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Why Minnesota’s projected $1.6 billion budget surplus isn’t going to end the Legislature’s debate over taxes

Republicans said the new numbers prove that tax hikes would only further burden families and businesses. DFLers are taking a much different approach.

Minnesota Management and Budget Commissioner Jim Schowalter
Minnesota Management and Budget Commissioner Jim Schowalter: “This change is really large, and unusual under the circumstances in part because it’s so late in the biennium. But we don’t typically see such large changes in federal fiscal policy either.”

It might be tempting to think the healthier state economic and revenue forecast released Friday will put an end to the Legislative debate over tax increases.

The forecast, afterall, transformed a $1.27 billion shortfall for the next two-year budget period to a $1.6 billion projected surplus — nearly the same amount as the $1.66 billion tax increase proposed by Gov. Tim Walz in his budget rollout last month. It appears now that the Walz plan could be funded with current tax rates and revenue, though that plan also dipped into rainy day savings.

Ending the tax debate, however, is not happening in St. Paul. Walz said he was open to talking to lawmakers — particularly Republicans who control the Senate — about next steps, but also said he did not rule out still wanting tax hikes, and that he didn’t want to “negotiate with himself.” 

And DFL leaders and advocacy groups continue to push for some tax hikes on corporations and high-earners, for what they term as tax fairness issues rather than a requirement to pay for new spending. Walz’s plan would add spending in public education for both general support and summer school, small business assistance, child care grants, tuition assistance for job changers and other social and economic supports tied to the pandemic.

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The debate is a political one more than an actual option for crafting a two-year balanced budget. Even before Friday’s forecast, Republicans who control the Senate have said they will block any tax hikes this year. But the issue will continue to be used to distinguish the parties from each other — and to speak to their respective constituency groups.

Republicans said the new numbers prove that tax hikes aren’t needed and would only further burden families and businesses.

Minnesota Management and Budget
Senate Finance Committee Chair Julie Rosen, R-Fairmont, suggested the money be used for targeted tax cuts. “Today’s budget surplus is good news and an amazing testament to the resilience of Minnesotans,” she said. “But it does not change the fact that our state budget is unsustainable and has been for a long time. As chair of the Senate Finance Committee, I’ve got two priorities for the budget: first, we will be looking into government spending, government accountability, and seeing where this money is going. Second, Minnesota workers and small business owners are still struggling. Let’s get them some targeted tax relief.” 

Rep. Pat Garofalo, the Farmington Republican and ranking GOP member of the House Ways and Means Committee, called for tax relief for two groups impacted by the recession: businesses that received federal loans to keep workers on payroll and are subject to state income taxes on that money; and jobless workers who owe taxes on the $600 per week unemployment top-off payments they received last spring and summer. Garofalo also proposed an income tax exemption for tips by hospitality workers.

“People were skeptical about tax increases happening in the first place,” he said. “It’s not going to happen. The question is what is the state of Minnesota going to do with the billions of dollars it’s sitting on right now.”

DFLers took a much different approach.

“We need to make investments so that Minnesota can recover from the pandemic, address the growing disparities in our state, and build for a strong future for all,” said Senate Minority Leader Susan Kent, DFL-Woodbury. “This may require additional funding by asking the wealthiest and most profitable of Minnesotans to pay their fair share.”

At a virtual rally on Thursday evening of labor unions and progressive groups called to support tax increases on higher-earning Minnesotans and corporations, House Speaker Melissa Hortman predicted the new forecast would “look better” and that there will be those who say “this isn’t the time to be bold. But the truth is, people are still hurting, the needs are still great and this isn’t the time for the status quo.”

The confounding COVID-19 economy 

Friday’s forecast showed again that the economic impact of COVID-19 continues to confound the people charged with making predictions. A once-projected $1.27 billion shortfall for the two-year budget period that starts July 1 is now a $1.6 billion surplus, while a surplus for the current budget period — which still has four months to run — grew from just under $400 million to $940 million.

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These are major changes from a forecast just three months old and was attributed heavily to two numbers not known in November. The first is the $900 billion federal COVID relief law passed in late December that sent money to individuals and boosted jobless benefits, education funding, rental assistance and health care support. The second is $1.5 trillion, which is the amount expected to be spent in the third major stimulus currently before Congress.

