February Forecast: Whatever Goes Up Must Come Down…But Not Yet

“Seinfeld” and “The Simpsons” premier.  The Berlin Wall comes down.  Pete Rose is banned from baseball.  The year is 1989 and Minnesota’s fiscal year general fund budget is $9.1 billion – less than the $9.25 billion surplus reported this week by MMB in their February forecast release.  Factoring in federal fiscal recovery funds to be spent in the remaining 16 months of this biennium, $10.4 billion of resources are available for lawmakers.

MMB kept their current streak of prodigiously positive forecast upgrades going yesterday adding yet another $1.5 billion to November’s $7.75 surplus ($1.25 billion from additional revenue; $250 million from reduced forecasted expenditures).  Individual income, corporate income, general sales, and collectively all other state revenue sources are all appreciably above November forecast estimates.  There is now upwards of $4 billion “in the bank.” 

The planning horizon forecast continues to anticipate mostly sunny skies with FY 24-25’s structural balance (revenues over expenditures) inching higher to $6.3 billion.  Current planning estimate inflation for the out-biennium represents the fiscal equivalent of a passing shower.  Its “formal” incorporation into the expenditure estimates would still leave a positive structural balance of over $5 billion. 

The dollar totals continue to go up but so do the number of forecast caveats.  State Economist Kalambokidis emphasized none of the events in Ukraine are factored into the analysis.   That adds yet another complicated set of economic considerations and relationships on top of the standard list of risks accompanying these forecasts and the continuing uncertainties surrounding COVID recovery.

In the principals’ response to the forecast, we got a little bit more clarity on negotiating positions as they stand right now.  In his press conference, the Governor emphasized the significant “space for compromise” and the ability to do some of everything on both sides of the ledger.  In addition to pushing for a quid pro quo deal of UI trust fund replenishment combined with frontline worker pay, the Governor also cracked the door open on the possibility of income tax rate cuts.  However, he insisted such cuts could not expose the state budget and their benefits could not accrue to high income earners (presumably done through some offsetting bracket changes to neutralize any changes to the bottom tier).   He also suggested his proposed tax rebates could be tripled.    

In contrast, Republican leadership focused on a single idea in their response, and hit it hard  -- uttering the phrase “permanent / ongoing tax relief” 23 times in 20 minutes behind the podium.  Based on the supportive out-biennium forecast, leadership argued there is a need and ability to stop overcollecting while appearing uninterested, at this time, of any rebates or related one time relief ideas in concert with rate cuts.  Unsurprisingly DFL leadership largely echoed the Governor’s call for targeted spending and tax relief, although seeming to us a bit more lukewarm to rebate checks.  

Some Odds and Ends

Quid Pro Quo – Two of the biggest stated priorities for lawmakers are also two of the most expensive: UI trust fund restoration and frontline worker bonus payments.   The former has passed the Senate on a bipartisan 55-11 vote; the latter in the House on a 71-61 vote.   Prior to the updated forecast, together they would have consumed about $3.7 billion or 41.5% of all available ARPA and surplus funds.   By making $1.5 billion more available, the opportunity cost of a “quid pro quo deal” on the rest of everyone’s agenda is now lower.   Whether that’s enough to break the stalemate remains to be seen.   With a March 15 tax implementation date looming, these issues may be a canary in the legislative coal mine for how the rest of the session plays out.

Current Inflation – For all the attention, concern, and ink devoted to how to responsibly recognize the existence of inflation 16 to 40 months in the future, there seems to us to be a lack of discussion and curiosity about the impact the highest rate of inflation in forty years is having right now on our current biennium budget and government operations.    Today’s high inflation is not included in our current biennium spending projections because the forecast is based on current law and appropriations have been set.   The effect might be relatively minor since a lot of the big ticket purchases, like employee and other contracts, have been settled.   But the state will continue to buy commodities, goods, and services for the remaining 16 months of the biennium.  A better understanding of if, and to what extent, this may impact government budgets and service delivery in the near term would seem to be a good thing.   Especially since we are supposed to be putting together, at least theoretically, a supplementary budget.

Tax Relief “Leakage” --  A new DFL proposal for a $207 million summer gas tax holiday has a whiff of political expediency, if not anxiety, surrounding it.  It’s dubious tax policy for many reasons, including the fact that on the margin, cheaper gas will make people drive more pushing up prices.  But the incidence of the proposed gas tax holiday is worth considering since not all of the tax benefit is guaranteed to wind up in the pocketbooks of drivers.   The “final resting place” of a gas tax cut would get shared between the two sides of the market and whichever side is more responsive to price will get less of the tax cut.   How that would precisely play out in the Minnesota market this summer is unknowable, and is currently a subject of debate among national economists given a similar proposal at the federal government level.  One research study examined the temporary suspension, and subsequent reinstatement, of a gasoline tax in Illinois and Indiana following a price spike around the turn of the century.  Researchers concluded only 70% of the tax suspension was passed on to consumers in the form of lower prices (and most of the eventual reinstatement of the tax was passed on to consumers).  Moral: in tax policy matters, things are always a little more nuanced and complicated than they superficially may seem.

Rates Alone Don’t Tell the Whole Story.   Senate Republicans’ proposal to cut the first-tier income tax rate to 2.8% is frequently accompanied by the observation that our lowest tax bracket (5.35%) is higher than the highest tax bracket in many other states.   That’s certainly true insofar as it goes.  It is also true that Minnesota is one of only 9 states that conforms to the federal government’s large standard deduction ($12,900 for single, $25,800 for couple) and one of only four states that tacks on a dependent personal exemption ($4,450) to adjust for family size in addition to the federal standard deduction.   Most states have substantially lower standard deductions and personal exemptions – if they have them at all.  That’s why, as reported in our most recent multi-state income tax study (tax year 2018), Minnesota’s income tax burden for married joint filers – even at the $100,000 income level – was still lower than Alabama, Illinois, Ohio, Pennsylvania, and Utah -- all states with a top marginal rate below our first-tier rate.  (Brackets and other structural features, of course, matter too.  See “moral” above.)