2023 Session: Land of Opportunity

For Minnesota state government and politics, it was a November to remember.  Election day brought some big surprises, especially the Senate’s unexpected flip to DFL control.  A major sports upset is the metaphor that likely came to mind, but the best analogy for what happened might be the 1970’s game show “Let’s Make A Deal.”  Legislators had negotiated a supplemental budget framework that included $4 billion in tax relief agreed upon by both parties.   But agreements couldn’t be reached in several other areas leaving the state’s budgetary fortunes to the fate of what Carol Merrill would reveal behind the electoral curtain.   For Republicans it was the ultimate zonk: DFL control over all branches of government.

The November economic forecast generated more shock, if not awe.  A big number was guaranteed given the 2022 session rollover, but $17.6 billion elicited double takes even among the most watchful budget monitors.  The available balance’s invulnerability to a forecasted recession combined with an out-biennium predicted to have another structural balance in the multiple billions was as attention-getting as the size of the current balance itself. 

The result is a 2023 session still primed for pursuing big ideas.  A look at the landscape and how last year’s agenda may evolve.

The Playing Field:  Where Will the Goal Posts Be Set?

Table 1 presents a biennium-on-biennium perspective on general fund revenue and spending changes based on current law.  Notably, projected state revenue growth in the coming biennium is a relative non-contributor to the resources made available to decision-makers in the 2023 session.  Tax revenues in FY24-25 are forecasted to grow by a lackluster 0.9% and total current resources by an even more anemic 0.6%. While the anticipated recession is a contributing factor, adjustment of state income tax brackets for high inflation is also expected to take a roughly $400 million bite out of FY 24-25 individual income tax collections.  Meanwhile, projected current law spending in E-12 education (driven by higher compensatory aid and special education spending) and HHS (driven primarily by state Medicaid) are once again more than enough to offset the one-time supplemental spending that occurred in this biennium resulting in an expected 4.2% growth in biennium-on-biennium spending before “decision one” gets made next year. 

These numbers will change somewhat with the all-important February forecast which sets the budget playing field for the 2023 session. However, legislators themselves may be making an adjustment to that forecast before its release next year.   DFL lawmakers have long advocated for a return to a state policy that briefly existed for 11 years from 1991-2002: taking the MMB inflation estimate reported in every forecast and formally including it into the expenditure line item.  With the DFL now controlling all branches of state government, it would not be surprising to see an early DFL bill to make this change.  All else equal, the effect would be to reduce the February’s revised available budget balance by $1.55 billion as lawmakers begin their tax and spending deliberations.

Assuming the current $17.6 billion remains largely intact in the February forecast, a $1.55 billion cut might not trigger big budget decision-making repercussions or major political squabbling that could be expected in other years.   But as Table 2 shows, such a change can dramatically alter public perceptions about the state of state finances and the decision-making baseline lawmakers use to balance a new biennial budget.  In two of the previous three biennial budget years, the available resources for the coming biennium – some of which already resided in state bank accounts -- would have been cut by two thirds.  In 2019 lawmakers would have needed to tackle a small budget deficit.

When forecast inflation was first formally included in the early 1990s, the Department of Finance (now MMB) specifically noted, “The inclusion of discretionary inflation is not intended to suggest that inflation will be built into the FY 1994-95 budget base.”  Rather, the intention was to provide lawmakers with an “upper bound (emphasis ours) on the state’s current law obligations.”  Today, that idea has largely been replaced by the assertion that inflation’s inclusion communicates the “true cost” of providing current levels of services and the additional funding needed to maintain those services.  Even the state’s Council of Economic Advisors states without any caveats or qualifications, “the omission of inflation (in the forecast) understates the cost of maintaining current services levels as provided by law in FY 24-25 by roughly $1.552 billion…”  It may surprise a lot of taxpayers to learn that every drop of efficiency, enhanced productivity, reform, and innovation in service delivery has been squeezed out of state government.

Even though the formal return of inflation into the forecast expenditure line item doesn’t commit the state to inflationary adjustments, it’s unclear how the causes of efficient, transparent, fiscally responsible government are advanced by having a balanced budget decision-making context framed, and negotiations proceed, from an official baseline where the majority of government discretionary spending is formally indemnified against inflation.   It would create a $1.55 billion pool of “pre-booked” spending -- a potentially potent budgeting tool allowing hundreds of millions of dollars of new and expanded government spending never to be recognized as such (with the accompanying tails and own future inflationary pressures.)   It would also reduce whatever minimal pressures or incentives exist in state government to scrutinize base budgets. 

