2020 Session at a Glance

Our look at a couple of the major tax and fiscal policy issues that will be occupying lawmakers attention this year.

What do you get when you cross a non-budget year with a $1.3 billion surplus, a split legislature with different legislative objectives, and a November when every legislative seat is up for grabs, all in the most surreal and contentious political environment imaginable?    The best answer is a lot of proposals that go nowhere except on campaign literature.     But there is work to be done and undoubtedly some things will get accomplished as the 2020 legislative session gets underway.

DFL House leadership and Republican Senate leadership have provided outlines of their priorities (“Minnesota Values” vs. “Vision 2020” respectively) absent much of the dollar-related detail that will only come after digesting the release of the February forecast.   Outside of commitment to a bonding bill there are not a lot of shared priorities.  For those policy topics where the circles do overlap, there are considerable differences of opinion on what exactly to do about them.  Moreover, with what’s at stake this November, how lawmakers are perceived and portrayed during the session is likely to be just as important to them as what they try to accomplish.    It’s the sign of an election year when one leader criticizes the other side’s “continuing lurch toward socialism” while the other decries efforts to “shortchange Minnesota on behalf of the wealthy, corporations, and insurance companies” even before the gavel to open the session comes down. 

2019 Clean Up

While everyone is eager to start tackling the budget surplus in their preferred ways, lawmakers have a couple of leftover issues arising out of the 2019 budget agreement they may wish to address.     Neither require action this session, but both have potential implications for how much money is available for supplemental spending and/or tax relief proposals.  

First and foremost is the approximately $500 million raid on the budget reserve last session.    There is no trigger to restore that sum.  It is possible that the statutorily required dedication of a forecasted surplus this November may refill some or all of the reserve.  But if lawmakers decide that replenishing budget insurance ought to take first priority over current demands this session, that alone would put a serious check on everyone’s ambitions.  

Second was the bump in June accelerated sales tax collections to 87.5%.  It raised $34 million to balance last year’s biennial budget and continues for FY 2021.  This bit of budgetary cosmetology and convenience can have noticeable cash flow implications for small businesses.  

Meanwhile in Washington, the December passage of the federal “Consolidated Appropriations Act“ contains the usual end-of-year federal extenders plus some retirement related tax changes which will throw Minnesota income tax out of whack with federal adjusted gross income. Whether the issues are pressing enough to enact a conformity bill in 2020 remains to be seen.

Tax Policy

Senate Republicans have predictably made relief the tax mantra of “Vision 2020” with two specific proposals mentioned most frequently.  The first is a full exemption of Social Security income from state income taxation (see accompanying article for our analysis and discussion of this proposal).   As we argue it reflects terrific politics and lousy tax policy – a perspective perhaps best validated by past republican legislative majorities and executive office holders who, despite being enthusiastic supporters of lower taxes all through the 1990s and 2000s, refrained from proposing Social Security exemptions.    

The second is conformity to Section 179 expensing – the “Charlie Brown’s football” of state tax policy.   Conformity to Section 179 had the distinction of being included in the Governor’s original tax proposal as well as the tax bills that passed the House and Senate during the regular session only to be dumped in the end.     This common ground was once again a casualty in the negotiations from other budget demands – perhaps because everyone pointed their figures at the other parties in the negotiations to use their money to pay for it.  The set-up this year is ideal to take care of this issue once and for all -- a sizeable surplus to address a front-loaded expense (for effective tax year 2020 about $195 million total for FY21 and FY22 declining to $58 million by FY 23) with no long-term tails.      

A compounding problem is the TCJA’s changes to like-kind exchanges which makes Section 179 conformity all the more important.   The prospect of having to paying state capital gains taxes on exchanges without the benefit of expensing new equipment is especially relevant to the beleaguered Minnesota farm economy who are letting their lawmakers know about it.   Still, skepticism seems justified that this year’s effort for full 179 conformity will end differently as once again there will be plenty of competing demands to use the money elsewhere.   Odds are better that a less costly “Ag 179” conformity proposal gets adopted which limits it only to farmers.      

On the DFL side, the “Minnesota Values” agenda offers little guidance or sense of what, if any, big tax policy priorities will be pursued in 2020.    House Tax Chair Paul Marquart has once again made Section 179 a priority but noted if the dollars are not available to do so, his focus would transition to accomplishing a like-kind exchange fix, which would come at a substantially lower cost.   Expect him to also reintroduce some taxpayer transparency and accountability initiatives which has been an interest for him since he took the committee gavel.

