Sifting Through the Results of Another Legislative Session Spectacle

Even by the high bar recent legislative sessions have set, the messiness, confusion, and complexity surrounding the end of the 2017 edition has set a new standard.  Or as one veteran lobbyist is reported to have said, “Every session is different; this one is the most different.”

When the governor and legislative leaders agreed to a special session to begin immediately after the midnight deadline and last for only about a day, it suggested a successful and relatively orderly end to a turbulent four months of divided government.  The Fourth of July explosions of rhetorical fireworks and point of order pyrotechnics that marked previous midnight deadlines, as legislative procedures and processes were trampled to beat the clock, were notably absent.  In stark contrast, this year’s conclusion reflected a Christmas Eve-like vibe – anticipation and curiosity surrounding the actual terms of agreement culminating with everyone going to bed and waking up to see what leadership and the governor had left for them the next morning.

However, it quickly became clear that the agreement framework did not have nearly enough of the specificity and detail needed to move bills to the governor's desk in an expeditious and collaborative manner.  For most of “Christmas Day,” House and Senate webcasts broadcasted a political version of the televised Yule log – rows and rows of mostly empty legislative desks accompanied by soothing music and the words “in recess at the call of the chair.”  When the special session deadline arrived, no bills had reached the governor's desk, the Senate had taken no final action on any of the seven major bills still in play, and only two of those seven had passed the House.

Lawmakers forged ahead, negotiations continued in real time, and about 40 hours after the special session was originally scheduled to end legislators adjourned it sine die.  But it wouldn’t be a budget session without a last minute injection of chaos – this time creating a constitutional showdown.  Governor Dayton signed all the budget bills – ensuring no government shutdown – as well as the tax bill.  However, his line item vetoes of the House and Senate budgets in response to the legislature’s too-clever-by-half attempt to guarantee a signed tax bill potentially put several hard fought, agreed-upon tax and policy provisions back in play if they bring the legislature back to the table.  Thus, the final word on the 2017 session has not yet been written although the epilogue may be drafted in the courtroom rather than in legislative chambers.

The Big Picture on Spending

Table 1 presents the outcome of the 2017 session compared to current law projections for FY 2018-19 from the February forecast.  The table shows expenditures net of revenue changes, which generally provides the best sense of spending changes.  The main caveat with the table involves the much discussed additional $300 million of spending on transportation.  That $300 million is comprised of $96 million in new general fund spending in the transportation area as shown plus an additional $204 million in reduced general fund revenues (the sales taxes on auto parts, rental cars, and leased vehicles plus the rental car tax itself) that are now being dedicated to special transportation funds.

Ask interests in any individual spending area and the message undoubtedly would be that lawmakers should have done a lot more.  But the general fund is about allocating based on priority and need, and lawmakers appear to have found priorities and needs in almost all areas of government and appropriated accordingly.  E-12 education received a 2% per year bump in the all-important per pupil basic education aid.  Nearly $200 million in aids and credits will be distributed across the state including $40.5 million in new general purpose aids to cities and counties.  Even state government operations, whose budgets were under attack for most of the session in a pursuit of efficiency and budget restraint, saw a 6.4% increase in legislative appropriations.  (Because the accompanying table shows the budget as enacted, the 6.1% reduction in state government accounts for the roughly $130 million defunding of the House and Senate.)

Both the governor and legislators have recognized the need to find savings and reduce rates of growth in spending in the Health and Human Services bill – or “the beast” as one legislator has called it.  Minnesota’s larger amounts of spending on health and human services compared to other states has long been a distinguishing fiscal feature of the state –consistently 30-40% above the national average for many decades on a per capita basis and today over twice the national average on a per individual served basis.¹  Demographic trends are further fueling its growth rate.  Such spending may be a hallmark of Minnesota’s ethic but it also represents a powerful crowding out of other public goods and services Minnesotans hold dear.

Taming “the beast” can be done in three basic ways:  1) find savings through program redesign and operating efficiencies; 2) make the difficult decisions to cut programs and/or reduce program eligibility and benefit generosity; and 3) embark on shifts, transfers, and related numbers games.  From all indications, the $472 million reduction in biennial spending has some of 1 and 2 as well as a significant helping of 3.  The latter includes passing a $20 million tab for assessments for people with disabilities onto counties and raiding the Health Care Access Fund for one time money for ongoing programs – a funding source scheduled to disappear in two years.

In more challenging economic times various stakeholders would likely be exceptionally pleased with the decisions and results reflected in the summary table.  But a $1.65 billion surplus does not reflect challenging economic times.  So it wasn’t surprising a phylum of spending interests joined together under the Twitter hashtag “#vetoeverything” with little common DNA other than shared opposition to the idea of subordinating greater spending to tax relief.

