2023 Session Wrap: This Ain’t Your Father’s Miracle

“A single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country."

U.S. Supreme Court Justice Louis Brandeis

 If Justice Brandeis were alive today, he might observe that as a “laboratory of democracy,” Minnesota in 2023 had all the Bunsen burners turned to their highest possible setting and the beakers bubbling over.  Courageous and monumental to some, impudent and “bonkers” to others, what transpired this year was not just a reactive mixture of targeted tax cuts, tax increases, and spending increases.   It was arguably a transformation of state government greater in scale and scope than anything else in Minnesota history.  But although the outcomes of this year’s experiment may hold the rest of the nation harmless, the same cannot be said about the state and the implicitly greater fiscal risk it has now assumed to realize the outcomes it hopes for.

The Big Picture

According to Senate Fiscal, projected FY 24-25 General Fund spending (excluding impact of revenue changes within budget areas) is $69.5 billion.  This “appropriations perspective” on the general fund budget represents biennium-on-biennium spending growth of $17.7 billion or 34.2%.   It includes a considerable amount of one-time spending as reflected in a projected out-biennium (FY 26-27) expenditure total of “only” $64.4 billion excluding inflation.  Relative to the February forecast, which reflects current law spending growth had we done nothing this session, FY 24-25 spending is up 28.6%.

Revenue increases have an “eye of the beholder” aspect to them.  Tax increases in all state funds total $2.85 billion in FY 24-25.   Various fee increases add about another $100 million to that total.   The $10.2 billion that has been cited is comprised of all taxes and fee revenue increases over the next two biennia and includes the start-up payroll tax for the new state paid family and medical leave program.  (Reporting just the next biennium total has been the normal practice with the implicit recognition that any tax increase, like any spending, is going to have tails in the years ahead.  But because of the delayed implementation of the payroll tax, lawmaker interest in reporting projected fiscal 26-27 tax revenues as part of the session results is understandable.)

The accompanying table presents how budget areas fared in the appropriations process.   As the last column indicates, lawmakers embarked on a policy that might be described as “no agency left behind.”  Lawmakers’ special emphasis on transportation, housing, and public safety this session are clearly evident, while the two general fund budget behemoths – education and health human services --feature comparatively modest percentage changes that belie the scale of new spending and investment.  Perhaps the most curious feature is the $1.5 billion of spending categorized as “miscellaneous” somehow falling outside the purview of committee finance areas.

“Historic” was one of the words used to describe this session’s results.  Throughout the session, the Minnesota Miracle of 1971, a venerated moment in state history that had a transformative impact on state government finance, was routinely invoked to capture the ambition and spirit of the DFL’s 2023 policy agenda.  To offer some additional perspective on what transpired this session, we take a look at how the scale, scope and risks of these efforts compare.

Scale: Over 100% More Miraculous

A biennial session launched by a Governor’s budget proposing biennium-on-biennium state spending growth of over 35%.  Public concerns about the state of education funding and equity in the distribution of state support for both schools and local governments.  Taxpayer frustration over rapidly rising property tax burdens.   A large portfolio of proposed tax increases described by lawmakers as “reckless” reflecting “exploding progressivity” that would “devastate the economy.”  Single party control of both legislative bodies with a 70-64 margin in the House and a precarious 34-33 margin in the Senate. This describes the situation in early May, 1971.  (The difference is, unlike today, the state had divided government with the modern day DFL controlling the executive branch.  Technically, there were no parties, just conservative and liberal caucuses.   The 70-64 House margin existed for a period during the session upon the passing of a legislator; a subsequent special election in mid-May made it 70-65.  And the 34-33 majority was really 33-33-1 with an independent caucusing with the conservatives.  But the historical parallels were too interesting not to note.)¹

 About 170 days and two special sessions later, the reform which came to be known as the “Minnesota Miracle” was signed into law. The circumstantial parallels surrounding both efforts are striking, but Table 2 shows the scale of the respective efforts is quite different.

* New government accounting representations notwithstanding, the indisputable fact is the state had $19 billion of available resources in the form of cash in hand plus projected biennial revenues in excess of projected biennial expenditures to address expenditure inflation in any way lawmakers felt necessary to do.

** The lower end includes only tax increases; the upper end includes all new revenue sources including fee increases supporting services outside of the state General Fund

Sources: MMB 2023 February Budget Forecast; Senate and House Fiscal tracking sheets; “Miracle: A Roundtable Discussion,” Minnesota Historical Society, Winter 2007-2008; “Anderson Hopeful on Tax Crisis: Governor-Elect to Explain Needs.” Minneapolis Tribune, January 1, 1971.  MMB Historical Expenditures: General Fund and All Funds. Calculations by MCFE.

Today’s enacted biennium on biennium state spending growth is over 3 times as large as the Minnesota Miracle.  Adjusting for state population growth, it is still over twice that of its predecessor.   Remove the one-time spending, and spending growth per capita is still roughly 40% greater.

