Is Minnesota as Fiscally Healthy as We Seem to Be?

A new national ranking study finds that, at least compared to other states, Minnesota may have some room for improvement.

According to Minnesota Management and Budget’s (MMB) most recent Economic Update, the state finished FY 2015 with $555 million more than projected in the February Economic Forecast. That’s on top of the $865 million legislators left unallocated after crafting the state’s FY 16-17 budget and the $1.3 billion in the state’s budget reserve and cash flow account.1 So if asked what financial shape Minnesota is in, the correct response would appear to be, “just dandy, thank you.”

But whether or not general fund revenues are sufficient to cover a desired level of spending is only one dimension of fiscal health. For example, only about half of the state’s spending (52.7% in FY 14-15)2 is run through the general fund. The state collects and spends billions outside of the general fund, using what are instead called “special funds” to – among other things – provide financing for trunk highways or debt service or to account for federal dollars. In addition, a state’s fiscal health is also influenced by long-term obligations and by the capacity to respond to changing needs, demands and circumstances.

These facts about Minnesota state finances resonated when we picked up Ranking the States by Fiscal Condition, a new report issued by the Mercatus Center at George Mason University. Based on a methodology developed and first published in the Journal of Public Budgeting and Finance, the report provides a wide-ranging perspective on state fiscal health by ranking state fiscal health based on several dimensions of both short-term and long-term government solvency. Each solvency ranking is based on two or three quantitative indicators or measures of performance.

• Cash solvency (or liquidity)– the ability to pay its immediate bills over a 30-60 day time frame
• Budget solvency – the degree to which the state will end the fiscal year in surplus or deficit
• Long-run solvency – the ability to meet its long term commitments
• Service-level solvency – how much fiscal “slack” a state has to increase spending if necessary or demanded or respond to economic shocks
• Trust fund solvency – long term solvency analysis that also includes liabilities from pensions and other post employment benefit obligations

What makes this study unique – and less susceptible to the methodological faultfinding and nitpicking that occurs whenever a ranking study reports less-than-flattering results – is that most of the data come from state governments’ own Comprehensive Annual Financial Reports (CAFR). As a result, the report’s findings are based on a standardized and audited set of financial statements enabling consistent measurement and comparisons across states. In addition, when assembling the final rankings researchers standardized the raw values associated with each indicator by converting them into “z-scores”, which signify how many standard deviations each indicator is above or below the 50-state average. Standardizing the scores in this way provides a much better sense of each state’s relative fiscal health than averaging or weighting numerical rankings.

The area with serious potential for methodological quibbling is the weighting associated with each solvency area when calculating the overall scores. Researchers weighted the solvency areas based on their “budgetary immediacy” – i.e., measures with shorter time horizons were given greater weight. Thus, cash and budget solvency together account for 70% of a state’s final rank while the three remaining areas account for the remaining 30%. It is important to note that the Mercatus analysis is based on FY 2013 data, reflecting lag times for government releases of fiscal information that are common.

How did Minnesota turn out? Based on FY 2013 data, Minnesota ranked 31st among the 50 states in fiscal health. Table 1 lists each metric, its definition and interpretation in the context of the report, and Minnesota’s value and national rank for the measure. Following the table are some comments on each area.

 

Cash solvency: Although Minnesota ranks relatively low nationally at 31st, having $1.48 in cash and near cash for every dollar of current liability is certainly a reasonable position to be in with respect to paying the bills. (It’s certainly better than the 14 states whose short term liabilities exceeded their cash reserves.) We suspect our lower rank likely reflects the lingering reality of having raided the balances of so many state special funds to balance the general fund budget and our slower progress in 2013 on replenishing a budget reserve relative to some other states.

Budget solvency: By far our strongest area of performance. We can pay for our expenses and our per capita surplus was twice that of the national median. Take a bow, Minnesota.

Long-run solvency: Our ability to meet long-term obligations places us toward the middle of the pack nationally. Our net asset ratio is better than the national mean and median while the proportion of long-term liabilities to total assets is right around the national average. On a per capita basis, our long-term liabilities are 41% and 15% less than the national mean and median respectively.