Tax Relief:  Same Bucks, Different Tails

The early negotiating positions may not have foreshadowed it, but in the end the 2017 tax bill bears a strong resemblance in both size and substance to the ill-fated tax bill of 2016.  The 2016 bill passed on a vote of 123-10 in the House, 55-12 in the Senate, and based on statements to the press, was vetoed only because of a one-word drafting error and a lack of attention to the importance of attending high school athletic events tax free.

The aborted 2016 tax bill would have reduced revenues for the FY 18-19 biennium by $375 million and increased aids and credits spending by $169 million, for a total general fund impact of $544 million.  In comparison, the 2017 tax bill – based on a surplus nearly twice as large – reduces tax collections in FY 18-19 by $452 million and increases aids and credits spending by $196 million resulting in a $648 million impact on the general fund.  Moreover, the specific provisions and lists of beneficiaries “then” vs. “now” is strikingly similar – families with child or dependent care expenses, indebted college students, college saving parents, counties and cities, farmers,  and owners of lower valued business property, just to name a few.

It’s in the tails – the revenue implications for the FY 20-21 out-biennium and beyond – where the real differences lie.  Specifically, these changes in the tails can be traced to three primary differences between the 2016 and 2017 tax bills:

• Retargeting of tax relief away from the state Working Family Credit and towards a new Social Security subtraction.  The 2017 bill essentially swapped out $93 million of biennial relief for lower income households with $117 million of relief for middle-income seniors.  This change, however, has ramifications beyond simply creating a different group of winners.  The long-term revenue tails of a new Social Security subtraction are guaranteed to be much larger than the future growth of any refundable credits for low-income earners.  According to legislative staff the projected growth rate in general fund revenue losses from the subtraction from the FY 18-19 biennium to FY20-21 is over 10% – just as baby boomer Social Security eligibility ramps up in earnest.
• Increasing the estate tax exclusion from $2 million to $3 million.  The Department put a $34.5 million revenue impact on this provision which more than doubles by FY 20-21 largely due to the four-year phase in of the provision.
• Eliminating the automatic inflator on the State General Tax.  Both 2016 and 2017 tax bills included the $100,000 value exemption and a reduction in the levy to mitigate burden shifting, but the 2017 bill also prevents the state levy from being automatically increased every year based on a national measure of government inflation.

The governor cited major concerns about the state’s long-term fiscal stability as the justification for his extraordinary veto of the House and Senate budgets.  Given his expressed interest in leaving office with a structurally balanced budget plus all the uncertainty surrounding federal tax and spending policy, it’s understandable why the administration appeared even more circumspect this year about providing tax relief.

As a result, the governor has targeted three tax relief provisions as conditions for calling Special Session II:  repeal tobacco tax changes including reinstating tobacco tax rate indexing, canceling the estate tax exclusion increase, and restoring the state general levy’s automatic inflator.  Notably absent is the Social Security subtraction.  Even though the tails are very large, criticizing senior tax relief and arguing retiree self-interest is a dangerous threat to Minnesota’s fiscal stability and future well being isn’t exactly conducive to electoral health.   Smokers, the wealthy, and business have long proven to be politically safer targets.

Of these three tax-related provisions, only the general tax inflator repeal would likely compare to the significance of the new Social Security subtraction with respect to long-term revenue impacts.²  The administration’s concern about the freeze’s long-term costs to the state should be evaluated against the policy arguments in favor of eliminating the automatic inflator.  They are:

• Stopping the relentless and harmful state intrusion into local governments’ primary tax base;
• Restoring the original policy intent of the state general tax – balancing revenue and tax competitiveness concerns at the state rather than the local level;  and
• Restoring needed accountability into state tax policy decision-making.

Although the inflator has been repealed, there is absolutely nothing preventing lawmakers from raising $1 billion over the next 10 years through the state levy which the administration claims would be lost through a freeze.  The only difference is that lawmakers would be held accountable and responsible for that attempt – and whatever would result from it – rather than getting to hide behind an obscure inflation statistic.

Tax Policy:  Clearing Out the Inventory

Three years without a tax bill created a backlog of provisions that were discussed and passed in past legislative sessions but never enacted.  In addition to a number of overdue administrative clean up provisions in the Department’s technical and policy bills, the tax bill includes 16 TIF provisions and 18 local tax provisions – which we suspect is a record as far as the local option taxes are concerned.  Most of the local sales tax authorizations are the familiar dedication to local capital needs.  However, lawmakers broke some new policy ground and established a precedent in granting a 1% sales and use tax for a sanitary district serving a small city and township.  While some view this authority as an example of precisely the type of collaboration local governments will increasingly need to engage in over time, others see new administrative, equity, and accountability concerns in granting this kind of local sales tax authority.  Either way, it’s a crack in the historical foundation of local sales and use tax authorization which will almost certainly be exploited in years to come.

