When the state’s February forecast was released Monday morning, the news was surprising: Minnesota’s budget deficit for FY 2012-13 had fallen from $6.2 billion to $5.0 billion (or $6.0 billion if the cost of inflation is included). Although the change is important, the added boost in economic growth will not fully solve our state budget problems.
Where does the $1.6 billion improvement come from?
- The February forecast shows that the surplus in the current biennium, FY 2010-11, has grown by $264 million since November, mostly because the implementation of early expansion of Medical Assistance will start on March 1, not January 1 as assumed in the November forecast. That $663 million surplus carries forward and helps reduce the deficit in FY 2012-13.
- Revenues for FY 2012-13 have grown by $887 million since the November forecast. Almost all of that growth is the result of projected increases in the income tax and sales tax.
- There is also a very small net decline – $9 million – in state expenditures for FY 2012-13.
The $5.0 billion deficit in the current biennium equals 13 percent of general fund spending. The state also faces a $4.4 billion deficit for FY 2014-15 – or $7.1 billion with inflation – down from $5.1 billion in the November forecast.
The change in the forecast picture is mostly the result of stronger economic growth stemming from tax and unemployment insurance changes made by the federal government last December. According to state economist Tom Stinson, the changes included:
- A two percentage point reduction in workers’ Social Security payroll tax on the first $106,800 of wages. Nationally, this payroll tax reduction will add $120 billion to workers’ take home pay in 2011, the Center on Budget and Policy Priorities finds. It gets money into the economy quickly by putting it in the hands of those most likely to spend it right away, increasing consumer spending.
- A 13-month extension of federal unemployment insurance benefits.
- An extension of 100 percent bonus depreciation for capital purchases made by businesses through the end of 2011 (and a 50 percent depreciation for purchases in 2012).
- Delaying an increase in the federal capital gains tax rate, keeping it at 15 percent through the end of 2012.
Although the federal tax changes are expected to produce strong economic growth, which has a positive impact on the state’s budget situation, that growth is concentrated in 2011. The February forecast now predicts the national economic growth of 3.2 percent in 2011, up from the 2.3 percent predicted in November. However, predictions for economic growth in 2012 remain the same as in the November Forecast - just 2.9. The state budget may benefit from a quick jolt of money, but then it’s back to normal growth levels, although from a higher base of revenues.
There is still significant uncertainty in the forecast – which could be good or bad for the state’s budget picture. For example:
- More than one-third of the revenue growth in FY 2012-13 is attributable to projected increases in capital gains collections. This revenue source is notoriously volatile. The forecast acknowledges that projecting “a large increase in revenues from a small portion of the tax base significantly increases the risk associated with this forecast.”
- The forecast was completed before the recent unrest in the Middle East heated up and assumes oil will remain below $100 per barrel through 2013. If the turmoil increases, each $10 a barrel increase in oil could push gas up by 25 cents a gallon. If gas prices hit $5.00 a gallon, it could wipe out all of the positive economic effects of the federal tax cuts. However, if tensions decline, gas prices could actually drop.
- Congress is also facing a showdown on federal budget cuts. A brief federal government shutdown would not have a major impact on Minnesota because the state does not have a large federal workforce. However, a prolonged shutdown could impact the entire national economy and result in slower economic growth. Also, the ultimate outcome of the federal budget debate could mean fewer federal dollars flowing to state and local governments in the future.
Global Insight, the state’s national economic consultant, gives a 65 percent probability that the economy will follow the path predicted in the forecast. There is also a 20 percent chance that the economy will perform better than expected, and a 15 percent probability that economic growth will fall below projections.
In response to the improvements in the forecast, Governor Dayton has already announced that he will drop his proposal of a temporary three percent tax rate for the highest-income households, reduce cuts to the Department of Human Services and restore funding for transit.
As policymakers move forward with deciding how to resolve the state’s $5.0 billion budget deficit, they should remember that the state may be benefiting from a short-term burst in economic growth, but we will not be able to further “grow” our way out of this deficit. As a result, long-term budget solutions need to be on the table – but those solutions need to be smart. As Stinson noted during Monday morning’s press conference, relying heavily on spending reductions would be more damaging to the state’s economic recovery than a comparable increase in taxes.
More information on the forecast is available on the Minnesota Management and Budget website, including slides from this morning’s presentation and the full forecast document (if you have trouble accessing their website due to heavy traffic, you can use this alternative link).
-Christina Wessel
