Mis-spending the Imaginary Minnesota Budget Surplus: What both the Democrats and Republicans Get Wrong

The Minnesota DFL and Republican parties are about to do it again.  The “it” is engaging in irresponsible spending or tax cuts during an election year.   If either or both get their way the repercussions will be felt as soon as the 2021 legislative session when it makes the next biennial budget for the state. 

Minnesota  Management and Budget (MMB) in its November 2019 forecast projected that the State of Minnesota has a projected budget surplus of $1.332 billion.  As a result of this forecast the Minnesota DFL has proposed spending $500  million to subsidize day care costs.  The Minnesota Republicans want to use the total $1.3 billion to subsidize permanent tax cuts.  Both proposals are irresponsible, revealing a huge misunderstanding of budgeting.

Here are the basics.

The current two-year or biennial budget for the State of Minnesota that was agreed to in May 2019 is $48 billion.  The projected surplus of $1.332 billion is 2.8% of the entire budget.  Hardly anyone fiscally responsible would argue that 2.8% is really a lot of money, especially when the fiscal forecast is merely a projection.  It could vary up or down.  Moreover, many would argue that in budgeting one builds in contingency in case estimates are wrong.  The fiscal forecast assumes current obligations remain constant.  Except they do not.

The budget surplus is not really $1.332 billion. By state law, inflation is counted when calculating inflation while obligations are not.  The 2020 projected rate of inflation for 2020 is 2.5%, almost equal to the projected budget surplus percentage.  Inflation alone eats up the surplus.  There is no surplus for this budget cycle.  Even if there were, it could change if unanticipated expenditures occur; a surplus margin of error of 2.8% is very small.

Additionally, if one looks at the fiscal forecast it is important to remember that this is a surplus for only this budget cycle.  It is a one-time and not structural surplus.  Looking ahead, the MMB forecast notes that while at present the fiscal year 2022-2023  looks balanced,  all that assumes no basic changes in the revenue and expenditure projections  and that the economy will not experience a significant slow down that would impact tax revenues.  If any of this were to change, including adopting significant new state expenditures such as to subsidize childcare, or make some permanent tax cuts, then these projections change, running new risk of a structural deficit.

Both the DFL and GOP ways to spend the surplus are equally flawed.  Consider the idea of a one-time $500 million subsidy for childcare.  This sounds good, but what happens the second year?  The State will have to go subsidize again if the DFL want to make a permanent difference in costs.  This too assumes that a subsidy will address the cost issue—it does not in the long term. The reason in part why childcare is so costly is that there is a shortage both in the Metro and Great Minnesota areas.  Providing subsidies does little to address the shortage.  Moreover, offer subsidies and one may increase demand for childcare without doing anything to increase supply.  The result?  Perhaps even more costly childcare than before.  The subsidy sounds great but fails to address the underlying supply and demand problem.

The Republican tax cut proposal is equally irresponsible.  They seek to make a structural change in the tax code when the imagery surplus is possibly-one time.    They are confusing annual operating income with structural budgetary issues—a classic apples and oranges problem.  The current operating surplus is used to mask permanent tax code changes.  The last time this happened was during the Jessie Ventura administration. 

Back then when Ventura first took office in 1999 the State had a massive surplus.  It used that surplus and tax rebates (the “Jessie Checks”) to mask short term larger structural tax changes that eventually came to hurt the State when in 2002 Minnesota faced a massive shortfall, in part because of a combination of an economic recession and these tax cuts.  The result of that was the 2002 deal between then DFL and GOP gubernatorial candidates Roger Moe and Tim Pawlenty who as legislators agreed to change Minnesota law to count inflation for revenue but not obligation purposes.  It was that deal that has now created the image that Minnesota has a budget surplus now, when in fact it does not.

It was bipartisan irresponsibility a generation ago that yielded a host of problems that Minnesota has only recently and partially solved.  The DFL and GOP proposals for what to do with the $1.3 billion repeat those past mistakes.