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Minnesota legislators told to brace for a brutal budget forecast

Even the worst-case scenario might not reflect an accurate picture of the economy,  however, as the state will have to wait to see the full effect of the COVID-related shutdowns.

State Economist Laura Kalambokidis
MinnPost photo by Greta Kaul
Laura Kalambokidis, shown in 2017, told a special state Senate COVID working group that neither of two scenarios she examined for how the recession would reduce tax collections assumed things would be worse than the Great Recession of 2007-09.
Minnesota budget writers got a glimpse of the coming state budget woes Monday, when they were told that a worst-case scenario crafted just two weeks ago might not be pessimistic enough.

Laura Kalambokidis, the state economist, told a special state Senate COVID working group that neither of two scenarios she examined for how the recession would reduce tax collections assumed things would be worse than the Great Recession of 2007-09.

Turns out, they might be.

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The state Office of Management and Budget engaged in what Kalambokidis described as “a thought exercise” that attempted to show how far state revenues would fall if the COVID recession was half as bad or equally as bad as the Great Recession. If it is just half as bad, the state will lose $1.5 billion in revenue between now and the summer of 2021. If it is equally as bad, the revenue loss will be $3 billion, Kalambokidis said.

“In retrospect, perhaps we should have done a 125 percent as well as a 150 percent,” she said. 

That’s partly because the latest forecast from the state’s economic consultant, IHS Markit, is projecting a 5.5 percent decline in the gross domestic product over three calendar quarters, with a recovery not starting until the first three months of 2021.

“It reflects their view that activity will not begin to turn up materially until U.S. cases of COVID-19 are driven essentially to zero,” Kalambokidis said of the consultant’s forecast.

By comparison, the Great Recession saw a contraction of 4.3 percent in GDP over three quarters. While the current recession and the Great Recession might be similar in length — nine months — Kalambokidis said the pattern is much different.

OMB
The state Office of Management and Budget engaged in what Dr. Laura Kalambokidis described as “a thought exercise” that attempted to show how far state revenues would fall if the COVID recession was equally as bad as the Great Recession.
“This one has just started with a bang! We just slammed the door shut on the economy,” she said. “So it has started much more abruptly.” Yet because the U.S. economy was strong when this recession started, “when we get back into business, maybe the recovery is faster,” she said. 

So what do all the models mean for the ability of the state to keep paying for government services? The more severe scenario would consume all of the state’s current forecast reserves and all but $547 million of its Rainy Day fund. 

But both Kalambokidis and state MMB Commissioner Myron Frans said this estimate on impacts on tax collections doesn’t account for what appears to be a sooner-than-estimated decline in revenue, nor does it measure all of the pressures on the spending side of the budget.

“When I see money left in the budget reserve I have to remind myself that that was assuming that (fiscal year) ’20 ended up OK, and it assumed that the recession scenario that we’re heading into is not worse than the Great Recession,” she said. 

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Minnesota is just over nine months into a $48.3 billion, two-year operating budget.

Regardless of whether the economist was as pessimistic as she should have been, she said she hoped the Legislature gets the broader point: “We’re not going to get all the money that we had expected.”

Added Frans: “Spending has increased some with all of the emergency expenditures we’ve been granted from the Legislature. We also know that revenues are shrinking. We just don’t know how fast they are shrinking.”

The first official glimpse of the revenue picture will come on Friday when Frans’ office releases its quarterly financial update, which will show March tax collections and update the state’s budget forecasts. Until then, the only hard economic data has been the explosion of claims for unemployment insurance. More than 340,000 people have applied since March 14, portending declines in income tax withholding and sales tax collections.

The MMB leaders warned that report will have flaws, however, because of the delays in tax payments that are being allowed to help businesses get through the shock of state-ordered shutdowns. Kalambokidis referred to the situation as a “Reverse Tsunami” because the state has to wait to see the full effect of the COVID-related economic shutdowns.

In response to a question from Senate Finance Committee Chair Julie Rosen, R-Vernon Center, Kalambokidis said she doesn’t know when the state will have enough new and reliable economic data to update the official state revenue and spending forecast.

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MMB Commissioner Myron Frans, shown in 2019: “Spending has increased some with all of the emergency expenditures we’ve been granted from the Legislature. We also know that revenues are shrinking. We just don’t know how fast they are shrinking.”
“I want to know the answer too, and I know you all need to know what’s coming down the pike and what we can expect,” Kalambokidis said. “I want to produce that information at a time when it is useful and credible and not just adding to confusion or noise.

The state is also starting to get more information on how much money it will get from the $2.2 trillion federal stimulus bill, known as the CARES act. Direct payment to the state will be $1.87 billion with another $317 million going to Hennepin and Ramsey counties.

The state, however, will also benefit from many other appropriations in the federal act for public schools, colleges, social services, tribal nations, public health and transit systems. 

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In the meantime, Frans said he has put in place a freeze of hiring new state workers outside essential jobs. He is also moving state workers around — even between agencies — to put them where they are most needed.

Senate Majority Leader Paul Gazelka told Frans that the state needs to start looking at ways to reduce spending. At the same time, he said, Walz should consider allowing work that can be done safely, such as landscaping and lawn care, to resume. “It’s obvious that the coronavirus has dramatically changed our budget forecast and where we’re going,” said the Nisswa-area Republican. 

He also agreed with Frans on the need for budget action to be surgical, with cuts to some areas but not to others depending on needs.

Walz was also asked about the state budget during his daily media briefing on the COVID-19 crisis. He noted that the state was in good financial shape when the crisis started — with a projected $1.5 billion ending fund balance and a rainy day account of $2.4 billion. 

“The good news is we are in solid financial shape, we’re able to pay our bills but we will certainly have to balance our budget when we come out of this and there will certainly be a lack of revenues because of the shutdown,” Walz said.

And he pushed back on any suggestions that the modeling he is using to direct his actions, especially closures and shutdowns, are contrived to justify any specific result.

“Trust me, no one wants to run a deficit as governor and no one wants 10 percent or 12 percent or 15 percent unemployment,” he said. “There’s no joy in this. There’s heartache and pain. These are terrible decisions.”