The DFL controlled House, however, is not immune to the siren call of providing senior tax relief.   A bill has already been introduced to prohibit property value increases on homeowners over 65 with incomes under $60,000, thereby shifting tax burden onto everyone else including lower income homeowners who do not have the good fortune of having most of their income already exempt from state taxation.     From a broader perspective, this bill is one of many creative property tax proposals that inevitably get introduced each session (on a bipartisan basis) to target more tax relief to very specific property owner situations and circumstances, subject to a morass of specific eligibility conditions.  All of this makes efficient, effective property tax administration a torture at best and impossible at worst.    Why we can’t just let the nation’s most generous and accessible income-tested property tax refund program do its job (along with the special refund program and the senior deferral program) is one of Minnesota’s great policy-making mysteries. 

The Bonding Battle

Some type of bonding bill seems assured given everyone’s strongly expressed commitment to getting one done.   The size of the bill has often been -- and again may be -- a sticking point.  The Governor is asking for $2.6 billion, the Republican held Senate has said the $1 billion neighborhood of recent years is more to their liking, while the DFL House has argued for as much as possible without jeopardizing the state’s credit ratings.     That number is more difficult to pin down, but the MMB’s debt capacity forecast offers some perspective on what that might be. The state employs three debt capacity guidelines:

  • Total tax supported principal outstanding shall be 3.25% or less of total state personal income
  • Total amount of principal (issues and authorized but unissued) for state general obligations, moral obligations, and equipment and real estate leases is less than 6% of total state personal income
  • 40% of general obligation debt shall be due within 5 years and 70% within ten years

Adherence to these guidelines places the maximum new debt authorizations for FY 20 at $3.5 billion.

It is reasonable to assume that these guidelines have been reviewed and “blessed” by the rating agencies, so there is little reason to question the wisdom of their use.   Interestingly, however, there are no specific guidelines regarding debt service to protect current spending from being crowded out by debt payments.    That may be considered unnecessary given the implications of the guidelines the state does use or, as Commissioner Frans has argued, such a guideline would reduce needed flexibility when a stimulus may be necessary.    But current state taxpayers have an additional consideration that rating agencies (in the business of selling debt) and buyers of debt (at the front of the line for payment) may care far less about: maintaining the level and quality of public services current taxpayers expect from government while keeping a check on the tax prices being paid for those services.

What should inform this decision making is a more complete perspective on long term state financial obligations.  That requires at least some recognition of the billions in “off the books” obligations from unfunded public pensions and related liabilities.   Several years ago, J.P. Morgan began presenting a more holistic look at state debt and the degree of state fiscal stress it creates.   They calculate state “IPOD ratios” – interest on all net direct debt, plus pension, OPEB (“other post employment benefit”) and defined contribution payments as a percentage of state own source revenues.  They then compare these to “revised IPOD ratios” – what states should be paying to meet these long-term obligations.[1]     The good news is that in their latest (November 2018) update, Minnesota has one of the lowest revised IPOD ratios in the nation.  The bad news is closing the gap between Minnesota’s actual and revised IPOD ratios solely through tax increases would require an additional 3% of state own source general fund revenues for thirty years ($631 million in 2017).[2]   Importantly, as the report notes, “if spending cuts were chosen instead of tax hikes, they would be similar in magnitude.”

That estimate is subject to several key assumptions, and from our review of the methodology it appears the Minnesota revised estimate is likely overstated.[3]   Plus, unfunded pension obligations are a qualitatively different kind of government debt for many reasons, not the least of which is that the state has returns from over $70 billion in invested assets to address the problem.   The primary point, however, remains.  Having $15.2 billion of unfunded liabilities based on the latest valuation reports -- 25% more than the state’s total existing debt obligations – it seems imprudent to simply ignore this issue especially given the inherent funding risks accompanying market volatility.  It took years to pass a modest pension repair bill because of the modest budget implications.   We went well over a decade failing to make our annual required contributions because we couldn’t “afford to” given other budget priorities.  There is plenty of recent evidence that demands for larger state pension aids and the need for larger employer contributions are no different from traditional debt service in demanding and competing for general fund resources.

For all the reasons mentioned earlier, it’s unlikely the 2020 legislative session will be looked back upon as a moment of great legislative productivity.   However, plotlines will begin to emerge following the release of the February forecast and the unveiling of the Governor’s self-described “small” supplementary budget sometime thereafter.  With this added context, there may be some opportunities for productive negotiations, hopefully without sacrificing fiscal responsibility for the sake of wooing voters.

 

[1] “The ARC and the Covenants 4.0: The State of the States, 2018, J.P. Morgan Private Bank

[2]  Based on 3% of all own source, non-dedicated general fund revenue collected in 2017:  MMB November 2017 Economic Forecast

[3]  J.P. Morgan uses an interest rate assumption on net direct debt of 5% which is substantially higher than what Minnesota pays, and there appears to be an error in the Minnesota discount rate used by J.P. Morgan for its calculations.   On the other hand, the methodology employs a 30-year amortization period for unfunded liabilities when the Government Finance Officers Association’s standards recommends an amortization period 15 years, not to exceed 20, to avoid intergeneration transfer of obligations.