If lawmakers want to get a meaningful handle on understanding and addressing inflationary pressures and their impact on the state budget, what would really be helpful is an annual report documenting where the greatest cost inflation pressures resided in state government by purchased expenditure class/object (e.g. goods, services, compensation structures and elements including “off general fund” pension obligations), an examination of cost inflation pressures in those elements going forward, and -- most importantly -- an inventory of state statutes, regulations, and related factors that limit governments’ ability and flexibility to respond to inflationary pressures with various operating adjustments.  That might be perceived by some forecast inflation advocates as a little too much injection of reality into the inflation debate, especially since formally applying a general CPI number satisfactorily serves the primary interest: managing public perceptions about the adequacy of tax revenues. 

The Agenda: How Will it Change

Last session, in a departure from traditional mid-biennium supplemental adjustments, the Governor and the DFL House both proposed $5.6 billion in new spending for the FY 24-25 general fund.   Exactly how much of that was one time spending over the three year “triennium” versus permanent spending is not exactly clear but several major initiatives clearly qualified as the latter.  The DFL House’s and Governor’s tax relief and aids proposals bumped the total fiscal 24-25 impact up to $7.2 billion and $6.0 billion respectively. 

Now with single party rule, the question arises how much of this tax and spending agenda laid out by DFL lawmakers and the Governor early in 2022 will remain intact in 2023.   The answer at first glance appears to be “a lot.” It has been difficult to keep track of all the different legislative and budget initiatives DFL legislative leadership and the Governor have labeled “priorities” since the election.  Several are policy matters with no fiscal impact, but a $17.6 billion available balance can accommodate another run at anything wearing a price tag.  

What may alter the agenda in 2023?   For starters, regular biennial budget year appropriations for existing agency operations -- including some accommodation of inflation -- will be part of the calculus this year, taking away some of the fuel for new programming.   Heightened sensitivity to forecast uncertainties may cause some reevaluation.  Governor Walz has already gone on record expressing concern about economic uncertainties saying, “I think we’re going to have to focus heavily on one-time spending.”  Similarly, Speaker Hortman has reflected on the importance of being mindful of the volatility of the state tax system and the positive peculiarities of the COVID economy in the rearview mirror as justifying a larger emphasis on one-time infrastructure spending.  The ability to sidestep the super-majority requirement for general obligation bonding is obviously another consideration in play.

“Single party control” may give the appearance of smoother budget sailing but lying within the election results are lot of potential complications.  At the top of the list are the slim margins.   Senate Majority Leader Kari Dziedzic may have her hands full this session, since each member of her caucus effectively holds a veto over any proposal for which there is no Republican support.  In the House the six seat DFL majority provides a little more cushion but will still likely require an effort to work across the aisle on budget items.  

New faces and diversity within the DFL caucuses magnifies this issue.    Many DFLers and their supporters are ready to strike while the opportunity exists and pursue a budget advancing strong progressive policies and interests.  (Recent commentary from one of the state’s progressive policy organizations stated “raise more revenue” should be the top budget priority for the DFL majority in 2023.)   However, the DFL owes its hat trick to the party’s performance in the suburbs where results appear to have been driven as much or more by reactions to the threat on abortion rights and general MAGA-messaging exhaustion rather than an embrace of the details DFL’s fiscal policy agenda.  Notable differences of opinion on budget and policy priorities within the DFL are likely to materialize in the 2023 session – including in the area of state tax policy.   Under the leadership of new House Tax Chair Aisha Gomez (Minneapolis) and Senate Tax Chair Ann Rest (New Hope), the eventual 2023 tax bill side-by-side will almost certainly have some notable divergences and disagreements to iron out. 

It will be interesting to see how the DFL’s budget proposals attempt to balance the expectations of its more progressive membership base and major financial backers with attempting to secure gains it has made in the politically more moderate suburbs and the dwindling number of outstate areas where the DFL still has a foothold.  Perhaps no issue reflects this type of interest-juggling challenges awaiting lawmakers in 2023 than the fate of the full Social Security exclusion.   Following the election and the forecast release, DFL leadership and the Governor expressed new reservations about the centerpiece of 2022’s ill-fated tax agreement.   These reservations were met with a press release from several new DFL lawmakers reaffirming their commitment to the full exclusion as their electoral success was likely heavily influenced by their support for it.

Meanwhile, Republicans in the House and Senate, stripped of their offensive gameplan, are relegated to playing defense while looking to leverage and exploit whatever opportunities slim legislative margins and rifts in the DFL policy world may yield.  One example that has already arisen is a decided warming to the possibility of a tax rebate.   What was once described as an election year gimmick and an obstacle to permanent cuts may now be seen as the best chance to deliver tax relief to more Minnesotans while also depriving some of the oxygen to DFL spending interests.    From all indications, the Governor remains interested in providing rebates while DFL legislative leadership remains cool to the idea, creating another interesting political development to watch.

Put it all together, the 2023 session promises lots of intrigue and unpredictability.   We wouldn’t bet on it, but an argument could be made that 2023 will turn out to be the “year of the moderate” – a legislative landscape in which the prospects suggested by full DFL control is counterbalanced by slim margins and intra-caucus differences giving more influence and power to those who can work to bridge partisan divides.