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.

Rebating the Nonexistent Minnesota Surplus: Dumb, Dumber, and Brilliant Politics

So Keith Downey and the Republican Party of Minnesota are running ads saying they want to give back all of the $1.9 billion state surplus to Minnesotans.  Quiz time.
    This idea is:
    a)    Something they actually believe.
    b)    A way to make Kurt Daubt and the House Caucus ideas seem reasonable.
    c)    A smart political move.
    d)    A fiscally dumb idea.
    e)    All of the above.

    The  answer is (e), all of the above.  Why is that the correct answer?  Examining the politics of the budget surplus and how the DFL are just about ready to get out-maneuvered politically by the Republicans on it tells one a lot about state politics and the fortunes of the two parties.
    Let us begin first my declaring that rebating the surplus is actually something that Downey and most Republicans actually believe.  Rebating the surplus is really a continuation of  the party mantra for the last 35 years which has stressed tax cuts as a Republican solution for almost every problem confronted.  Economy in a funk, cut taxes.  Economy doing well, cut taxes.  Need better roads and bridges?  Cut taxes.  Expensive housing?  Cut taxes.  It is a one size fits all answer but it has been a successful one for the GOP fortunes.  Their base loves the idea of tax cuts and many actually do believe that it is the best way to help the economy.  When GOP Keith Downey was a legislator he never met a tax cut he did not like, and no surprise that he along with many other Republican legislators believe that the best thing for the state of Minnesota is simply to rebate all of the money back.
    Yet even if it is an idea that Downey does not actually believe, it is a terrific way to make Speaker Kurt Daubt and the Republican House caucus proposals look good.  Their ideas various call for cutting taxes, spending more on education, and also using the money to repair roads, bridges, and highways.  These are all great ideas that appeal both to their base who want tax cuts, but also to rural constituents who feel that too much spending is going to Twin Cities mass transportation.  Spending on education is a good priority that appeals to swing voters, and it is also a way to help undermine  some of the equalization formulae that try to rectify imbalances in tax bases across Minnesota school districts.  The problem with their proposal of course is that $1.9 will not go very far toward paying for many of these projects.  Additionally, so far the House has not been clear in that the big winners of  their proposals, especially the tax cuts, will not be working or middle class Minnesotans. 
    But nonetheless, the call for rebating all of the surplus is politically brilliant.  The public hears surplus and thinks the government has too much of my money, I should get some back.  The  idea of rebates sounds terrific–mailing checks to voters or giving them rebates at a time when Minnesotans are doing their taxes.  It was a tactic used once by Governor Ventura and the legislature back in 1999-2000 and it was popular.  Everyone loves Santa Claus; everyone loves people who give us gifts.
    Tax cuts have been a staple message of Republicans for decades and there is no reason to think why it should not continue to be a successful message into the future.  It is a great wedge issue against Democrats.  How can they oppose giving the people their money back?  If the DFL does not support it they are just the tax and spend liberals we know they are.  They are the party of big government and extravagant state office buildings, refusing to help working Minnesotans out by sending them a few hundred dollars back.
    But rebating is simply dumb on so many grounds.  One again needs to point out that of the $1.9 billion the first billion does not exist.    If all of the current programs funded by the state are continued at their same spending level into the next biennium it will cost the state another $1 billion to fund them because of inflation.  In order to reap this first billion as a surplus one needs to cut one billion in spending first.  Second, the surplus is only a surplus because of the tax increases. Cut the taxes and the surplus disappears.  There is no structural surplus.  Third, the other $900 million is hardly a surplus either.  With Dayton having proposed a $40 billion biennium, that $900 M is barely 2%.  If we think of the total real obligations that the State has for the next two years which includes both what Minnesota pays for along with the federal government, real spending obligations increase by tens of billions of more dollars.  That $900 M is nothing.  Assume any serous federal budget cuts or another shutdown and the state is still on the hook and it has no money as a cushion.  Or assume that there are other natural disasters that  occurs and a special appropriation is needed.  Or simply assume a slowdown in the economy or even that the surplus forecast is off just a percent or so.  Suddenly that $900 million is gone.
    The margins for error are great here.  Giving away this remaining $900 million is bad accounting.  Generally accepted accounting practices declare that organizations should have contingency funds or accounts set aside.  It should be a certain percentage of a budget.  The exact size of the contingency depends on risk, but a 5% contingency of an entire budget is not out of line.  Thus, smart budgeting suggests that saving this remaining $900 million would be good accounting.
    On top of which, the last time the state gave away it surplus was back when Ventura was governor.  The state of Minnesota went from an approximately $4.5 billion surplus in 1999 to a multi-billion dollar deficit in 2002.  To this day Minnesota has yet to recover from the stupidly of this move along with the changes in budgetary law that have continued to create the fiscal problems  that face the state.
    Thus, the correct answer is all of the above. Those of you who gave this as an answer can go to the head of the class.

Statistics mask reality: Unemployment isn't going down, and Minnesota doesn't have a budget surplus

Today's blog appeared in Minnpost as an editorial on December 7.

