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Budget officials say Minnesota’s economy is doing better than expected. Which doesn’t mean it’s doing well.

The state’s Office of Management and Budget says actual tax collections have been better than initially predicted when COVID-19 hit Minnesota. 

State Economist Laura Kalambokidis
MinnPost photo by Greta Kaul
Consumer spending, and the sales taxes that go along with that, have been more robust than predicted, said Laura Kalambokidis, the state economist with the Office of Management and Budget.
It isn’t exactly good news. But coming in the midst of a pandemic recession that has knocked $3.6 billion out of Minnesota’s revenue projections, it might pass for that.

The state Office of Management and Budget quarterly revenue and economic update has reported that the distressing interim forecast in May might have been somewhat too pessimistic. Since that document was produced by state economists, back in the early weeks of the recession, actual tax collections have been better than feared.

In the calendar quarter from July to September, tax collections have been $593 million more than what was predicted in May. That’s 12.7 percent higher than was predicted.

All sources of state taxes have shown higher collections, with individual income taxes up $165 million from the May estimate and sales tax collections up $271 million. Due to the vagaries of when income tax payments are made — and whether money sent in will actually be due once returns are completed — the sales tax is a better indicator of economic activity.

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Consumer spending, and the sales taxes that go along with that, have been more robust than predicted, said Laura Kalambokidis, the state economist with the Office of Management and Budget.

“The pandemic and the subsequent recession, while it affected every business, every household, every nonprofit and every government in the state of Minnesota, has disproportionately affected low-wage workers,” she said. 

That’s because so much of the job losses are in lower-wage jobs like restaurants, bars, lodging and tourism that faced broader closures.

But other workers who kept jobs and  income have spent more on taxable purchases than economists thought they would in May. They couldn’t spend it on restaurants and services, but they could on consumer goods and home improvement.

“Receipts have not fallen as much as you would have expected given the severity of the increase in the unemployment rate we were seeing in the spring,” Kalambokidis said. “Consumer spending has been stronger than what we expected.”

Retail spending was also helped by the federal CARES Act with its stimulus payments to households and the $600 a month unemployment insurance boost that has now expired.

But before budget writers get too giddy, MMB’s update stresses that just because collections are better than projected in May doesn’t mean they are good. “For the period of March through September … sales tax receipts are about 3.8 percent lower than during the same period one year ago,” the October update noted. And income tax payments are about 2 percent lower than the same period a year ago.

“Coming in ahead of projections doesn’t mean revenues are larger than they were last year,” Kalambokidis said. “The decline is not as large as we expected.”

Economists might be forgiven if their early-recession forecasts were not spot on. The COVID-induced recession is unlike any other in how quickly it hit — and how deeply it was felt. The 31.4 percent drop in gross domestic product in the second three months of 2020 is the worst on record, and the novel coronavirus’ impact on the economy and government tax collections has been affected by numbers not normally in an economist’s data set: infection rates, community spread, hospitalization, openings and closing orders, vaccine development timetables.

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That has led national economic forecast services to decrease the confidence levels of their forecasts. IHS Markit, the international firm that provides the state’s macroeconomic forecast, assigned just a 50 percent probability to its latest national economic forecast.

That baseline is now forecasting that Minnesota’s decline in real gross domestic product will be 3.5 percent this year, better than the 5.4 percent decline it foresaw in its April report to MMB that was used to build the May forecast.

“The change between April and October is driven by upward revisions to consumption and investment, which were partly offset by lower net exports,” is how the state summarized the new IHS forecast. 

But the better-than-expected performance of the economy isn’t expected to last into the last three months of the year, “primarily attributed to the rate of COVID-19 cases remaining elevated this fall as cooling temperatures move activities indoors and in-person classes resume,” the state report said.

The forecast is based on a COVID-19 vaccine being available in mid-2021 and with a significant percentage of the population being vaccinated by mid-2022.

“This will allow the economy to transition from recovery to expansion, particularly in sectors hardest hit by social distancing and virus concerns, such as consumer spending on healthcare, entertainment and travel. IHS expects gross domestic product to surpass the pre-pandemic peak in late 2021 and the economy to again reach full employment in mid-2023.”

But even that presumes Congress and President Trump will agree to additional stimulus actions, such as unemployment boosts and stimulus checks, all of which is still uncertain.

A more pessimistic forecast, something IHS assigns a 30 percent probability, will also be COVID-19 related. If there is an upturn in cases, the pace of business reopenings will slow — as will consumer spending. 

“They’re sort of in this new normal of uncertainty,” Kalambokidis said of national economic forecast services. “And yet every macroeconomic forecast right now depends critically on the path of the pandemic and the prospect of treatments and a vaccine. Their forecasts will change as their knowledge and assumptions about the pandemic change.”

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While the numbers are a little better — half a billion dollars better — the state still has a large deficit to resolve. Last February, the MMB projected the state would end its current two-year budget period, in June of 2021, with a $1.5 billion surplus. The May update erased the surplus and replaced it with a $2.4 billion deficit. 

MMB has also looked forward to the following budget period, which will run from mid-2021 to mid-2023 and foresees an additional $4.7 billion hole if no changes are made to current taxes and current spending between now and next summer.

Gov. Tim Walz and his budget team have not shown that immediately action is needed, partly because the state also has built up a $2.36 billion rainy day fund. But it can’t be spent both to resolve the current budget’s shortfall and the next budget’s deficit. Legislative Republicans have been urging Walz to start making budget cuts now to ease the burden on budget writers when the next Legislature convenes in January.

State Rep. Pat Garofalo
State Rep. Pat Garofalo
Rep. Pat Garofalo, a Farmington Republican and the ranking minority member on the House Ways and Means Committee, said the recent tax collections don’t much change his concerns about the budget deficit. “The shorter the budget window you are looking at, the more volatile and less accurate it is,” Garofalo said. “So when you see little blips like this, it has more to do with timing and payments than the overall health of the economy.

“I’m happy to see it, but it’s like having a couple of drinks before the hangover kicks in,” he said. “But no one should be fooled into thinking that it’s clear sailing ahead.”

The state has both higher unemployment and higher need for government services in a recession. And the hopes for what is termed a V-shaped recession — one that goes down quickly but also climbs back quickly — are not being realized. Instead, Garofalo said, the state and nation are more likely to see a graph line that looks like the Nike “swoosh”: a quick decline and a much-slower recovery.

Garofalo said some of the extra tax revenue could be due to spending allowed by the CARES Act stimulus: extra unemployment payments and one-time cash to families.

“It turns out $3 trillion is a lot of money,” he said, referencing one estimate of congressional spending on the virus response.