How does a state budget go from a $1.51 billion surplus to a $2.42 billion deficit to a $641 million surplus in 10 months’ time?

Welcome to the world of economic forecasting in the midst of a global pandemic.

Tuesday’s update of Minnesota’s projections of tax revenue and spending for the final seven months was seen as good news. Having $641 million extra on hand instead of being $2.42 billion in the hole will have that effect. “Minnesota’s forecast is significantly improved even as COVID-19 impacts remain,” said Minnesota Management and Budget Commissioner Jim Schowalter. “Due to improved economic conditions, the projected deficit anticipated last May has been eliminated and we now project a $641 million surplus for the current fiscal period.”

That fiscal period runs from July of 2019 to June of 2021 and is budgeted to cost $48.8 billion, or about $2 billion each month.

A few weeks ago, policymakers were wondering how much of the state’s sizable rainy day savings account would have to be used to get through this budget. Now, the surplus means that the fund won’t have to be tapped at all. At least not yet.

“If our forecast holds, we’ll still be able to use it as a buffer for projected shortfalls in the next biennium or to provide more services to Minnesotans affected by both health and economic crises caused by COVID-19,” Schowalter said.

Sure, it’s not the $1.51 billion that was projected in February, a time when the novel coronavirus was but a glimmer on the fiscal horizon; when then-Commissioner of Management and Budget Myron Frans called the effects of COVID-19 “a dynamic situation that changes daily,” and noting that all forecasts have unknowns. “These numbers always have an asterisk on them.”

Things got very bad, very fast. The Legislature went into hiatus and Gov. Tim Walz ordered a major shutdown of the economy and society.

Normally, the state produces two economic forecasts each year: one in November, which is used by the governor to draft their budget requests to the Legislature; and one in February, which is used to guide the writing of the budget. 

Like lots of things, that practice was altered by the pandemic, and a special forecast was prepared in May to get a better picture of the economic fallout from COVID-19. Using hastily gathered national economic data and a batch of best guesses as to how deep the pandemic would cut into state revenues, the resulting forecast projected the state would end its current two-year budget period in a deep hole. A few weeks later, state economists said the hole would grow even deeper during the 2021-23 budget period. 

But forecasts are estimates of the future, not money in the bank, and it’s clear now that the May forecast was overly pessimistic. Minnesota’s economy never performed as poorly as was predicted then, something that started becoming obvious almost immediately, when each month’s tax collections exceeded the amounts projected.

Had the state’s economists not heeded requests from legislators and produced that May forecast, this week’s numbers might have been viewed as bad news: an $870 million decline in the originally projected surplus, money that could have been available to respond to the economic impacts of the pandemic.

Instead, the May forecast made Tuesday’s numbers a cause for celebration, with some notes of caution. Senate Minority Leader Susan Kent, DFL-Woodbury, for one, called the new forecast a “cautiously hopeful picture” of the economy. And other lawmakers focused on the projection for the next budget period, which predicts a $1.27 billion deficit, down from the $4.7 billion hole for the next budget that was announced in July.

Why the May forecast was so wrong

The state economic forecast starts with a global and national estimate produced by its macroeconomic modeler, IHSMarkit. It loads those numbers into its computers and adds state-specific economic data to produce forecasts. In May, IHSMarkit projected that the U.S. economy would decline 5.4 percent this year. Now it thinks it will decline 3.6 percent. 

“This improvement is due to higher consumer spending and business investment so far this year than had been forecast in the spring,” said Minnesota State Economist Laura Kalambokidis.

Unemployment rose rapidly but not as much, and for not as long, as was thought in May. And because many people remained employed, total wage and salary income, as well as income tax collections, stayed relatively healthy. Finally, retail sales actually increased from pre-recession levels as consumers who couldn’t go to restaurants and entertainment venues shifted to buying taxable goods.

IHSMarkit now expects the national economy to get back to pre-recession levels by early 2022 and the economy to return to full employment in 2024. The national forecaster bases these estimates on two important assumptions: that a COVID-19 vaccine will be broadly available by mid-year, and that Congress will not pass additional relief. If the vaccine takes longer, the forecast could turn out to be too optimistic; if additional relief is passed, it could be too pessimistic.

The improvement in the forecast is due not just to higher-than-expected tax collections, however. A few areas of state spending have also been reduced, specifically per-student allotments to school districts. The was due to a 12,600 reduction in student enrollment and lower than expected use of medical assistance. 

On Tuesday, MMB’s Schowalter was asked Tuesday to explain what might seem like wild swings in the state forecasts. “This year has brought things that nobody anticipated,” he said. “When we started 2020 nobody would be thinking the economic, the health, the social issues that we’re all grappling with would happen in one year. We took information in May, incomplete as it was, and made estimates and looked forward. Now that we’re in early December, we’ve got more information; we can make better estimates.”

Kalambokidis echoed the point. “We learned a lot between May and now and we’ll learn more between now and the February forecast,” she said. 

While the overall economic picture was brighter, Schowalter tried to show that the reason for that is because the pandemic hasn’t affected everyone the same. Larger businesses and higher income taxpayers didn’t suffer as much as lower-income workers, who make up the bulk of the 107,000 workers have left the labor force and who are most affected by restrictions like bar and restaurant closures.

“Clearly the impacts of this recession and the impacts of COVID-19 are really concentrated,” Schowalter said. “Some sectors, and particularly some employees and some families are particularly hard hit.”

Lawmakers want to send checks to bars, restaurants and gyms by the end of 2020

It is those disparate impacts that is now driving a bipartisan drive at the state Capitol to spend some of the surplus on a COVID-19 relief package aimed at helping businesses closed last month: bars, restaurants, health clubs and entertainment venues. 

Among the remedies being discussed: direct cash payments to businesses as well as extending unemployment benefits by 13 weeks for those who have used up both regular state benefits and federal CARES Act extended benefits.

DFLers are also proposing tapping federal dollars to give $500 one-time payments to families receiving support from the state’s welfare program, the Minnesota Family Investment Program. “We need a package,” Walz said. “I think what this forecast gives us, it gives us more certainty, which is a hard thing to come by in COVID.” 

He described any state relief plan as “a bridge path” to a time when a COVID-19 vaccine is broadly available and perhaps when additional federal help is approved.

While both Walz and legislative leaders had raised expectations that a special session could be convened this week or next, it now appears that passage will wait until a mid-month special session. That session must be called to give lawmakers a chance to rescind the next 30-day extension by Walz of Minnesota’s peacetime state of emergency, which gives the governor power to issue executive orders.

House Speaker Melissa Hortman said this week would be spent creating an agreement in concept, while next week would be used to iron out details and the following week could see passage of the legislation. House Majority Leader Ryan Winkler, DFL-Golden Valley, said that timeline would still allow checks to businesses to go out before the end of 2020.

But House Republicans warned that any moves by DFLers to add items to a list that started with direct payments to closed businesses could cause delays. The payments to those on the Minnesota Family Investment Program, for example, is one item that doesn’t have GOP support.

And House Minority Leader Kurt Daudt, R-Crown, stopped short of predicting a relief package would pass. “There is no certainty in anything” the Legislature does, he said. “I am 100 percent confident that we can. Whether we will or not remains to be seen.”