Service-level solvency: This group of metrics reflects much of the conceptual thinking behind the Minnesota Price of Government but puts Minnesota’s situation in a one-year national context rather than a context that looks back over multiple years of in-state results. While the Price of Government report suggest that state and local government revenues relative to personal income have declined since the early 1990s, these results indicate that state government claims a relatively high amount of personal income compared to other states. Some argue that the decline in the Price of Government over time represents a decline in Minnesota’s investment in public goods and services and see that as a liability. Interpreting these metrics through the lens of service-level solvency illustrates how such figures can be interpreted differently: that state government’s relatively high claim on economic activity is a potential liability limiting our ability to respond effectively to another economic shock.

Trust fund solvency: Report rankings here may be a bit misleading. States like Minnesota – where local government employee pension plans are administered at the state level – have those local plans included in the analysis. However, in some states local pension plans are operated locally, and the analysis does not include those locally-operated plans. States where pensions are operated this way will have their pension liabilities underestimated vis-à-vis states such as Minnesota – making their rankings look better. Including all municipal pension plans across the country – understandably difficult at best – would likely push Minnesota’s ranking a little higher.

Nevertheless, part of our lower ranking reflects a methodological treatment that is necessary to compare legacy cost liabilities between states fairly. Reported pension plan health is hugely dependent on the rate chosen to discount future liabilities and states differ significantly in their use of discount rates. Minnesota has historically directed its actuaries to discount pension liabilities using rates that are among the highest in the nation.

To adjust for these discrepancies and allow interstate comparisons, the researchers discounted the pension liabilities each state reports using a risk-free discount rate. Regardless of whether one agrees with this method or not, it treats each pension plan the same. Moreover, because the rankings are based on the relative differences between each state’s standardized z-score and the 50-state average, increasing liabilities for every state does not bias the results to favor any particular philosophy.

So how does this change affect Minnesota? Using the state-specific discount rate assumptions, the combined funded ratio for the state pension plans places us 29th. Using the risk free discount rate drops our ranking by four places – to 33rd. The drop in rank is a testament to the power that the assumptions underlying the valuations have on an evaluation of a pension plan.

A Peek Ahead to 2014

This analysis covers FY 2013—a year for which the budget framework was enacted in the context of a turbulent three-week government shut down with no new revenues. Of course, the following budget period – which lawmakers spent the first months of calendar year 2013 crafting – saw the passage of a major tax increase and the benefits of economic recovery. How has our situation now changed?

Table 2 revisits these indicators based on the latest information, from the state’s 2014 CAFR. Perhaps unsurprisingly, liquidity improved dramatically. Interestingly, however, budget solvency measures declined over FY 2013. From what we can tell, that is primarily a function of non-general fund “business type activities” which includes such areas as the MNSCU system, the lottery, and unemployment insurance fund. In FY 2013 the charges these entities imposed for their services and the operating grants and contributions they received exceeded expenses, creating net revenue of about $200 million. Contrast that with FY 2014 when business-type activities instead spent more than they raised, to the tune of around $150 million – a $350 million swing from the previous year. Long-run and service-level solvency measures presented a mixed bag of changes. Of course, any change in Minnesota’s rankings for FY 2014 will depend just as much – if not more – on the decisions made in the other 49 states.

 

Inherent Limitations, Inherent Potential

Of course, the absolute measures themselves are ultimately much more important than any relative state rankings based on them. A state may have a ratio that is completely adequate and acceptable by general standards and practices of financial management but appear “bad” only when compared to other states. Or, a state can be the best-performing patient in a 50-state ICU. Like any relative ranking or comparison study, context still matters.

However, the report does prompt two welcome and important trains of thought. First, the report drives home the dangers of evaluating governments’ fiscal health using a limited perspective. Focusing entirely on the general fund while ignoring the $18-$20 billion in revenue and spending that passes through the state’s special funds creates a sizable blind spot in any evaluation of financial health. Moreover, ignoring the balance sheet in favor of an income statement-only perspective runs the risk of missing important trends in state liabilities and assets that have direct bearing on fiscal performance and sustainability. Taking a holistic perspective of the state’s finances is critically important.

Second, methodologies like this offer opportunities to benchmark and compare government financial performance. Comparing governments is irresistible, and there is no shortage of methods – developed both within the public sector and outside of it – for comparing the finances of state and local governments. Many of these methods are frequent targets of criticism because of the “uniqueness” of individual governments. But audited financial statements based on uniform accounting standards offer the possibility of transcending a significant amount of the complexity introduced by how governments have designed their budgets and their financial operations. It’s something we plan to look at much more closely over the coming months.

Endnotes