Well, now we know what we are facing…lots and lots of red ink. Minnesota Management and Budget (formerly known as the Department of Finance) announced the bad news at a press conference late this morning.

• For the current biennium (FY 2008-09, which ends June 30, 2009) the deficit is $426 million (that’s about half the size of the deficit we already closed during the 2008 Legislative Session).
• For the next biennium (FY 2010-11) the deficit is $4.8 billion (add another $650 million for inflation).  That deficit amounts to about 13% of our budget. That’s alot. State Economist Tom Stinson says this recession is expected to last 24 months - which would be the longest recession on record.
• For the biennium after that (FY 2012-13) the planning estimate predicts a $4.6 billion deficit (add another $1.5 billion for inflation).

By the way, in case you are confused by the $5.2 billion deficit announced in the media - that adds the FY 2008-09 and FY 2010-11 deficits together.

So, how will we solve this deficit? You are going to hear again and again that we need to tighten the belt on state (and local) government. Sure, spending cuts are one of the tools we are going to need to conquer this mammoth problem. But, here are a two things to keep in mind during this initial frenzy:

1. We have been tightening our belt since 2003…and it shows. The Minnesota Budget Project is releasing a report next week talking about what has happened to the state’s investment in critical services over the last decade. Let’s just say the report is called “The Lost Decade.” We’ll announce the report’s release on the blog next week.

2. Raising taxes should be on the table. And here’s just one of many reasons why that’s true: We’ve said it before, and we’ll say it again (and again) - huge spending cuts can be more of a drain on the state’s economy than making targeted tax increases. Nobel-prize winning economist Joseph Stiglitz and Congressional Budget Office director Peter Orszag wrote during the last recession that government spending cuts take money directly out of the state economy. But a focused tax increase on high-income earners is less likely to have a drag on the state’s economy because those individuals are likely to maintain their levels of consumption, but compensate for the tax by saving less. Plus, the state is more likely to spend money in Minnesota, while high income earners are more likely to spend money outside of the state (or even outside of the country).

If you find this stuff totally fascinating, you should also look at an editorial by Dane Smith, President of Growth and Justice, in today’s Star Tribune talking about how “Governments shrank, the top got more and paid less, and the economy is underperforming.”

-Christina Wessel

A report published today by Citizens for Tax Justice, a nonpartisan research and advocacy group, gives us the latest figures from the IRS on how many deaths in Minnesota led to estate tax liability: In 2007, just 221 estates in Minnesota owed any estate tax. Doesn’t sound like too many? That’s because it’s not - it’s less than one percent of all estates in Minnesota (0.6%, to be exact).

But the fact that the estate tax only effects the highest of the high-income taxpayers isn’t why it’s a tax worth keeping. The estate tax makes good sense because it asks those people with great wealth to contribute their fair share. To quote the CTJ report:

“A society whose government provides the goods and services necessary for wealth-creation must decide how to pay for them, which means we must decide what to tax. We have decided to tax income from work through the federal income tax and payroll tax, which the vast majority of Americans are familiar with. If we tax earnings from work, it would seem only fair that we also tax transfers of large fortunes to those who do not need to work because of the enormous wealth of their families…If the families who pass huge fortunes down through successive generations are no longer asked to help pay for the goods and services that make such wealth possible, then surely Americans will question whether ours is truly a country where hard work counts more than a family name.”

As CTJ points out, this idea is not new - it goes back over a hundred years to Rockefeller and the President Theodore Roosevelt. The estate tax is worth keeping (for more information on the estate tax, read our issue brief on the subject).

-Katherine Blauvelt

The latest news is all about recession. Yep, the National Bureau of Economic Research announced yesterday that the nation has been in a recession since December 2007.

Over the coming months, we are going to be pointing out how this recession is different for Minnesota than the 2001 recession. One difference is unemployment.

Last recession, Minnesota’s unemployment rate stayed well below the national average. But that’s different this go around. Since January 2007, Minnesota’s unemployment rate has risen above the national average six times. In October, Minnesota’s unemployment rate inched up to 6.0%. We’ve lost more than 16,000 jobs over the last year.

Now to add some context to the mix: Minnesota’s unemployment, calculated as a three-month average for August - October 2008, has risen 52% compared with the same period two years ago. Only nine other states experienced unemployment increases of 50 percent or higher (although it could be worse: Florida saw an increase of 104%!). About half of the states (including D.C.) saw increases of 30% or more. Only three states have not had unemployment increases.

Is anyone else feeling like the “invisible hand” has been all thumbs?

-Katherine Blauvelt

The Minnesota Budget Project team was out at a conference during the week of November 17, and one thing I was very sorry to miss was the meeting of the Legislative Commission on Planning and Fiscal Policy on Friday, November 21.