The Minnesota Miracle did raise a lot more state taxes – about 50% more on an adjusted dollar basis.  That is because the Miracle had nothing close resembling the same fiscal tailwind in 1971.  The Miracle’s $30 million ($225 million in today’s dollars) of available resources entering the 1971 session represented about 1.4% of the previous biennial budget whereas available resources entering this session represented about 36% of FY 22-23 spending.  Importantly, it included about $6.6 billion in positive FY 24-25 structural balance (i.e., not “one time money").²

Scope: Turbocharging “Wagner’s Law” at the Subnational Level

The larger scale of effort indicates a larger scope of effort.  The purposes of the Miracle legislation was essentially threefold: 1) improve equity in school finance, 2) ensure equitable access to essential local government services across the state, and 3) address the statewide anger against rapidly rising and unaffordable property tax burdens.   All three objectives were addressed by substituting new state revenues for property tax revenues and thereby having the state assume a greater role in financing schools and local governments.    The Miracle was really about the redistribution and funding of existing government service responsibilities, not more spending per se.   As Governor Anderson stated in his budget address to the Legislature in early 1971, “First, the plan does not increase total spending on elementary and secondary education beyond present estimates of those costs for the next two years. Instead, it develops a system to finance those costs that does not rely so heavily on property taxes.”

Recommitting to the Miracle’s purpose and responsibilities was a major objective this session as reflected by the significant bumps in both Local Government Aid, County Program Aid, other local aids, and school funding.  But the majority of this year’s spending reflects a “law” of public finance attributed to a mid-19^th German economist named Adolph Wagner who observed how the economies of industrialized countries transformed over time.  “Wagner’s Law,” otherwise known as “the law of expanding state activity,” states that as a state's economy and personal income grows, so too will the size of the state relative to the size of the economy because of increasing political pressure to advance what Wagner described as “social progress” such as welfare functions and regulatory actions. 

This session might best be described as “Miracle Plus” – in which the state embarked on an expansive set of spending, tax, and regulatory initiatives to address societal concerns and welfare functions on top of recommitting to existing Miracle obligations.  The number of new programs and initiatives enacted this session across all areas of government likely would have caused the notoriously curmudgeonly Wagner to break into a “I told you so” smile.   Some examples include:

• New state insurance program for paid family and medical leave
• Free school lunches
• Free college tuition for families with incomes under $80,000.
• A state-sponsored retirement program for private-sector employers without retirement plans
• Expanding the publicly subsidized health insurance program to undocumented immigrants
• New state housing voucher program
• Extension of unemployment benefits to hourly school workers during summer break

The pursuit of welfare outcomes was also the driving force behind tax policy decision-making.  Reducing child poverty and addressing income inequality were the primary objectives behind this year’s tax changes.  Minnesota’s refundable working family credit, already one of the most generous and accessible in the nation, has eliminated income tax liability for many state households.  The credit now features a major additional boost with the inclusion of a coordinated supplemental child tax credit targeting lower-income households.  The transformation of the renter’s property tax refund -- also among, if not the most, generous in the nation -- into another refundable income tax credit also supports these objectives.   

Session outcomes also include a significant expansion of the state’s administrative and regulatory footprint.   They include a new sick and safe time mandate, ban on restrictive franchise agreements, a variety of new permitting and reporting requirements, building code changes, new workplace standards and definitional changes, and limitations on permissible communications in the workplace.  As one veteran lobbyist remarked to us, “while this session will be remembered for increasing state spending by more than 30 percent it will also be remembered for a striking expansion of the state's authority to regulate certain segments of the economy.   These are well-intentioned laws that will likely have many unintended consequences.” 

During the legislative session, the DFL appeared indifferent, if not dismissive, of concerns about potential economic consequences arising out of the scope of this year’s “Wagneresque” agenda.   However, a recently released study found Minnesota ranks 10^th out of 12 Midwest regional states in new and expansion projects per capita.  The study also found Minnesota-based companies are expanding in other states at a higher rate than out-of-state companies are expanding in Minnesota resulting in a net investment deficit of $6.6 billion in capital expenditures.³   While this session’s spending and investments may strengthen the state’s economy in several ways, these findings suggest that some over-confidence already exists in the irresistibility of the value proposition offered by the state’s tax levels, spending activities, and general business climate.

Risks: A High Wire Act of Fiscal Responsibility

How fiscally responsible and economically sustainable are the results of the 2023 session?   The long-term budget numbers are already flashing a couple of red indicator lights.   According to Senate Fiscal, end of session tracking, expenditures in the out-biennium (FY 26-27) are expected to exceed revenue collections in that biennium by almost $500 million.   If inflation is included, that structural deficit swells to $1.34 billion.   Making several of the new tax increases effective for payable tax year 2023 rather than tax year 2024 prevented the state from having to report a projected budget deficit for the out-biennium.   The margin the state has for dealing with an economic downturn is thin, especially with a reserve currently funded to accommodate a biennial budget about 25% smaller than what now exists.

