Four Questions Regarding the Homestretch

With a month to go, we look at some questions surrounding 2022 budgeting, tax relief, and spending priorities.

Having returned from their Passover/Easter break, lawmakers begin the arduous process of trying to find areas of compromise and reconcile two very different perspectives on state government.   A look at some questions we have been asking ourselves:

How Much “Triennial Budgeting” Will Be Enacted?

Once upon a time, according to the 1972 State Joint Committee on Flexible Sessions Report, lawmakers concluded the first year of the biennium should be used for the "major financial planning of the State” and base the second session of the biennium on “the experiences and an evaluation of the needs of the State” which would include “budget review, action on the results of interim studies, and consideration of emergency measures.”  Those lawmakers probably never imagined a budget surplus well over 15% of the biennial budget and a projected structural balance (revenues in excess of spending) of over $6 billion in the out-biennium.  As a result, neither party has shown much interest in waiting around for the 2023 budget session to engage in “major financial planning” for the state, preferring instead to strike while the forecast is hot.  

The result has been what might be called “triennial budgeting” – budget proposals that have just as much influence on the next biennium -- and for that matter beyond -- as they do for addressing the needs of the current biennium.   Another Senate tax bill is forthcoming, (and the different committee structures and spreadsheet updates and layouts require an asterisk accompany this attempt) but the accompanying table offers our best take on what everyone’s “triennial budget” proposals going forward look like at this time. 

Unsurprisingly, the different emphasis placed on tax relief versus new spending/investment makes a “triennial agreement” difficult.   But even if that gulf could somehow be bridged, huge differences also exist regarding where any additional budget resources should be deployed.   The House is proposing supplemental FY 22-23 spending increases of $100 million or more in twelve different program areas.  In contrast the Senate concentrates new spending almost exclusively in the public safety, transportation, and health and human service areas.  The discrepancy is especially stark in proposed E-12 education spending: the House is proposing an additional $3.275 billion for FY 23-25; the Senate $32.1 million.  

This is not a promising landscape for a meeting of the minds on a three-year budget plan.   When all is said and done, outcomes reflecting the intent and purpose of an even-numbered year session as envisioned by lawmakers 50 years ago are much more likely…although there is certainly no guarantee of that either.

What (If Any) Tax Relief Will Business Get This Year?

It’s too early to declare session “winners and losers” but the tea leaves don’t look promising for the general business community.   Several provisions are in play that would certainly are important to and benefit business but are mostly one-time measures that likely fall short of business’ idea of relief.   These include federal conformity (included in all three tax bills), exclusion of COVID recovery grant income from taxation, and administrative benefits like reducing June accelerated tax payments for mortgage, deed, tobacco and liquor taxes.   Unemployment Insurance Trust Fund replenishment from one-time ARPA funds and some surplus would be a tremendous assist to business, but this fix is functionally negating a required tax increase created by government actions in response to a pandemic rather than providing relief for business.   As of this writing, the nature and extent of trust fund replenishment remains in limbo as negotiations with respect to frontline worker payments remain at a stalemate.  However, the current surplus minus the House’s FY 23 general fund targets still leaves about $1.88 billion of negotiation capacity.

A second Senate tax bill expected to be unveiled this week and is likely to include a bill to reduce or eliminate the state general levy.  This may become an area of negotiation as there is some bipartisan interest in using the surplus to address this tax to put Minnesota’s business property taxes more in line with neighboring states.   But the relief priorities among all the principals clearly lie elsewhere. 

How Will the Wooing of Senior Hearts and Votes Turn Out?

“Targeted” has been a theme in both parties’ tax relief messages, and in 2022 seniors and their Social Security income are the bullseye.  The 1993 House Ways and Means recommendations underlying the federal government’s 1993 Social Security tax reform, under which Minnesota largely operates today, was justified by “enhancing both the horizontal and vertical equity of the individual income tax system by treating all income in a more similar manner."   The existence of social insurance benefits may still be a policy anathema to some (one legislator this year called it a Ponzi scheme and a casualty for most people) and the program itself is certainly in need of some serious attention.  But it is not double taxation as the withholding tax acts economically as a pre-tax 6.2% employee contribution to something roughly analogous to a collective defined benefit plan, with taxes only paid based on the difference between what employee contributes and the benefits received as determined by actuaries.   These policy arguments may carry weight in tax journals and public finance courses but hold no currency with senior constituents at the local coffee shop.

A closer look at household income trends indicates a third equity-related issue -- generational fairness – deserves at least a little consideration in constructing state tax treatment of seniors:   

  • As the accompanying chart from the St. Louis Federal Reserve illustrates, seniors have been the undisputed heavyweight champion in improving their income status over the last two decades.   From 2000 -2017, change in real median household income for the 65 and over demographic was 24%, or 6 times greater than the 55-64 age group.   During this period real median income growth was negative for the prime working age group (25-54).