“I feel like we’ve been on a year-long roller coaster; an unwelcome ride,” Minnesota Management and Budget Commissioner Jim Schowalter said Friday. “This change is really large, and unusual under the circumstances in part because it’s so late in the biennium. But we don’t typically see such large changes in federal fiscal policy either.”

Higher than expected revenue is only part of the equation, he said. Two significant spending areas have seen reductions as well: payments to school districts because of declining enrollment; and reduced use of health care coupled with an increased share of those costs covered by the federal government. 

Those savings are worth $456 million. Walz has already proposed using state funds to hold school districts harmless for enrollment losses, though Senate GOP leaders are less willing.

The state’s economic and revenue forecasts have swung widely during the pandemic, first because of the economic damage from stay home orders and business restrictions, then from the difficulty economists have had in forecasting the impacts. 

Before the pandemic was declared, Minnesota had a $1.51 billion surplus and $2.36 billion in a rainy day account. That was all based on a two-year budget of about $48 billion.

The debate in the Legislature last February was whether and how to spend the extra revenue. By May, a new forecast meant to give lawmakers some sense of what COVID-19 would mean for the state’s finances showed that surplus transforming into a $2.42 billion deficit for the current two-year budget.

Gov. Tim Walz said he was open to talking to lawmakers — particularly Republicans who control the Senate — about next steps, but that he did not rule out wanting tax hikes, and that he didn’t want to “negotiate with himself.”
Gov. Tim Walz said he was open to talking to lawmakers — particularly Republicans who control the Senate — about next steps, but that he did not rule out wanting tax hikes, and that he didn’t want to “negotiate with himself.”
Over the summer, however, state tax collections were stronger than had been predicted — the first indication that the recession was hitting different sectors of the economy very differently. While many lower-wage workers were suffering from closings of hotels, restaurants and retail stores, others kept their jobs and incomes while working from home.

There was also a positive effect from the state’s share of the $2.2 trillion federal CARES Act, which extended jobless benefits, added a $600 weekly “top-off” to those benefits and sent checks directly to residents. Federal Paycheck Protection Program loans also kept many people on payrolls who might otherwise have been laid off or furloughed.

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By November, the deficit was gone and was replaced with a projected $641 million surplus for the current budget period. And the outlook for the next two-year budget period that will begin July 1 shrank from a projected $4.7 billion shortfall to a $1.27 billion shortfall.

Now, surpluses are expected in both the current budget and the next budget. Part of the better numbers result not just from an economy that bounced back sooner than expected but from the fact that it never fell as far as feared. State economist Laura Kalambokidis showed charts Friday indicating that while unemployment reached as high as 10 percent at one point in 2020, the yearly decline in total wage and salary income fell just 0.6 percent.

“These job losses have disproportionately impacted lower-wage workers,” she said. And workers in sectors like hospitality and retail earn less than average in the private sector. 

That disproportionate impact of the pandemic is at the center of Walz’s plan to increase taxes on wealthier Minnesotans and corporations while using the revenue to help those most hurt by the economic fallout from COVID-19.  

“I don’t ask for the tax hikes to be punitive… but I do think we’re going to have to come to grips as a nation and a state with income inequities and the pandemic exacerbated those,” Walz said. “Yes, the situation is vastly improved but this ability to try and balance out how and who is getting hit the hardest on this is still there.” 

Outlook ‘remains volatile’

To make their forecasts, state budget officials look at actual tax collections and past economic activity but also at professional projections for the state and national economies. Friday’s forecast includes projections by the state’s macroeconomic consultant, IHSMarkit, which has continued to upgrade its outlook on the economy. 

The positives were the federal relief laws; higher than expected consumer spending in January, which was helped by new federal stimulus checks; and progress against COVID-19 that allowed reopening of more of the economy.

“The U.S. outlook remains volatile and uncertain and depends critically on the path of the pandemic,” the new state forecast states. 

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Given the ups and downs, how confident is Schowalter that these numbers are reliable enough to use them to craft a two-year budget of more than $50 billion? 

“I do put a lot of faith in the numbers, and I do think they’re going to change,” he said.