A Flip to “Plenty” Still Comes With Plenty of Budget-Creating Challenges

Last November at our annual meeting, MMB Commissioner Schowalter remarked that the uncertainty and hazards of budget planning in such a volatile economic environment reminded him of the old television commercial in which a diamond was cut in the back seat of a moving car.  Fast forward to the ongoing 2021 session  a different vintage commercial comes to mind.  It’s a Covid recovery budget!   It’s a biennial operating budget!   It’s two, two, two budgets in one!   Although our fiscal situation has improved dramatically, this “dual-purpose” budgeting task supported by an avalanche of additional federal cash is unlikely to make budget decision-making easier, and it may make reaching an agreement more difficult.

Things got better in a hurry for lawmakers with the February forecast which set a rather familiar biennial budget-making context.  The $1.57 billion of available resources/surplus for FY 22-23 is in line with what was available in 2017 ($1.65 billion) and 2015 ($1.87 billion), and even larger than the $1.05 billion that existed in 2019 to assemble our current budget.   That’s where the comparison ends thanks to the continuing demands of COVID recovery and Minnesota’s share of the $1.9 trillion American Rescue Plan.

The table below from the Committee for a Responsible Federal Budget (CRFB) breaks down federal aid distribution from the House version of the plan.   The final version kept the overall size of package largely intact but adjusted some of these line item totals and also tweaked language including putting some additional guardrails and conditions on spending – for example, barring cities and states from using the aid to pay down pension costs.

According to the latest information we’ve seen, Minnesota is targeted to receive $4.722 billion:

• $2.597 billion to state government,
• $595 million to metro cities,
• $1.109 billion to counties.  
• $420 million to other local governments

For first time the $2.6 billion to state government can be used  “for the provision of government services to the extent of the reduction in revenue due to the COVID–19 public health emergency relative to revenues collected in the most recent full fiscal year of the State.”  While backfilling state revenue losses has been a highly sought after feature by state and local governments for this round of aid, this language confuses us. Using our most recent full fiscal year as a revenue baseline against which subsequent revenue reductions would be measured means revenues collected from July, 2019 through June, 2020 which includes the worst of the pandemic's impact.   

In addition, the National Education Association estimates Minnesota will get nearly $1.392 billion for E-12 education and $594 million for higher education.  Put it all together, it’s a total recovery aid and grant package for Minnesota state and local government of around $6.7 billion.   To put that in perspective, an additional $6.7 billion is 77% of the state-level $8.7 billion in grant funding Minnesota received from the five previous federal COVID-relief acts combined.   

Many have questioned the magnitude of this round of state and local government support in the act.   A recent article reported the state aid in the American Rescue Plan Act is 116 times states’ revenue losses and argued, “increasingly, federal proposals to provide a cash infusion for state and local governments has become a solution in search of a problem.”  That analysis is a bit misleading as states have been fiscally impacted not just by actual revenue declines but also by lost revenue growth from the pandemic economy which was used to assemble state budgets.   For example, this analysis reports Minnesota’s year-on-year calendar revenue collections from 2019 to 2020 declined by $472 million.   But MMB reports a revenue shortfall compared to forecast about 2.5 times larger for the current biennium.    Nevertheless, as the Rescue Act detail shows, there is no question governments are poised to receive a lot of one-time money to support government spending needs and interests that exist with -- and without -- a pandemic.

Mixing one time money and spending associated with COVID recovery with a two-year operating budget introduces complex budget considerations and calculations with a lot of moving parts.  We got a small taste of this in assembling a very modest supplemental budget last year.   Now with something on the order of $50 billion of General Fund spending in play and billions more of federal assistance on the way, the complexity grows proportionately.   It’s safe to say our political and budgeting systems will be mightily taxed figuring all this out.   Some issues facing legislators:

• Timing -- Ideally lawmakers would be able hold back on spending and investment decisions until federal support shakes out.   But even though the Act will be signed by the President imminently, Minnesota decision-making may be affected by having to wait on additional federal guidance and interpretations on language pertaining to permissible uses, maintenance of effort requirements, and related matters.   The timeline for obtaining this needed clarity and understanding may clash with our constitutional deadline.   In addition, the varying amounts of time that federal resources remain available across all the Act’s numerous provisions adds another decision-making consideration.   It may be one-time money, but in some cases it’s one-time money whose availability extends beyond our forthcoming biennium.  For example, the $195 billion under the State Fiscal Recovery Fund remains available through December 31, 2024.
• Fungibility – Federal support is clearly intended for COVID-related spending and recovery purposes but there can be substantial overlap between spending done to support these outcomes and spending done as a matter of general government operations.   In last year’s relief bills, states were able to reduce their own contributions in areas like to education, highways, and mass transit while maintaining current funding levels due to the federal infusion.  States have every incentive to use every dollar being made available to them, and that may include augmenting or replacing general fund support to free up spending on other priorities.    Optimizing this within the federal government’s requirements with a recognition of the one-time nature of the money will require taking strategic thinking and budget engineering by lawmakers and agency officials to another level.  
• Equity – This year’s hot button issue appears ready to become a Defcon 1 political topic as the distributional formulas of federal aid are poised to create some head-turning discrepancies across Minnesota.   Nowhere is the potential greater than in E-12 education.    Federal education support for COVID has been and continues to be allocated through formulas (Title 1A) that are based primarily on census poverty estimates.  This can result in huge differences in per-student allocations across districts.  For example, in Michigan across the three federal Covid aid packages supporting schools, the median district receives $3,400 per pupil; 100 districts receive less than $1,000 per pupil; and Flint receives $42,000 per pupil ($158 million total) –which is more than two times the district’s annual budget.  Moreover, there are few restrictions on programming these dollars (one permitted use under the Rescue Act is “other activities that are necessary to maintain the operation of and continuity of services in local educational agencies and continuing to employ existing staff of the local educational agency”).  Minnesota will need to step in to ensure some semblance of horizontal equity.  But how to do that and how those adjustments ripple through the rest of the state’s complicated education finance system is sure to keep lawmakers busy.

All these issues are layered on top of the “regular” political challenges and disagreements revolving around state budget development including the role of the legislature in assuming more direct control over the use of funds and total levels of taxes and spending.  The Rescue Act even complicates this most basic and fundamental budget debate with this provision regarding tax cuts that has already gotten legislators' attention:

A State or territory shall not use the funds provided under this section ... to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.

As the Tax Foundation highlights, this language about indirect funding of tax relief raises questions of what kind of control the state would have over its own tax system over the next few years.

The federal government’s support has been and continues to be vital to the health and economic recovery of the state, but the fiscal entanglements are likely to impose additional burdens on a timely and successful closure to the session.   Money can’t buy happiness, and it's doubtful it can buy a smooth end to the 2021 session either.