  • The Wall Street Journal reports, “baby boomers and older Americans have spent decades accumulating an enormous stockpile of money.  At the end of this first quarter of 2021, Americans age 70 and above had a net worth of nearly $35 trillion, according to Federal Reserve data. That amounts to 27% of all U.S. wealth, up from 20% three decades ago. Their wealth is equal to 157% of U.S. gross domestic product, more than double the proportion 30 years ago.1
  • A recent report by the Social Security Administration has confirmed earlier research that “underreporting of retirement income continues to be an issue with public-use data” and that “retirement income from sources other than Social Security to be significantly underreported in the Current Population Survey (CPS).”  It found pensions (including IRA withdrawals) rather than Social Security are the largest source of aggregate income among the population aged 65 or older and the proportion persons aged 65 or older relying on Social Security for 90 percent or more of their income is half that reported in the public-use CPS.2

The Senate has declared full exclusion of Social Security benefits its top tax priority.   The House has adopted a partial enhanced benefit allowing a 100 percent Social Security benefit subtraction for taxpayers under a new income threshold: adjusted gross income rather than provisional income.  For married joint filers and surviving spouses, the threshold would be $75,000 of AGI.  For single and head of household filers, the threshold would be $58,600.  The subtraction would be reduced by ten percent for each $4,000 of AGI above the phaseout threshold.    It reduces the general fund impact by nearly 80% compared to a full exclusion, but would eliminate taxation of all social security benefits for all senior filers at or below the state’s latest estimate of median senior household income while making the taxation of social security income much simpler for taxpayers to grasp (e.g. “for a married joint filing retiree with less than $75,000 in AGI, Minnesota will not tax your Social Security income.”)

The influence of enhanced transparency should not be underestimated.  One of the questions surrounding a full exclusion is: what explains its apparently significant popularity given the fact that a lot of beneficiaries are not currently taxed on this income and the benefit of a full exclusion would be heavily skewed towards higher income earners?   A possible answer comes from a 2014 National Tax Association journal article examining the effects taxation of Social Security benefits had on older workers’ income and claiming decisions.3  Noting the complexity of Social Security taxation and seniors' unresponsiveness to the incentives/disincentives created, the authors concluded “overall, the findings suggest that older taxpayers have little understanding of the rules governing Social Security benefit taxation.”  A shift from provisional income to AGI makes the existence of any taxation of Social Security benefits much more transparent, and might influence the politics surrounding it.   

The Governor’s tax bill does not include Social Security tax changes and is proposing a more “generationally agnostic” tax relief package, albeit with more of a targeting emphasis on low to middle income working families via various income tax credits.  An enhanced exclusion of some sort would seem the likeliest outcome, but implementing another incremental measure may make the Senate’s interest in a full exclusion more difficult going forward.  

This is an issue that is not going to go away, but neither will the long-term fiscal implications nor the opportunity cost imposed on alternative tax actions that could improve Minnesota’s economic climate.   According to IRS statistics of income, taxable social security income in Minnesota grew at an average annual rate of 7.1% per year over the past 5 years.   The Department of Revenue’s current forecast projects the total Social Security income of Minnesota income tax filers to grow by 22% over the next three years.   With “peak boomer” levels still several years away and the number of retirees aged 65 and over expected to increase by 370,000 in the next twenty years accompanied by the government spending this demographic typically demands, the budget implications reach far beyond the next biennium.

What May Not Get Done that Should Get Done?

Even-year sessions are an opportunity for mid-course adjustments to appropriations and other measures to reflect developments and special circumstances.   Although beliefs concerning the nature and extent of any needed adjustments will always be in the eye of the beholder, some issues deserve to be at the top of the list.   They include spending needed for well-functioning government operations that voters don’t know about, don’t benefit from, and don’t care about … unless something goes wrong.

That includes mission critical government infrastructure.   For example, in the state government finance area, Minnesota Management and Budget has requested $24.2 million of one-time funds over three years to provide the necessary maintenance and upgrades to the state’s Enterprise Resource Planning Systems (ERP) which support essential human resource functions like payroll, benefits, recruiting, and training; procurement/vendor transactions, and the state’s data warehouse.   According to MMB testimony, maintenance deficits and inadequate updates due to lack of funds are now resulting in performance and security risks and higher costs.  The reserves in the account used to pay for this have been used up and the account is projected to have a deficit next year.  The annual cost to run these systems is $22 million per year.  MMB has submitted four budget requests since 2015 to address this issue; the amount of funding provided over this period has totaled $13.5 million.  Similarly, MN IT has requested $18 million in one-time funds in order to match available federal funds to mitigate city and county cybersecurity risks.   

Yet, the prospect for tackling these system needs is in some doubt.   The Senate State Government Finance Committee was only given a $10 million budget to spend (which it did on election security).   In the House these proposals were lumped into a much larger ($76 million) state government omnibus finance bill which include several initiatives which several committee members objected to as unnecessary bloat and government growth - a perspective likely shared in the Senate.  That bill passed the committee, but whether agreement can be reached on a stripped-down conference committee bill to focus on these essentials remains to be seen.   One thing is certain: should breaches of security or system failures occur causing a major disruption to government operations and trigger a big expense, there will be bipartisan demands for investigations and hearings and a lot of sudden indignation expressed as to how such a thing could happen in a state that prides itself on good government.

As many legislators have observed, a time of abundance often makes finding compromise more challenging, not less.   With a month to go, that observation certainly appears to be holding true.  The X factor heading into final month is the political calculus of weighing action against inaction.   Stalemates, especially when public expectations are so high, could be harmful to electoral health.  As a recent MinnPost article succinctly put it, “the politics of the session are a choice between whether doing nothing and waiting for the election is more advantageous than getting something to talk about during the campaign.” 

Endnotes

1 “Older Americans Stockpiled a Record $35 Trillion. The Time Has Come to Give It Away.”  Wall Street Journal, July 2, 2021

2 “Improving the Measurement of Retirement Income of the Aged Population,” ORES Working Paper No. 116, January, 2021

3 "The Effects of the Taxation of Social Security Benefits on Older Workers’ Income and Claiming Decisions” Burman, Coe, Pierce, and Tian, National Tax Journal, June 2014, 67 (2), 459–486