The 2022 Session: Uncertainty in a Time of Abundance

In the aftermath of the stunning November economic forecast, the focus now turns to what to do with all that money.  When the 2022 session begins at the end of January, lawmakers will be dealing with a fiscal situation rivaling one of, if not the most, momentous and consequential budgeting environments in state history.  In the February 1999 forecast, at the apex of the multi-year tech boom, the general fund available balance amounted to 15.6% of projected biennial spending.^[1]  Today it’s 14.9% (17.0% including unallocated federal cash).  

Respectable surpluses in the “off budget year” aren’t unusual for the state.  One has to go back to 2009 and the Great Recession to find a November economic forecast in an odd-numbered year that didn’t convey a sizable surplus for supplemental biennial budget decision-making purposes.  The difference in 2021 is three-fold. 

First is the magnitude of the surplus.  In the previous five odd-year November forecasts, the current biennium surplus was remarkably consistent ranging from a low of $880 million to a high of $1.65 billion.  The estimate for the current biennium is over 6 times the average of that 10-year span.  And unlike previous years in which a lot of surplus was rooted in yet-to-be realized expectations for the remainder of the biennium, today $3.2 billion is already “in the bank.”   

Second is the no less eye-catching out-biennium planning estimate.  The last five odd-year November forecasts projected either negative structural balances for the out-biennium or modest positive balances that were mostly or completely offset when factoring in inflation.   These estimates functioned as a cold shower on any new tax cuts or spending plans with big tails.  The latest planning estimate projects a $4.8 billion positive structural balance for FY 24-25 -- even after subtracting over $1 billion in inflationary pressures.    

Finally, on top of all this is the additional $1.1 billion in federal recovery dollars available to be spent in 2022.  And thanks to Treasury’s accommodating determination of how a state revenue system’s return to normal in the aftermath of COVID is measured, this one-time money is available for general operations spending.  

Put it all together, the wherewithal and temptation both exist to pursue far bigger tax relief and spending ambitions than what would be expected in a typical supplemental budget year.   However, these interests face the realities of a polarized and divided legislature, election year and redistricting distractions, fragmented caucuses, federal spending coordination and complications, the compressed timeframes of short session, and inevitable efforts to leverage policy issues into tax and fiscal decision-making.   Available resources are just one piece of a hugely complicated legislative jigsaw puzzle.  A few of questions we are asking ourselves heading into 2022:

Will tax relief happen?

Given the numbers, it might be election year malpractice for lawmakers in both parties not to advocate for some type of tax relief.  The runway appears clear as the state’s relentlessly positive tax collection variances likely eliminates the danger of failing the federal government’s “organic growth” requirement that could trigger a clawback of fiscal recovery funds.  But as we saw in the failed attempt to give frontline worker bonuses at zero cost to the state, details and politics can thwart even the most publicly popular proposals. 

DFL leadership has gone on record that ongoing tax reductions will not be a part of any compromise in this short session.^[2]  Taking this at face value, it indicates the universe of tax relief possibilities in 2022 will be limited to temporary relief for the current biennium propelling some form of tax rebate to the top of the possibilities list.  A rebate offers both policy and political advantages.  As one-time spending from revenue already collected, it reduces fiscal risk, and the size of the rebate itself can be scaled accordingly for the same purpose.  It would also be the broadest and most inclusive “give back” mechanism with the ability to benefit both parties’ constituencies simultaneously.  

Minnesota could draw on its turn-of-the-century experience with sales tax rebates (a.k.a “Jesse checks”) which taxpayers received for three straight years.  These rebates were based on mimicking the estimated sales tax burdens paid by Minnesotans based on the individual's amount of income – a methodology blessed by the IRS at that time employing the Department of Revenue’s incidence database.  Because the sales tax is a mildly regressive tax, sales tax rebates would be mildly progressive smoothing over omnipresent fairness arguments and political disagreements over making a rebate on an already highly progressive income tax also progressive.  (It’s worth noting the primary reason for employing a sales tax rebate around the turn of the century was to avoid having the rebate subject to federal tax.  Now with the SALT cap, federal taxability is a negligible consideration.)