"Lies, damn lies, and statistics." Proof that this adage rings true can be seen in two recent stories declaring the national unemployment rate had dropped to 8.6 percent and that the State of Minnesota had a budget surplus of $876 million. While many herald these numbers as signs that the American and Minnesota economies are improving, the truth is that both mask a reality that is far grimmer than the statistics reveal.

The meek jobless recovery from the 2008 recession persists. With unemployment hovering around 9 percent, the American economy seems stuck in terms of job production. Obama had proposed a series of tax cuts and projects to stimulate hiring, but their fate in Congress during a presidential election has doomed them. Even if passed, the original September $450 billion jobs plan would do little to encourage business hiring. That will not occur until consumers are willing to spend enough money on goods and services to make it profitable for businesses to hire. As late as just a few weeks ago the Federal Reserve Board predicted that well into next year unemployment would not fall below 8.5 percent. Such a number poses a political problem for Obama – with the exception of FDR, no president has been reelected with an unemployment rate greater than 8 percent.

The surprising drop in the unemployment rate from 9 percent to 8.6 percent in November appeared to be good political and economic news. Yet it is not for several reasons. First, the rate reflected less a robust growth in the economy than many individuals leaving the workforce because they could not find work. The official unemployment rate calculates only those actively looking for work. If you cannot find work and have stopped looking, you are not counted among the ranks of the unemployed. Buried in recent unemployment figures was evidence that the workforce was contracting — many individuals have simply stopped looking for work. Perhaps half if not more of the drop in the rate in the last month was due to this fact.

Low rate of job creation

Yes, the economy produced 120,000 new jobs. That appears to be good news, but not really. The country is millions of jobs away from re-creating all of the positions lost since 2008. Millions of additional jobs are also required for new workers entering the labor force. The economy needs to produce perhaps 300,000 or more new jobs per month for several years before the loses of 2008 are recaptured. This would require economic growth far greater than the 2–2.5 percent increase projected for the near future.

There is little sign of significant turnaround for the American economy. Consumer debt remains high – nearly $830 billion – and student-loan debt will soon be $1 trillion. Housing prices and sales remain flat, consumer confidence low, and despite some bright signs that Black Friday and Cyber Monday were good, few are foretelling a serious consumer economic boom. The 8.6 percent unemployment rate fails to capture all this.

Minnesota: In the money?

If the 8.6 percent unemployment rate is a lie, news of the $876 million budget surplus is even more so. With predictions prior to the announcement last week that the state was up to at least $1 billion in the red, news of the surplus was greeted as proof that the Minnesota had turned the corner. Republicans cheered the news as proof that balancing the budget with cuts alone and no tax increases was correct. Dayton, with nodding approval of Zygi Wilf, hoped that the surplus would make public financing of a new Vikings stadium more salable. But despite claims by all that a surplus exists, the reality is: It does not.

First, recall the budget deal from last July to end the government shutdown. It came with $2.2 billion taken from K-12, and $700 million in borrowing off of Minnesota’s tobacco endowment. This was on top of other budget cuts to vital programs.

The reality is that the balanced budget was achieved by serious debt financing.

Second, the budget projection benefits from a law that calculates inflation when it comes to state revenue but ignores it for obligations. This means that the actual projection released last week is distorted by overestimating income and underestimating obligations.

Third, the budget agreement from July required that approximately the first $900 million of surplus must be used to replenish the state budget reserves and rainy-day funds. Thus, this $876 million is already called for and not available for spending.

One-time fixes

Fourth, whatever the reality of the current state budget, the fixes, such as borrowing to balance it last July, were one-timers. They failed to address to long-term fiscal imbalances in state financing, setting up the next biennial budget to again be several billions of dollars in the hole.

Finally, whatever the fiscal forecast stated, another one is due at the end of February 2012. That is the one that will be used by legislators to make the budget. It is still not clear whether it will be as optimistic as the one just released, especially if the state and national economies fail to recover.

Minnesota really does not have a surplus. Nor is the United States experiencing a serious decrease in unemployment. These two statistics mask a reality that shows how numbers do not always tell the truth.

Top Ten Things That Should or Should Not be Done with Minnesota Unexpected Budget Surplus

A surprise for all–Minnesota appears to have a $876 million budget surplus. Santa came early and now the talk at the state capitol will be over how to spend the money. Here is my short list on some good and not so good ideas.

My suggestions are in descending order from good to bad ideas. Expect debate in MN to focus more on the bad as opposed to the good ideas.

1. Do nothing. The surplus is illusionary and may vanish or change dramatically before the next fiscal forecast by the end of February, 2012.
2. Save it. Bring up the state’s rainy day fund.
3. Save it for the deficit in 2013-14 budget.
4. Use the money to pay off the interest and borrowing off of the tobacco endowment.
5. Repay the money borrowed from K-12.
6. Restore the cuts to the homestead tax credit.
7. Restore local government aid funding.
8. Restore health and human services cuts.
9. Tax cuts for businesses and wealthy to create jobs.
10. Money for the Vikings stadium.

Bonus suggestion: Provide a down payment on Zygi Wilf's next townhouse.