volatility.
The “unbalanced stool” metaphor played a major role in the tax policy changes made in 2013 – the idea being that collections of income, sales and property taxes should be roughly equal when considering all levels of government in Minnesota. At that time property taxes were considered to have too long of a leg. Fast forward to the end of 2016, and the income tax leg is now longer than the property tax leg was when “balance” was identified as a problem that needed to be fixed. Moreover, we have seen how estimates can deviate from forecast – especially with income sources associated with the highest earners on whom we are now more reliant. For example, in this year’s February forecast, MMB anticipated capital gains realizations would grow by 2.0% in 2016. That has since been revised to a decline of 5.7%. The $2 billion budget reserve target reflects the now-greater volatility of our revenue system. As excessively large as it may seem to be, it’s the price we pay for our revenue system’s new realities.
Much can change between now and the definitive February forecast, especially with huge question marks punctuating every area of federal tax and fiscal policy. State officials and legislators appear very cognizant of this uncertainty and the potential implications for the state budget. The disposition of the ACA, economic repercussions of aggressive trade policies, and federal corporate income tax reform in conjunction with a repatriation of foreign earnings (which could be a large windfall for the state) are just a few of the more notable national developments state officials and legislators will have to keep a close eye on.
The 2017 legislative session will be framed also by November’s election results. The conventional wisdom in the months leading up to the election suggested that DFLers had a good chance to reclaim all three lawmaking levers (the House, Senate, and governor’s mansion). Instead, Minnesota’s voters continued to express a preference for divided government. The House GOP added three members to their caucus; and with 76 seats (and the potential for another at a February special election), the caucus has passed 75 members for only the second time since party designations were put back on election ballots in the early 1970s. DFLers were unable to make gains in rural seats and unexpectedly lost a handful of seats in the metro area.
The major surprise was in the state Senate, where the GOP now holds a 34-33 advantage as the Republican wave that deluged rural House DFLers in 2014 came back for many of their Senate colleagues. Republicans picked up seven seats outside the seven-county metro – primarily in northwestern Minnesota and south of the Twin Cities – while losing only one. A substantial number of senior DFL senators will no longer be around in 2017 – either through retirement or defeat – including the chairs of the Taxes and Capital Investment Committees and the assistant majority leader.
On the flip side, the GOP Senate caucus will be far more experienced in 2017-2018 than they were in 2011-12, even with the loss of their leader. Only one member of that earlier majority – Sen. Doug Magnus – had ever chaired a legislative committee, and that was as a House member. Given that none of those senators had ever even in been in the majority unless they had served as House members, there was a fairly steep learning curve for the caucus. We might expect this relatively more experienced group to have an easier time with the transition of power.
The election results obviously change the dynamics between the three institutions charged with lawmaking – the House, Senate, and Governor Dayton. But clearly the dynamics change the most in the Senate, as the House returns the same leadership with roughly the same political makeup. The last four years in the Senate often saw a struggle within the DFL caucus to find compromises between rural, more conservative members and the more liberal wing – primarily from the metro area. Perhaps the best example came during the 2015 special session, when the final agriculture and environment bill was nearly derailed in the Senate. Looking ahead to the next four years, the operative word will be “consensus”. With a 34-member caucus and 34 votes needed to pass any bill, every GOP senator effectively has a veto on legislation that DFLers decline to support – with implications for the caucus’ ability to pass controversial measures.
The dynamics between these institutions is likely to be somewhat different than the 2011-2012 session. In large part, that’s because the financial situation is far different – the state is dealing with a $1.4 billion surplus instead of a $6 billion deficit. But another difference will relate to the makeup of the incoming crop of legislators. The 2010 election produced a considerable number of Tea Party-affiliated legislators who had an interest in being confrontational. By all accounts, this group of legislators is much more heavily weighted toward small business owners and leading citizens with strong histories of civic engagement. Words like “practical,” “thoughtful,” and “grounded” have been used to describe many of them to us. Between this and the very small GOP edge in the Senate, it may be easier for the dealmakers to close the agreements than it was in 2011 and 2012.
Our staff crystal ball acts more like a Magic 8 ball but we’ll still offer some predictions about how these election and forecast results will shape the upcoming legislative session. For starters, the election results would seem to foreshadow continuing challenges for the “One Minnesota” ideal, as the parties have now largely coalesced geographically on urban/rural lines. It’s nearly impossible now to find a DFLer whose district is either outside the seven-county metro or the Iron Range if it doesn’t have a city of at least 25,000. It wouldn’t be surprising at all to see the majority caucuses prioritize legislation that focuses on rural economic development, rural transportation infrastructure, and elder issues as outstate Minnesota is considerably older than the Twin Cities. Center cities will have a bulls-eye on their back, and will likely have to rely on Governor Dayton to defend their interests.
On the tax front, whether a special session happens or not may be largely inconsequential. The tax bill left on the table in 2016 will be the bill likely to be passed, whether in special session or during 2017. It already has that rarest and desirable of features – bipartisan support – and the money to do any significant expansion on either the relief side or the tax expenditure side really isn’t there. Any add-on provisions will likely be heavy on no-cost or low-cost policy/administrative dimensions. If the committees do have some money to work with, one potential tax relief area is in the estate tax, as both tax chairs (Greg Davids in the House and Roger Chamberlain in the Senate) have previously expressed interest in conforming to federal provisions.
But the real question is – will the legislative stakeholders be able to work together productively? One canary in the coal mine will be the budget proposal that Governor Dayton must release by January 15th. Will it be filled with tax provisions and spending increases at a level that renders the budget dead on arrival – and antagonizes the majority caucuses in the process? Or will there be provisions building on the past and subsequent efforts on both sides to help close the remaining differences that left us tantalizing close last May? If it’s the former, watching the 2017 session may turn out to be like watching a bad action movie – all the car chases and gun fights may be entertaining, but 10 minutes in you know exactly how it’s going to end.