However, Minnesota has a history of bipartisan skepticism toward one-time tax rebates.  In 2006 Governor Pawlenty rejected the idea arguing “we should do real tax relief, like permanent tax relief for low-income or middle-income people,” but also adding “we'd be also well-served by using some or all of that money on some of our other priorities like reforming education."^[3]  In 2015, Governor Dayton rejected the idea arguing one-time rebate checks were not a responsible way to manage government and was dismissive of the size of the benefit equating the projected $240 per family average rebate at that time with what is spent on several weekends of takeout food.^[4]  And most recently in 2018, then Senate Majority Leader Gazelka, also balked at the concept questioning the bang for the buck gained from the “Jesse check” experience, arguing the money should be used to repair roads and bridges.^[5]

Objections to rebates based on a lack of “bang for the buck” and meaningful relief is interesting given how relatively little attention these issues often receive in other tax relief proposals and how relatively little benefit they can confer on taxpayers.   The prospects of an average $240 rebate from a few years ago may not have kept up with household pizza demand but it is over twice the $8.50 per month average tax relief generated by the 2019 2^nd tier rate cut and ten times the $2 per month average relief generated from the 2019 Social Security subtraction change.^[6]  

Having a surplus many multiple times larger than anything recent history has offered might change opinions about a rebate’s practicality and merit.  But as these lawmaker comments in the past indicate, hesitancy toward rebates is also influenced by an interest in keeping options open and powder dry for other and bigger ambitions.   For Republicans it’s providing bigger and more permanent tax relief, preventing non-general fund tax increases by directing existing general fund support to non-general fund spending, and perhaps using available revenue as leverage for implementing spending reforms.  For the DFL, it’s the pursuit of new social program and other spending.  Or, in the words of a sales tax rebate critic from the turn of the century now being echoed almost verbatim today – “not lose out on a great opportunity to collectively create the future of our state.”^[7]  Rebates have a “go big or go home” quality to them — a lot of money is needed to provide a noticeable benefit to very large numbers of taxpayers.   As a result, both parties may prefer to let more of the surplus “ride” in anticipation of gaining leverage for their respective agendas in 2023.

Other tax proposals paid for by one-time money will likely get airtime.   Such proposals come in two flavors: “voter pleasing” and “politically unsatisfying.”  The former are highly targeted tax relief efforts favoring specific types of taxpayers, taxpayer circumstances, or taxpayer actions.  This has been a staple of Minnesota tax relief thinking for a very long time. In 2022 a lot of this interest is likely to be directed toward property taxpayers.  Recent Truth in Taxation statements sent shockwaves to many homeowners due to rising home values (especially among homeowners in metro area cities often least able to afford big property tax increases) combined with pandemic-influenced commercial valuation declines and sizable local levy increases.   Bills for temporary enhancements of the state’s circuit breaker and special refund programs along with more complicated proposals like additional state levy buydowns would seem rather likely.  Another popular target is likely to be seniors.   Full exemption of Social Security income would have significant tail impacts beyond the current biennium which the DFL has declared (at least at this time) a non-starter.  But the pressure to do something to benefit this influential voting bloc will be significant.

The other category includes items that are really more about clean up than tax relief per se, but do offer administrative and timing benefits for taxpayers that are affected by them.   This would include:

• Cleaning up remaining temporary and partial federal COVID response conformity items
• Immediately allowing deduction of the disallowed amounts of section 179 allowances for tax years before full conformity applied – say in equal amounts in tax years 2022 or/and 2023
• Increasing the percentage of bonus depreciation allowed in the year the property is placed in service and allowing faster deduction of previously disallowed amounts

These changes would have one-time effects and would free up resources and provide budget flexibility in the future.  But their adoption also means less money on the table for 2023.   Moreover, they offer little or no political appeal for either party.  Republicans and their constituencies will not consider them as real tax cuts, and Democrats won’t want to do them because they do not advance their policy agenda in any way. 

In short, whether and to what extent tax relief actually materializes in 2022 is a function of much more than the size of the surplus.  Even though expectations are likely elevated, we would not be particularly surprised if the primary tax-related deliverable of the 2022 session was political signaling for the November elections and the 2023 session rather than actual relief.

How will unemployment insurance tax increases be dealt with?

Ironically, in the context of a large surplus, one of the 2022 session’s lightning rod issues is an impending tax increase.  Over the course of the pandemic, Minnesota borrowed over $1 billion from the federal government to cover its share of unemployment insurance payments.   This spring the bill is coming due.  Unemployment insurance tax hikes on Minnesota employers of all sizes and types were already going up to restore trust fund reserves depleted during the pandemic.  They will go up even more if they need to pay back the federal loans and the interest being charged by the federal government.

The size of the potential hit on employers can vary significantly based on their experience rating (the less unemployment that an employer's workers have experienced, the lower the organization’s experience rating is) and the compensation levels of employees.  But an employer with an average experience rating with an employee base earning $38,000 or more could see a tax increase of more than 40% or around $400 per employee in 2022.

