A Closer Look: The Governor’s 2023 Budget Proposal

The curtain really rises on legislative sessions when the governor presents his biennial budget proposal, and what an overture for 2023 it is. Combining the largest biennial spending increase in state history with the largest package (in dollars) of tax relief/rebate proposals in state history isn’t normal budgeting practice, but that’s what $17.6 billion in available resources can do. Governor Walz’s $65.2 billion FY24-25 budget proposal offers some expected, but nevertheless startling, numbers: 

• It is a $13.4 billion (25.9%) biennium-on-biennium increase over the current FY 2022-23 base and an $11.2 billion spending increase over the currently forecasted FY24-25 base.
   
• The budget proposal consists of about 600 new or expanded agency services/initiatives/programs which includes supports for schools, local government, and nonprofit programming. Approximately $2.9 billion of the $11.2 billion is one time spending.
   
• For some perspective on the split between paying for existing services versus paying for new/expanded programming, $664 million of the $11.2 billion (6%) is budgeted for maintaining current levels of agency services. That number, however, is understated to some extent because it does not include some of the one-time $2.9 billion spending on necessary capital improvements and upgrades in software, cybersecurity and related agency infrastructure to deliver current services.
   
• When comparing the FY 23 estimate of full-time equivalents (FTE) in executive branch agencies with the FY 25 Governor’s FTE recommendations for those agencies – as found in the expenditure overviews accompanying budget change submissions – the proposed budget pays for 3,045 new state government full time equivalent employees over the next two years.
   
• The budget creates $8.7 billion of spending tails in the FY 26-27 biennium. If the impact of the Governor’s budget is added to the November Forecast, the forecasted structural balance (projected revenues minus projected spending) for FY 26-27 is a $1.23 billion deficit. Adding inflation into the expenditure line item increases the structural balance deficit to $4.26 billion.  

 On the tax side, the Governor’s interest in rebates remains unabated. The one-time sum of $1000 for singles under $75,000 and $2,000 for married joint filers under $150,000 comes with a cost to the General Fund of $3.9 billion. Interestingly, there is no phaseout of the rebate checks resulting in the mother of all cliff effects. Various tax credits provide most of the other tax relief in his budget and focus primarily on households with children: the new child tax credit, expanded dependent care credit, and a more accessible K-12 education — all refundable — together have a $1.68 billion impact in FY 24-25 increasing to $1.77 billion in FY26-27.  

The Governor remains opposed to full exclusion of Social Security income, choosing instead to support an expanded partial exclusion. A new sales tax exemption for construction purchases made by local governments and non-profits costs the general fund an additional quarter of a billion dollars. Curiously, this exemption only lasts for two years. That may be in recognition of fiscal risks and low margin for forecast error accompanying this ambitious budget, especially in the out years.  

Such a recognition also helps explain the inclusion of a few proposed tax increases in a decision-making world in which nearly $18 billion in available resources exists. The centerpiece is a 1.5% surtax on capital gains and dividend income between $500,000 and $1,000,000 jumping to 4% for income over $1,000,000. Reluctance to tap into the general fund for transportation funding support underlies a proposed 1/8 cent increase in the metro area sales tax for transit support and a motor vehicle tab increase ($153 million and $286 million in FY 24-25 respectively). Including the new tax regime on legalized cannabis and conformity to federal NOL caps, projected general and non-general fund tax increases total $1.14 billion in FY24-25, increasing to $2.5 billion in FY 26-27 when a new payroll tax to support a state-run paid family and medical leave insurance program kicks in.  

Governor Walz has described his proposal as a transformational budget, but with respect to tax policy it really reflects the culmination of a trend that has been building for years – the use of the tax code as the preferred means to deliver social policy. Tax credits exist on the Venn diagram of tax policy in the shrunken area where the Republican and Democrat circles actually overlap. Republicans like them because, in spite of their preference for lower taxes, their constituents still want government to do things. Indirect “spending” through the tax code is the way to accomplish these legislative goals while appearing true to tax cutting principles. Democrats like them because they can incentivize all sorts of societal outcomes and redistributive behaviors in a highly targeted way – and sell them to Republicans as tax cuts.  

Tax credits do not make government smaller but do exacerbate existing pressures on the state fiscal system. The credits still have to be financed. In the Governor’s budget, $1.74 billion in FY23-24 in resources will need to be used to provide the spending for these targeted refundable credits - a sum that will grow in the future.  When massive surpluses don’t exist, those resources will still have to come from somewhere, creating significant competition for general fund appropriations in the process – including spending programs that address progressive spending interests.