Two other administrative provisions of note which received considerable discussion and attention in previous sessions finally passed with little attention or fanfare this year.  One is the marketplace providers and referrers language, which among other things substantively expands the definition of affiliate nexus that triggers the duty to collect sales tax on e-commerce.  Minnesota’s patience with federal sales tax Godot has worn thin, and this effort has caused considerable ripples and discussion in the national tax community.  Yet here in the state the provision triggered little if any debate this year.

The second provision related to determinations of Minnesota residency for both individual income and estate tax purposes.  Language explicitly prohibiting the location of an individual’s attorney, CPA, financial advisor, or place of business where an individual applies for credit or opens/maintains an account from factoring into such determinations has finally been enacted into law.  The provision offers closure on a topic that has been a thorn in the side of Minnesota’s professional services community for a very long time.

Some high profile administrative provisions the practitioner community sought were not so fortunate.  Language pertaining to a new private letter ruling program, dual audits, changes in penalties and assessment authority, and statute of limitation changes regarding refunds were all dropped from the final tax bill.  Arguments for and against a private letter ruling program aside, it’s likely the costs the Department would incur in administering such a program were a contributing issue – especially given the other costs associated with implementing and administering the bill’s many new tax credits and the operating budget assault the Department faced for most of the session.  Unfortunately, we do not know what those cost estimates were.  We have seen situations in other areas of government in which a cost estimate developed by an affected interest group or agency becomes a major obstacle in advancing a policy initiative.  This session’s newly created Legislative Budget Office appears to be taking over the oft-criticized fiscal note process and may be an avenue for a more independent assessment of such policies.

Pensions:  Another Proposal, Another Veto

The only special session bill the governor vetoed was the “preemption bill” – so-called for its controversial provision preventing local governments from regulating their local labor markets.  Yet a completely different topic comprised 220 of the bill’s 238 pages – the omnibus pension bill, which included the latest effort to repair the state’s pension system.  With $20 billion in unfunded existing obligations (about $8.2 billion of which are city and county government employee obligations) all based on earning at least 8% per year one might expect the issue would be treated with no less seriousness and attention than a fight over local regulatory affairs.  The fact that the pension provisions took a back seat to preemption and were essentially nothing more than a media and political footnote captures the remarkably nonchalant attitude and lack of urgency that continues to surround this topic.

This year’s ill-fated effort included another package of contribution increases and retiree cost of living adjustments.  Based on the recommendations of a commission the governor established to examine the issue, the assumed rate of return – which is used to evaluate the adequacy of contribution policies – would have been reduced to 7.5%.  And it wouldn’t have been a pension repair effort without another clock reset in the form of a fresh 30 years to pay off the unfunded liabilities to keep  current costs down (at least on paper). 

One new cost saving tweak proposed this year was the phased in elimination of “pension augmentation” in which future pension benefits for individuals who have left public employment are increased by an established annual interest rate until the defined benefit is claimed.  This cost saving measure has one major drawback:  the way defined benefit pensions work, the economic benefit of working in the public sector would be even more conditioned on making government a lifelong career choice.  Any public service-minded individuals devoting anything less than 20 years of their working career to government service would find their own retirement security and interests irreparably damaged.  Similarly, those already in government would be held hostage to longer careers in government due to simple retirement economics.  Without augmentation, defined benefit plans become a retention tool on steroids.  Whether this is good or bad depends on how important one believes labor mobility is to good government.

Yet even before being lumped in with the toxic preemption bill and undergoing the governor’s veto pen these sustainability efforts were unraveling at the legislature.  The provisions for TRA were conditioned on finding the $100 million in general fund resources necessary to cover school districts’ increased contribution costs –which never materialized.  Another amendment exempted PERA from most of the reforms in return for a study to generate solvency recommendations.

As a result, seldom has a group of legislators worked so hard to accomplish so little.  The package was touted as significant reform, and from a purely political perspective that description is accurate.  Nothing comes easy in the world of pension policy especially when disproportionately influential retiree groups portray even the most modest changes affecting them as anesthetic-free oral surgery.  But from the perspective of the public interest, the proposals remain woefully inadequate.  While every legislative session might be different, at least one thing remains the same.  Minnesotans will wait yet another year to see if the political will materializes to address the true existential threat to Minnesota’s fiscal future.