Minnesota is not alone facing this situation.  Many states around the country have chosen to use federal COVID support funds to pay back the federal government.  According to the latest information we have seen, nine states have used federal American Rescue Plan funds to completely eliminate their trust fund debt.  At least seven other states that didn’t need a federal loan in the first place have nevertheless directed federal recovery resources into their trust funds to replenish their reserves.  In addition, at least 23 states used previously provided federal CARES Act money to pay out unemployment claims or otherwise replenish their trust funds.  In the cause of using one time money for one time spending to address the economic aftereffects of COVID, many states have made restoration of their UI trust funds a top priority.

When asked about this issue at his news conference following the release of the November forecast, Governor Walz replied “we’ll fix it.”  But the clock is ticking as first payments with the new tax rates are due at the end of March, giving lawmakers about two months to implement a fix.  And the lack of any sense of urgency to date, or detail of what such a fix should/might entail, coming from the DFL suggests this may become one of those high priority, highly sensitive policy issues that will be used for maximum leverage in end of session budget negotiations.   

Such was the case last year in dealing with federal conformity to the Paycheck Protection Act in the 2021 session.  One could have tied Paycheck Protection Act conformity to a chair, blindfolded it, and snapped a picture of it holding the daily newspaper and it couldn’t have looked more like a hostage.  But there is a fundamental difference in using the threat of unemployment tax rate increases as negotiation leverage.  This year’s hostage would be most of Minnesota’s employment base rather than a relatively small subset of it.  And the issue is a significant tax increase, regardless of an employer’s profitability or ability to pay, in a critical period of economic recovery, not a special tax break on positive taxable income earned during a pandemic.  

We might see a classically Minnesotan effort to segregate employers by “deserving” and “undeserving” of protection from these tax increases based on employment size or some other crude assessment, but adding administrative complexity and cost to a fix in the process.  However this may get resolved, a failure to act and act promptly strikes us as a high risk, low reward proposition with respect to the state’s economic interest -- especially given all the resources available.

How supplemental will supplemental budget proposals be?

It’s tough to get a fix on how lawmakers are thinking about the 2022 session.  On the one hand, leadership on both sides have said the right things about waiting until the state’s February economic forecast is released to obtain more information on the state’s finances and pandemic developments before making decisions regarding the surplus.  On the other hand, lawmakers are already offering some very big ideas with price tags that extend far beyond the current biennium.  For example, as already mentioned, among Republicans there is clear interest in exempting all Social Security income from taxation (that’s about $1.1 billion in tails for the 24-25 biennium).  Meanwhile the recently released “Phase 1 Report” of the Governor’s Council on Economic Expansion contains $2.8 - $3.5 billion of new spending recommendations.  That’s just “Phase 1” -- a second set of recommendations is due next summer.

All parties could compromise on a package of one-time spending and tax relief consistent with the idea of 2022 being a “bonding session” accompanied by some mid-biennium budget adjustments to address current needs and conditions.  Constraining such actions just to the resources already banked still offers about $4.2 billion for “adjustments” which is a lot even in a COVID-inflicted economy.  That’s one of the reasons why the idea of doing some cash bonding has already gotten some discussion.  Tack on the additional $4.5 billion in forecasted gain this biennium and factoring in another $4.5 billion of projected positive structural balance in the out-biennium and it’s easy to see why lawmakers’ minds are drifting toward much bigger, bolder, and more permanent proposals. 

The release of the Governor’s supplemental budget and the legislature’s response to it may tell us a lot about whether the 2022 session ends with bang or a whimper.  If it reflects traditional off year supplemental budget proposals with minimal tails, then an avenue for compromise seems possible even if the initiatives and the accompanying dollar figures are bigger than normal.  But the more it encompasses “golden opportunities” as the Governor has described longer-term spending and investment interests, the more likely the session ends with a thud.  In the same way DFL leadership has stated ongoing tax reductions are off the table in 2022, Republicans are almost certainly inclined to treat permanent spending increases the same way.    

Regardless of how the 2022 session evolves, one thing we are certain of: big surpluses in a time of divided government create risks as well as opportunities.  On the basis of that 1999 February forecast lawmakers enacted the first sales tax rebates and reduced income tax rates while increasing biennial general fund spending by 14.1% (on top of the average 14.5% biennium spending growth rate that occurred over the three biennia before that).  As a long-time member steeped in Capitol experience told us, the circumstances we face today are tailor-made for “unholy compromises that throw caution to the wind and commit to do unsustainable amounts of both priorities.”