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Larger budget surplus comes with weak economic projections for Minnesota

A longer-term outlook suggests the current surplus is not just one-time money, but reflects a more permanent situation where tax revenues exceed spending.

Many people will be tempted to say the large surplus reflects a strong economy.
REUTERS/Bernadett Szabo

The November Budget and Economic Forecast projects a $1.871 billion surplus for the current FY 2016-17 budget, which is about $1 billion more than was projected last February. State law requires a portion of this surplus to go to repay environmental funds and to increase the budget reserve. This leaves state lawmakers with a surplus of $1.206 billion.

Peter NelsonPeter Nelson

The forecast also projects a $2 billion surplus for the following FY 2018-19 budget. This longer-term outlook suggests the current surplus is not just one-time money, but reflects a more permanent situation where tax revenues exceed spending.

Major factors increasing surplus not tied to state economy

Many people will be tempted to say the large surplus reflects a strong economy. Indeed, in discussing the surplus Gov. Mark Dayton said, “Overall this is very good news for Minnesota in terms of the economy.” The Star Tribune headline put it this way, “Strong state economy brings Minnesota $1.9 billion surplus.”

While any surplus certainly suggests a healthy economy, the major factors driving the larger surplus are not tied to the state’s economic growth. A substantial chunk of the surplus — $416 million — is due to lower than expected spending on Medicaid. The Affordable Care Act expanded Medicaid enrollment substantially, and it appears this new enrollment included a healthier group of people than expected.

A second major factor creating the surplus is higher than expected tax liabilities on 2014 tax returns. The July 2015 Revenue & Economic Update explains that “MMB economists believe the additional revenue is primarily due to larger than expected capital gains realizations and other non-wage income in 2014.” These higher capital gains realizations are almost certainly driven by national and global stock market gains and not by local economic gains.

Surplus appears alongside weakening economic projections

Instead of reflecting a strong economy, the surplus is appearing just as various economic indicators project Minnesota’s economy is weakening relative to the nation. After noting the state’s labor market has performed strongly since the end of the recession, the forecast went on to summarize a number of challenges facing the state economy.

Manufacturing, mining, and agricultural activity in the state has struggled in 2015, as Minnesota producers adjust to lower commodity prices, the strong dollar, and weak global growth. The pace of the state’s housing recovery has been slow in part due to persistently slow household formation, although there are recent signs of improvement. Moreover, Minnesota’s labor force growth remains weak, despite the fast-tightening job market. This is impeding the state’s ability to increase employment.

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Wage growth has also been weak for several years. According to the Forecast, MMB economists “believe that without a substantive rebound in productivity growth in the forecast horizon, total wage and salary income is likely to rise slower than expected.”

Finally, the forecast also projects net corporate profits will “fall 2.7 percent in 2015, compared to 4.4 percent growth assumed in February, and that weaker profit growth in 2015 is expected to continue into 2016.”

None of this suggests Minnesota’s economy is headed toward a dismal downturn. What it does show is that Minnesota’s economy is projected to grow a touch slower than the nation as a whole. Between 2015 and 2019, the four key economic indicators used to compare the state to the U.S. — personal income, wage and salary disbursements, non-farm employment and average annual non-farm wages — are all projected to grow slower in Minnesota. For anyone unsatisfied with below average, this presents a problem.

Growth hampered by labor market nearing ‘full potential’

A large part of why growth slows in Minnesota is because there are simply not enough workers to fill the jobs necessary to sustain higher levels of growth. Beyond 2017, according to the forecast, “Minnesota’s labor market settles into full potential, and job growth becomes increasingly constrained to the market supply of labor and demographic trends.”

Two key demographic trends limit labor market growth. First, baby boomers are retiring from the work force. And second, fewer people on net are choosing to move to Minnesota. Between 1991 and 2001—as shown in the table below created by the Minnesota State Demographic Center — Minnesota consistently attracted net population gains from both domestic and international movers. Minnesota continues to gain population from international movers, but has lost population to domestic movers every year since 2002.

My preliminary analysis of new IRS migration data reveal higher-income households represent a substantial portion of this net domestic loss of population to other states. On net, Minnesota lost nearly 9,000 people in tax filing households in 2014 and well over half — 5,253 to be exact — of that loss was from people in households with incomes over $100,000.

The state probably isn’t going to change the retirement equation all that much, but the state does have policy levers to attract and retain workers. As the state demographer explains [PDF], the sizable flows of people to and from Minnesota each year — more than 100,000 in both directions — “present an opportunity to change the migration equation to better benefit our state.”

Lowering taxes on workers would be a great policy to start. While there will certainly be heated competition to use the surplus in other ways, such a move is well justified to stem the increasing outflow of people and income Minnesota has experienced since the Legislature and governor raised taxes on top earners in 2013. 

Peter Nelson is the director of public policy for the Center of the American Experiment in Minneapolis. He received his B.A. in economics from Wheaton College and a law degree from the University of Minnesota Law School.

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