COVID Economic and Process Update

Minnesota Management and Budget’s “April Revenue and Economic Update,” released last Friday, was the subject of a House Ways and Means “tele-hearing” this week.   State economist Dr. Kalambokidis discussed the update, while MMB Commissioner Frans offered perspective and responded to a number of member questions on the process going forward.   To anyone listening in, the takeaway message was uncertainty, and unprecedented amounts of it.  We are operating under IFR flight conditions -- zero visibility and our instrumentation is balky.   The evolution of the COVID storm is a question mark, filing delays and related administrative changes add to the murkiness, and economic outlooks are all over the map.  Meanwhile, we continue to wait for important guidance from air traffic control (a.k.a. the federal government) on how some key features of its trillions in relief will be implemented.

Because the revenue update covers February and March receipts and captures only the beginnings of the economic lockdown, the numbers belie the magnitude and seriousness of what’s to come.   General fund receipts were down $103 million (3.8 percent) from forecast.    Most of that could be attributed to net individual income tax receipts which were $101 million (9.0 percent) less than forecast.  However, MMB believes most of that shortfall was due to faster than expected income tax refund processing, not necessarily lower than expected tax year 2019 liability.   Income tax withholding payments were $5 million (0.3 percent) less than forecast – a number guaranteed to worsen.   The primary area where the pandemic’s impact can already be seen is in the sales tax.   Gross sales tax receipts for March were $51 million (12.1 percent) below the forecast, and MMB estimates that about $50 million of the shortfall is due to businesses identified in Executive Order 20-04 delaying their remittances originally due March 20.

Under the subheading “U.S. Economic Outlook Crumbles,” Minnesota’s macroeconomic consultant IHS Markit (IHS) offers perspective and foreshadowing about what’s in store:

• IHS is now forecasting a global recession and 5.4 percent contraction in real GDP in 2020 (compared to 2.3% real growth in 2019).  
• IHS characterizes the whopping $2 trillion-plus CARES Act as only a “modest stimulus that provides a small offset” to the effects of the suspension of economic activity.
• IHS expects the unemployment rate to reach a high of 10.3 percent in the fourth quarter of 2020 before gradually drifting back down to pre-COVID19 levels three years from now in 2023.
• IHS expects the federal funds rate to remain near zero until late 2025.
• IHS assigns only a 20% probability to a faster, “V-shaped” recovery but a 35% probability to a more pessimistic scenario, in which the COVID-19 outbreak causes a deeper recession, with even greater impacts on production, employment and income.
• And IHS may be the optimists in the room.   IHS forecasts 6.3 percent GDP growth in 2021 while the “Blue Chip Consensus” -- the median of 50 business and academic forecasts -- calls for only 3.8 percent growth in 2021.   

Process guiding the next four weeks

Ways and Means committee members had several questions for Commissioner Frans on process and procedures in light of this information and the session’s increasingly compressed timeframe.  

• There will not be an updated economic forecast.  The timeframe is too constrained to employ the modeling that goes into an official forecast and the extreme volatility and unavailability of some important model inputs compounds the problem.   Instead, a new “interim budget projection” will be put together for the current biennium only.   More data and clarity on the federal response is expected to be available in the coming weeks allowing this interim budget projection to be available in early May, including a determination on whether we have flipped from surplus to deficit. 
• The interim budget projection will serve as a replacement of sorts for the February forecast and be the basis for bringing the 2020 session to closure.  (The State Economist warns because the IHS forecast will be a month old and there is no 2019 income tax baseline to work from given filing delays, we should not expect this to have the robustness of a normal forecast.)  Nevertheless, if it flips us from surplus to deficit, policymakers will have a couple of weeks to figure out what to do before the adjournment date.  If that doesn't happen, we will either need a special session or the Governor and MMB Commissioner could decide to use the authority provided in Minnesota statutes to first use the budget reserve and, then, if necessary, make unallotments.   However, Commissioner Frans emphasized the importance of an “ongoing dialogue” among policy makers as decisions need to be made.  Summer and fall “check-ins” will be necessary perhaps triggering the need for one or more special sessions as new information warrants and developments occur.
• It’s not just the general fund; state dedicated funds need to be balanced and are being looked at closely.     Many of these funds are heavily reliant on sales tax and related revenues which are poised to experience collection declines far exceeding Great Recession levels.

A couple comments and reactions

Mark May 13 on your calendar – If we understand the statute correctly, the Governor’s declaration of a peacetime emergency lasts for 30-day increments at which time the power shifts to the legislature giving them the ability to vote to end it.  Given that 1) there is already some significant grumbling among republicans about the executive orders being implemented under these powers; 2) this vote must take place while the legislature is in session; 3) the second 30-day period expires 5 days before the constitutionally required end of session; and 4) there seems to be general agreement that the applicable Minnesota statute regarding this is poorly drafted and ambiguous about extensions and terminations, there seems to be an opportunity for some political fireworks around this time.  

The possible return of a reliable, albeit derided, budgeting tool -- Should we flip from surplus to deficit one of the least painful mechanisms to help us get us through FY 21 would be to reopen the package of state accounting shifts – including education payments.    They are the scorn of editorial pages, the subject of indignant floor speeches, and historically perhaps the most routinely shot arrow from the state's deficit-reducing quiver.

More selective federal conformity --  Thanks to the federal CARES Act, tax conformity questions are back in the spotlight with significant budget, administrative, and political implications.   For example, the Act includes a provision that excludes any loan forgiveness under the “Payroll Protection Plan” from taxable income.  If we don’t act, the loan forgiveness would be included in adjusted gross income under “pre-CARES” internal revenue code and be taxable in Minnesota.  Since there would be no loss of existing revenue, conformity here may not be contentious.  It’s a different story for other provisions.   Conforming to federal noncorporate loss provisions and net operating loss changes in the CARES act would likely come with big state price tags.   Not conforming would make dealing with state budget problems easier but in the words of one tax expert “royally complicate” Minnesota’s tax system.

Some kind of tax bill would appear to be prudent.   Even before the pandemic struck, Minnesota was facing some other conformity matters arising out of federal action pertaining to retirement related-tax changes.   And of course there is the long-standing issue of full conformity to Section 179 which suddenly morphed into a much more serious problem for Minnesota farmers and small businesses post-TCJA due to the like-kind exchange issue.   But the inherent tension between providing needed relief to businesses in these chaotic times and the budget implications in these chaotic times is certain to make any tax bill controversial.