The Minnesota Miracle itself is a case study of how big ambitions can result in ongoing fiscal challenges.  Lawmakers and local government stakeholders have criticized the state for abdicating its commitment to supporting local governments as evidenced by general purpose aid appropriations that have been largely stagnant over the past 20 years.  That is because the state’s own service delivery responsibilities and programs have grown and competed intensely for resources.   The same dynamic applies to a lesser extent with school finance (although the state still pays more of the share of school district operating costs than after the Miracle was enacted.)   As former state Finance Commissioner Jay Kiedrowski remarked several years ago, "The Minnesota Miracle has been diminished, if not eliminated.  If I was a betting man, I'd bet that there would be reduced local government aid for cities and counties into the future as human services costs go up."⁴

In 2023, lawmakers have attempted to restore the state’s commitment to the ideals and purpose of the Miracle while also committing billions to new program expenditures, making already daunting general fund competition even more formidable.   The fiscal exposure is further magnified by $3 billion of refundable and non-refundable income tax credits, exclusions and exemptions over the next four years which have concurrently narrowed the income tax base.  Compared to local aids and other appropriation adjustments, these tax features are much more politically difficult, if not impossible, to reverse should budget circumstances require.   The question deserves to be asked, if the Minnesota Miracle has proven to be a challenge to adequately finance over the years, how confident can we feel about the prospects for “Miracle Plus?”

The degree of fiscal risk the state has now assumed will also be influenced by the answers to some questions:

How reliable and dependable are the state’s offsetting revenue raisers? – Minnesota’s new targeted tax relief/income tax redesign replaces the least volatile sources of state income tax revenue – salaries, wages, and Social Security income – with the most volatile sources.   According to an analysis by MMB, corporate profits are a little over 3 times more cyclically volatile than salaries and wages.  Net capital gains are over 12 times more cyclically volatile than salaries and wages.   That is just from fluctuations in economic cycles and does not include potential timing and realization effects – the ability of taxpayers to defer realizing gains until they die or move to another state.   Relying on these income streams to finance permanent tax credits and large spending increases is a precarious strategy.

It remains to be seen if the actions taken this session meaningfully accelerate outmigration rates of high-income households.   But we can say with certainty that fiscal impact of any high-income earners that do leave will be magnified – especially with state government reliance on individual income taxation at an all-time high.   Based on our most recent individual income tax comparison study (TY 2018), if a single $1 million married filing jointly household would leave the state, 22 new families with two dependents at the $100,000 income level would be needed to make up for just the lost income tax revenue.  That “replacement ratio” will increase going forward.

How much of the new spending from “one time money” turns out to be really “one time?”   In this year’s tug of war between one-time tax relief and one-time spending, one-time spending was the clear victor.   A lot of it is linked to federal matches, capital projects, needed technology upgrades, and other special projects for which the use of one-time money is ideally suited.  At the same time the 2023 session has also established a plethora of new grant programs, pilot projects, and related initiatives across government.   Over the next two years program advocates and constituencies will inevitably form resulting in political pressure for their continuation and/or scale-up.   

How will government labor contract negotiations shake out?   Contract negotiations are underway across the state, and a historic budget combined with historic recent inflation is likely to result in historic asks by government employee unions at the local government, school, and state level.   The results of these negotiations will influence how far new aids and resources go and how labor cost trajectories change.   Longer term consequences include impacts on government pension systems as changes in payroll growth assumptions result in higher employer contribution requirements.

Is the state’s program management and evaluation infrastructure and human capital system up to the tasks at hand?    Minnesota’s past experience in launching major new state programs has not exactly been stellar, and based on numerous recent OLA reports, state accountability, oversight, and internal control systems have often been found to be lacking.   Nor is government immune from state workforce shortages and challenges in accessing needed talent.  Embarking on the greatest expansion of government programming in state history raises the stakes in being laser-focused in pursuing productivity, accountability, and efficiency improvements to keep costs from exploding.

In 1971, Minnesota state government permanently became the central player in government service delivery.  In 2023 Minnesota state government has taken on the responsibilities of many of the redistributive and regulatory activities traditionally left to national governments that are far less exposed to border effects.   The 2023 session checks the boxes of “historic,” “consequential” and “transformational,” but “fiscally responsible” and “economically sustainable” remain blank at this time.   

Will Minnesota’s experiment be a model for 21^st century governance in other states, a case study in economically damaging political hubris, or something in between?   We are on our way to finding out.

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Footnotes

¹ As reported in “Miracle: A Roundtable Discussion,” Minnesota Historical Society, Winter 2007-2008. 
² See footnote to Table 2.
³ “2023 State of Business Retention and Expansion in Minnesota” Minnesota Chamber of Commerce
⁴ “Minnesota Scrutinizes 40-year-old 'Miracle'” Minnesota Public Radio, December 23, 2011