Minnesota Public Radio and other news outlets have reported that information presented this meeting suggest that the state’s budget deficit may be around $4 billion for the next biennium. That seems consistent with the $4 to $6 billion going around the rumor mill.  We will have more precise figures when the official forecast is released on this Thursday, December 4.

$4 billion is about 11% of the state’s general fund budget for FY 2010-11. Clearly big challenges are ahead. We recommend that policymakers keep the following principles in mind as they consider the deficit:

• A balanced approach is needed. With a deficit of this size, we cannot afford to take any of the primary budget-balancing tools - raising revenue, using reserves and other one-time measures, and cutting spending - off the table.
• The state needs to respond to the economic downturn and help build a stronger economy in the long run. Services that help people get and keep jobs, and that help families make ends meet must be allowed to work during these tough times. Budget-balancing choices should not make the impact of the recession worse for those least able to weather the economic downturn, including low-income families, laid-off workers and other vulnerable populations.
• We must understand the impact of state budget decisions on the economy. Joseph Stiglitz (a Nobel Prize-winning economist) and Peter Orszag (currently director of the Congressional Budget Office) have argued that spending cuts can be a bigger drag on a state’s economy than a targeted tax increase. As Christina has stated in a previous blog entry, cutting state spending takes dollars out of Minnesota’s economy. A targeted tax increase on high-income earners is likely to have less of a drag on the state’s economy, because those individuals are likely to maintain their levels of consumption, but compensate for the tax increase by saving less. That maximizes the amount of money moving in the state’s economy.

And if you missed it, the Star Tribune had an interesting story this week-end that looked behind the scenes at how the forecast is developed. It covers the art and science of forecasting, but also confirms that we are going to hear some very bad news on Thursday when the forecast is released.

-Nan Madden

Thanks to the economic downturn, states across the country are drowning in red ink - and now we have a not-very-well-publicized ruling from the IRS that could add to our fiscal woes.

Up until this point, tax law prevented companies from using a newly-purchased company’s tax losses to write off their own taxes. This was quite intentional - it prevented companies from buying other companies just so they could avoid paying taxes. But in late September, the IRS issued a ruling making an exception to this: a bank that acquires a failing bank with tax losses attributable to bad loans can use the losses from the deal to write off future taxable profits.  The first case that this applies to: Wells Fargo’s pending acquisition of the uber-troubled Wachovia Corp.

This is a huge policy shift, done without Congressional approval, and the cost is considerable. As the SF Chronicle reported, some experts are saying that these new tax advantages will more than pay for the entire Wachovia deal. That’s worth repeating - the cost of buying Wachovia could essentially be - nothing. It’s a tax write-off worth more than $14.4 billion for Wells Fargo. And when the dust settles from all other acquisitions, the total tax revenue loss from this IRS ruling is estimated around $140 billion. This has understandably incited a reaction from members of the U.S. House and Senate, where legislation was recently introduced to reverse the IRS ruling.

Pending legislation notwithstanding, the practical question of the moment for Minnesota is whether this new ability of acquiring banks to minimize their corporate tax liabilities will trickle-down to states, resulting in less revenue for our already-in-deficit state of Minnesota. According to an analysis from Citizens for Tax Justice, a nonpartisan tax research and advocacy organization, at least 18 states - including Minnesota - could be hit. Wells Fargo certainly has a large presence in our state, so I’d expect some impact. According to their web site, Wells Fargo is ”the second largest private employer with 20,000 team members…it has the largest distribution of any financial organization in the state.”

Certainly an issue worthwhile for Minnesota to follow.

-Katherine Blauvelt

A few weeks ago I attended the second-to-last meeting of the Minnesota Budget Trends Study Commission. To recap, this commission, established by the state legislature (not to be confused with the Governor’s 21st Century Tax Reform Commission), is made up of state budget experts and is tasked with recommending how we can minimize volatility in our state budget and tax system and prepare for the fiscal impact of demographic changes.

The commission discussed some of their draft findings (no draft report was handed out). We’ll get their final word in December. From what they discussed, here’s what you need to know:

• Inflation in the forecast matters. There was near unanimous agreement (with two or three notable exceptions) that the current practice of including inflation in the economic forecast for revenues and not expenditures creates a false picture of the budget.
• The need to limit growth in health care spending will be a major finding of the report. It’s not clear how the the commission will recommend we resolve this very sticky issue. I very much hope the commission recognizes that health care costs have been rising in both the public and private sectors. And in fact, private health care spending rose faster than public health care spending in 2005 (see this Minnesota Department of Health report). This is not a “big government” problem.

There are two meetings of this commission left. Next meeting is scheduled for Tuesday, November 25th at 9 am in the Centennial Office Building (could be changed since it’s close to Thanksgiving).

-Katherine Blauvelt

It isn’t the highest-profile outcome of the recent elections, but North Dakotans overwhelmingly rejected Measure 2, which would have cut their state personal income tax by 50% and cut the corporate income tax by 15%, with an estimated two-year cost of $420 million. The Bismarck Tribune reports that about 70% of North Dakotans voted against the measure.

