So Much for “Supplemental”

In an off-budget year featuring a massive surplus and a generous, accommodating federal government, neither side is holding back.

When Representative Davids held the House tax chair gavel, omnibus tax bills were occasionally branded with a reference to a popular song that described the political situation.  With respect to the 2022 session and the disposition of the surplus, right now it's difficult to get a sense of where on the musical spectrum we will end up.  Will it be Dave Mason’s melancholy plea “So let’s leave it alone. Cause we can't see eye to eye” or Prince’s call to “Party Like It’s 1999?”

Prince’s lyrics could be especially apropos because not since 1999 have lawmakers been fiscally able and tempted to embark on a similar indulgence of both tax relief and new spending.  Big money attracts big ideas, and an off-budget year is not stopping both parties from offering major tax and spending proposals with the potential to dramatically alter the state’s fiscal landscape for years to come. 

It starts with the $7.75 billion forecasted surplus now accompanied by hints from legislators that this number will go even higher in the February forecast.  Even though macroeconomic forecasts have been slightly tempered, we have learned the hard way that when casual comments like this dribble out, they are often foreshadowing something real.  On top of that is the $1.15 billion in one-time unallocated state fiscal recovery funds to spend this session.   MMB has stated ARPA funds are not included in the budget forecast but that is a bit of an overstatement. Lawmakers appropriated $663.1 million in ARPA funds last year to general fund revenue replacement in FY 22-23 which does flow through the budget forecast.  (Similarly, the $550 million in ARPA funds appropriated last year for FY 24-25 general fund revenue replacement flow through the out-biennium planning estimate, although there is nothing preventing the legislature from reversing that if $8.9 billion is somehow deemed not enough for current decision-making purposes.) 

All Spending as Pandemic Spending

If Minnesota needs additional ideas and ways to spend the remaining roughly $2.36 billion in remaining federal Fiscal Recovery Funds, the Treasury Department’s now issued final rules are there to assist.   Last year’s interim guidance had enough ambiguity to warrant some conservatism in how funds would be deployed lest appropriations would trigger some after-the-fact conflict with final guidance.  All such concerns can pretty much be set aside as the final rules “provide broader flexibility,” or in other words, significantly expands permissible uses of funds and broadens eligibility in the four expenditure categories of the act.  Some features of the Treasury Department’s final rules:

  • Expands the set of households and entities meeting the conditions of “impacted” or “disproportionately impacted.”
  • Broadens eligible uses in affordable housing, childcare, early learning services and certain community development and neighborhood revitalization activities for impacted communities.
  • Allows use of funds to expand government employment above pre-pandemic baselines.
  • Allows capital expenditures (in addition to programs and services) that support eligible COVID-19 public health or economic responses like affordable housing, childcare facilities, schools, hospitals, and other projects.
  • Significantly expands eligible projects under the “investments in water, sewer, or broadband infrastructure” category.  (e.g., lead remediation and dam repair /non-point pollution control having drinking water benefits) Of particular note is the expansion of eligible areas of broadband investment and definitions of “investment need” that includes “lack of access to a connection that reliably meets or exceeds symmetrical 100 Mbps download and upload speeds.” That’s a fiber-oriented speed standard that exceeds even the state’s current 2026 broadband goals.  The final rule also encourages (but doesn’t mandate) the use of funds that “prioritize support for broadband networks owned, operated by, or affiliated with local governments, nonprofits, and cooperatives.”  (See our accompanying article in this issue.)

In addition, the final rule also enhances local government use of fiscal recovery funds by allowing a claim of a “standard allowance” of a $10 million revenue loss -- even if local revenues actually grew -- while providing greater flexibility on the time periods used in calculating whether they truly lost revenue.

From all indications, just about anything targeted to serve low- or moderate-income households or communities appears to be classifiable as a pandemic response and eligible for fiscal recovery fund use.   It’s easy to see why House DFL, as of this writing, is expressing reticence in devoting all of the ARPA money to the UI Trust Fund debt elimination and replenishment.

Profoundly Different Agendas

Even without the federal government’s generosity, resources are not lacking.  As we have previously observed, the Governor’s supplemental budget proposal consumes $7.6 billion or 98% of the current surplus as is now reported and, when factoring in one-time unallocated ARPA money, 85% of total resources available.  But the proposed spending also includes considerable out-biennium tails — $5.54 billion — which consumes 93% of the currently forecasted FY 24-25 structural balance.  Using the most recent November forecast as the baseline, the Governor’s supplemental budget represents 10.2% biennium-on-biennium projected spending growth -- seventeen months before the next biennium even begins and nine months before we elect lawmakers to determine what the FY 24-25 budget needs and priorities should be.

Meanwhile, Senate Republicans have not yet unveiled the specific elements of their tax relief plan or details on how much their tax cuts would total.  But if bill introductions are any indication of what may be coming, it would be safe to conclude Senate Republicans will match the Governor’s aspirations albeit in the other direction.   

The one sure thing is a bill to exclude all Social Security income from taxation.  Based on revenue analysis from last year, such an exclusion translates into a $1.1 billion biennium revenue reduction and increases from there.  A few of the other tax relief bills which have been introduced include the following (with very rough estimates of revenue collection impacts based on the latest available DOR estimates of tax rate change impacts -- no dynamic scoring offsets.)

  • Eliminate the first tier of the state income tax ($7.16 billion per biennium).
  • Reduce the first tier of income rates from 5.35% to 4.10% for all filers ($1.7 billion per biennium.)
  • 1.3 to 2.85 percentage point cuts in income rates across all existing tiers combined with significant upward adjustments of bracket thresholds exposing more income to lower marginal rates. ($7.7 billion per biennium plus bracket adjustment effects)
  • Elimination of State General Tax ($1.5 billion per biennium)

Of course, a divided legislature guarantees neither side’s visions of a fundamental transformation of the state’s budget and fiscal structure will be enacted.  As a result, any compromise that is reached likely means money – and maybe a lot of it – will be left on the table for the next legislature to deal with.  The good news is there are enough resources and overlapping of interests to tackle some near-term state needs and issues and also satisfy partisan interests and messaging expectations heading into November.   If that outcome comes to fruition this session, lawmakers shouldn’t feel sad because as Meat Loaf observed “two out of three ain’t bad.”