Forecast: Good news, for now

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Surprise $876 million surplus doesn’t alter state’s chronic budget problems

Positive budget news has been in short supply at the Capitol in recent years. So it’s no surprise that Republicans and DFLers alike greeted with relief the surprise announcement that the state is projected to have an $876 million surplus in the current two-year budget cycle. It’s the first time in nearly five years — since before the country plunged headlong into the Great Recession — that revenues have been forecast by state budget officials to be running above expenses.

“We’re not out of the fiscal woods by any means,” said DFL Gov. Mark Dayton at a news conference on Thursday. “But it’s a day where we should be proud to be Minnesotans.”

In the short term, the surplus will undoubtedly provide increased fiscal stability to state government. That’s because the money is statutorily earmarked for the state’s cash flow and budget reserve accounts. The former will receive a $255 million deposit, while the latter will be increased by $621 million. (Coupled with $27 million from a workers compensation assigned risk plan, that leaves the budget reserve just $5 million short of its $653 million statutory target.)

But a closer reading of the numbers suggests that Thursday’s forecast is hardly an occasion for tossing confetti. Most notably, the economic outlook is considerably less optimistic than it was at the time of the February forecast. Back then state budget analysts predicted that the economy would grow at a rate of 3.1 percent during the 2012-13 biennium. That number was revised downward to 1.7 percent in the most recent forecast.

“It’s no secret that the U.S. economy and the U.S. economic outlook are worse than in February,” said state economist Tom Stinson, citing the reduction in projected GDP growth. “That’s a significant slowdown in the economic activity of the country.”
Those growth numbers could erode further if the economy suffers any one of a number of possible setbacks that are beyond the state’s control. In fact Global Insight, the state’s economic consulting firm, estimates the chances of the economy dipping back into recession next year at 40 percent. The ongoing European debt crisis could snowball in the coming months and upend U.S. credit markets. In addition, the forecast relies on an assumption that Congress will extend long-term unemployment benefits and payroll tax cuts that are set to expire at the end of the year. If that doesn’t happen — and Congress is hardly a model of efficient, effective action these days — it could reduce growth by as much as 1 percent, to a minuscule 0.6 percent.

“You’d be in a no-growth situation,” Stinson noted. “If there’s some shock to the economy — bad weather, some kind of oil price shock, any kind of thing like that — it could plunge us into recession.”

The projected revenue figures illustrate the state’s continuing economic struggles effectively. Estimates of state sales tax collections during fiscal years 2011 to 2013 were reduced by $135 million from prior projections. Individual income taxes are estimated to swell by $153 million in 2012 compared with the last estimate. But then, for 2013, projected income tax collections are reduced by $117 million. The bottom line: Revenues in the next biennium are actually projected to be $24 million lower than they were at the time of the February forecast.

Sources of surplus

So where is this surplus cash coming from if revenue projections are down? Primarily from two areas: reductions in spending on health and human services programs and revised tax collection figures for 2011. The state spent $149 million less than expected on HHS programs in 2011 and is projected to spend $308 million less in the following biennium. Given that it is the fastest growing segment of the state’s budget, this is positive news.

But while “reform” is the explanation for these cost savings favored by both Republicans and Democrats, the forecast suggest other explanations. A quarter of the cost savings in the 2012-13 biennium comes from lower enrollment in the state’s Medicaid program than previously projected. In addition, another quarter of the cost savings is achieved through increased pharmacy rebates that the state is eligible for under the federal health care law. Roughly half of the savings, in other words, largely occurred outside of any action taken by the Legislature or the Department of Human Services.

The revenue figures also raise concerns about the state’s future economic well-being. Minnesota finished fiscal year 2011 with general fund revenues $358 million above projections. The biggest chunk of that — roughly 80 percent — came from unexpectedly high individual income tax collections. And two-thirds of that figure was due to increases in final tax payments on income earned in 2010. That means that nearly $200 million of the increase in revenue was actually due to higher earnings in 2010.

Out-years budgets still burdened

The state’s budget outlook appears even bleaker if you consider the long-term spending and revenue projections. The forecast shows a $1.3 billion deficit for the 2014-15 biennium. That’s $600 million less than previously anticipated, a substantial improvement. But that projection fails to take into consideration two factors that could make the fiscal bloodletting significantly worse down the road. For starters, it doesn’t take inflation into account. According to the budget forecast, if inflation is factored in the deficit would increase by another $1.3 billion. (A caveat: Not all state spending — debt service, for instance — is subject to inflation. But conversely, some sectors, like human services, grow in cost at a faster rate than general inflation.)

Even more important, the forecast doesn’t include repayment of the various K-12 school shifts that the state has used in recent years to patch budget holes. The state now owes school districts roughly $2.8 billion. In other words, if you consider the full extent of the state’s financial obligations, it could be argued that the actual deficit for the 2014-15 biennium will be in the neighborhood of $5.4 billion — though, statutorily, the $2.8 billion in K-12 payment shifts are not booked for repayment next biennium. That sounds awfully similar to other deficit projections in recent years.

But in at least one regard, the surprise surplus is likely to change the dynamic at the Capitol. It should temporarily thaw relations between Dayton and the GOP-controlled Legislature. That’s because in the short term it removes the central flashpoint of the last 12 months: Dayton’s desire to increase taxes on the rich versus Republican insistence on a cuts-only approach. With no need to further trim the current budget (barring significant economic erosion between now and the February forecast), that argument should be largely mooted. “The Dayton tax hike plan is dead,” declared Senate Majority Leader Amy Koch, a sentiment that Dayton didn’t exactly refute.

Proponents of state dollars for a Vikings stadium were cheered; whether they are able to lay claim to any of the surplus general fund money, they are at least assured of a legislative calendar that should permit plenty of time for their push.

And the surprise surplus will almost certainly spur serious discussions among Republican legislative leaders about tax cuts. Last month House Taxes Chairman Greg Davids, R-Preston, unveiled a proposal to reduce property taxes by $80 million, in part by beginning a phase-out of the statewide business property tax. The political pressure for property tax relief has been heightened by rising levies in some parts of greater Minnesota after the repeal earlier this year of the Market Value Homestead Credit.

But with the state’s chronic budget deficits unlikely to disappear, it’s probably only a matter of time before the central dispute over how to balance the state’s books once again preoccupies the Capitol. In the meantime, there is already the looming fact of an election with all 201 legislators on the ballot. “They’ve got an extreme view of protecting millionaires from a dollar more in taxes, and everyone else gets socked,” Dayton said on Thursday of the Republican majorities. “Let them take that to the polls next November.”