In rejecting this measure, North Dakotans recognized that the oil boom that fueled their current budget surpluses was not going to last forever. They have retained the flexibility to enact better targeted changes to their tax laws and the ability to invest in the strong workforce and quality infrastructure that can build a healthy state economy into the future.

- Nan Madden

Today the Center on Budget and Policy Priorities released a report on how, in each of the 42 states that have a state income tax, the income tax impacts the very poor - those households with incomes near or below the poverty line. In 2007, the federal poverty line for a family of four was $21,203, and the line for a family of three was $16,530.

Why do we care about income taxes paid by low-income people? CBPP argues (and we would agree) that high taxes on very low-income families are counterproductive to efforts of those families to become self-sufficient and move out of poverty. The report states:

“Taxing the incomes of working-poor families runs counter to the efforts of policymakers across the political spectrum to help families work their way out of poverty. The federal government has exempted such families from the income tax since the mid-1980s, and a majority of states now do so as well. Eliminating state income taxes on working families with poverty-level incomes gives a boost in take-home pay that helps offset higher child care and transportation costs that families incur as they strive to become economically self-sufficient.”

Note: This is not about exempting very poor people from taxation - they still pay plenty of sales taxes, property taxes and other kinds of taxes.

Not surprisingly, states range the spectrum from levying substantial taxes on people with incomes below the poverty line to providing tax refunds. Families in severe poverty - with incomes significantly below the poverty line - must pay an income tax in 10 states, including Alabama, Ohio and Michigan.

Instead of making the hurdles higher for poor families, states can employ the tax system to help families move out of poverty. Fortunately, Minnesota is one of of those states. The report found that we are among 14 states that offers income tax credits to families with incomes at the poverty line as a strategy to help families become self-sufficient.

-Katherine Blauvelt

I’ve previously written about the process for developing the Governor’s budget and the instructions that state agencies received as they put together budget options for the Governor to consider.

In mid-October, cabinet-level agencies received new instructions. Noting the significant risk of a larger deficit in the November 2008 Forecast, state agencies have been asked to achieve a 5% reduction in their general fund spending in the proposals they must submit by November 3.

Specifically, the directions state: “The preliminary options you submit on November 3rd should result in a 5% reduction in your total General Fund base as well as your direct appropriated Other Funds base for FY 2010-11 (excluding Federal Funds and Internal Service Funds).” The directions also say that, “unless otherwise directed, any proposed increases should be factored in” in coming up with the 5% reduction.

To give that 5% figure some context: 5% of the state’s projected general fund spending in the FY 2010-11 biennium is $1.8 billion.

What are the implications?

• I do not think the Governor will propose 5% across-the-board cuts in his budget. In his past budgets, Governor Pawlenty has tended to take a more precise approach, so this is about developing a set of options for where cuts might be made.
• I also don’t think that 5% is the maximum amount of cut that will be proposed in any particular area of the budget. The Governor is likely to propose larger cuts in some areas than others.
• In addition, the Governor’s budget will likely have some new initiatives, and the cost of these new initiatives would need to be offset by actions elsewhere in the budget.

While I would assume that the Governor’s FY 2010-11 budget will try to address the budget deficit through a significant and painful amount of cuts, that does not mean the deficit will be made up entirely through cuts. We’re likely to see one-time savings through timing shifts, such as delaying payments to school districts. This move has been done to address past deficits, and its use in the 2009 Legislative Session seems quite probable.

-Nan Madden

More on the Governor’s tax reform commission! Remember the commission asked for public comments on how to improve Minnesota’s business competitiveness? The Minnesota Budget Project, Growth & Justice, and others have had the opportunity to testify before the commission. Now the Institute on Taxation and Economic Policy (ITEP), a national nonprofit tax research group, has sent its own comments to the commission. A couple of quotes from the ITEP public comments:

• State and local taxes are a very small part of the cost of doing business. If you add up all state and local taxes paid by businesses, they account for only 0.8 percent of business costs.
• Reducing minor state and local taxes through rate cuts or more tax credits isn’t likely to impact a
  corporation’s decision to locate in a state. For example, long-time business leader and New York
  City Major Michael Bloomberg told the New York Times that “any company that makes a decision
  as to where they are going to be based on the tax rate is a company that won’t be around very long. If you’re down to that incremental margin you don’t have a business.”

Coincidently, Art Rolnick, Senior Vice President and Director of Research for the Federal Reserve Bank of Minneapolis, recently testified to the commission that tax incentives for particular businesses should be avoided: “Even though tax incentives look good from a parochial point of view, having an economic bidding war – playing cities and states off against each other – that’s counterproductive.”

Finally, check out ITEP’s blog called Talking Taxes, which is a great way to learn about what’s going on in other states when it comes to state and local tax proposals.

-Katherine Blauvelt