Minnesota's Economic Forecast: Decision-Making in a Time of Plenty

Based on Minnesota Management and Budget’s revenue updates throughout this year, everyone knew something like this was coming.  But the magnitude of the announcement likely startled even the most attentive fiscal prognosticator.  The newly-released December economic forecast projects a $7.7 billion surplus for the current biennium – the largest (at least in absolute terms) in state history.  Total tax revenues are now projected to increase by a whopping $5.1 billion in the current biennium, or 10.5% over end of session estimates.  Individual income ($2.7 billion) and corporate income ($1.25 billion) taxes together constitute 78% of this increase. 

Two other considerations make the forecast, and its implications for assembling a 2022 supplemental budget, even more remarkable.  First, $7.7 billion is what is left even after all the statutorily-mandated transfers and adjustments occurring prior to any legislative decision-making because of a positive December forecast.  Budget reserve: fully topped off at $2.56 billion.  Accounting shifts: all taken care of.  Special fund raid reimbursement: done.  Even accelerated June sales tax payments -- dead last in the pecking order for any allocations of positive general fund forecasted balances -- have now been eliminated.    

Second, this total does not include the large amount of federal recovery dollars still available to be spent.  Last session $663.1 million of fiscal recovery cash was reserved for revenue replacement for the FY 22-23 general fund (which essentially covered the biennial cost of federal tax conformity) and $550 million of the FY 24-25 biennium.  That leaves an additional $1.1 billion or so of one-time fiscal recovery money for 2022 session appropriations.

Even the state’s out-biennium planning estimate didn’t rain on the good news parade.  Often this estimate injects a note of caution into everyone’s ambitions by projecting something closer to structural breakeven or even a shortfall, especially after factoring in the state’s inflation estimate.  Not this time.  The new long term budget outlook forecasts a $5.95 billion structural balance in FY 24-25.  Including the inflation estimate still leaves $4.8 billion in projected revenues in excess of projected spending.

Put it all together, the green flag has been dropped on an aggressive pursuit of everyone’s big spending and tax relief ambitions.  The usual questions take on more intrigue in an election year.  Will gridlock continue to persist as parties bet that the election will increase their leverage in 2023?  Or will the need to show results to key voter constituencies encourage compromise?  And perhaps the most important question of all: will fiscal responsibility be a casualty of a political compromise that includes large doses of both new spending and tax relief?  As one of our members and a long time Capitol observer told us, a large budget surplus will make it politically challenging for legislators to avoid digging a budget hole that the fiscally prudent may later regret.   The turn of the century tax cuts combined with biennial general fund expenditure growth that averaged over 14% during the dot com boom years is Exhibit A.

Of course, the forecast comes with the standard list of risk factors and interrelated uncertainties including the path of the pandemic, chronic supply chain disruptions, and labor force participation.  Any of these independently or in concert could turn portions of that $7.7 billion into Monopoly money sooner than anyone would like.

Based on our experience in recent years, it’s not unduly cynical to believe there is a strong correlation between the size of the surplus and how antagonistic the session can turn out to be.   Oscar Wilde said “when the gods wish to punish us, they answer our prayers.”   We don’t know what circumstances caused him to utter those words, but it wouldn’t surprise us if it was a debate over a massive surplus in a time of highly divided government.

A couple comments:

How long can the federal government’s support for General Fund operations last? — During the 2021 session, it became clear federal fiscal recovery money available to support state general government operations was much larger than anyone had been anticipating — something on the order of $2 billion.  As news outlets have reported, the state didn’t actually lose revenue in the pandemic; it just didn’t collect as much as it “should” have in the eyes of the Treasury Department.  This “what if the pandemic never existed” calculation is the basis of Treasury’s formula for determining how much recovery money could be used by states for general fund support.   To our knowledge there still has been no public disclosure by MMB of how this was calculated or when we are projected to have “caught up” in the eyes of Treasury.   As noted, we have set aside $550 million for the out-biennium general fund support which one might think could be in some jeopardy if the avalanche of cash continues to roll in as currently expected.

“We’ll fix it” — That was Governor Walz’s response to a question about the $1 billion of state unemployment trust fund debt.   Despite some attempts to portray the prioritization of this issue as another tax relief sop to “big corporations,” there seems to be general acceptance that this is a big deal and important issue for state employers of any type and size.  Based on the latest data we have seen, nine states have used federal recovery funds to completely eliminate their trust fund debt.  At least seven more states that didn’t need a federal loan in the first place have nevertheless directed federal resources into their trust funds to replenish their reserves.  In the spirit of using one time money for one time spending to address the economic aftereffects of COVID, this should be near or at the top of the list.

Real structural transformation demands more than just new spending programs – The surplus is being called a “generational opportunity” to make needed structural changes to the Minnesota economy to position the state for economic growth and success in the future.   Such structural changes are typically presented as new spending and investment.   For example, the recently released “Phase 1 Report” of the Governor’s Council on Economic Expansion charged with identifying ways to generate an “equitable, inclusive, sustainable, and resilient economy” contains $2.8 - $3.5 billion of new spending recommendations.   As important as some of these initiatives may be, it would be a mistake not to also view the surplus through a lens of opportunity to address the needs and reform the systems behind the spending.  This includes our tax system, our human capital system, and our pension system just to name a few.    Investments in how we do things are just as crucial to our long-term economic success as spending on what we do.