The hundreds of pages of rules released by the U.S. Treasury Department last week outlined what states can and can’t do with the massive amount of money allocated by Congress under the American Rescue Plan, including the $2.88 billion Minnesota state government is getting directly from the bill. 

But a few of those pages of guidance provided a surprise for states, one they’re still trying to understand. State officials knew the federal law would allow them to use some of the ARP funds to replace tax revenue lost during the COVID-19-induced recession, but they didn’t realize how much.

Now they do. Minnesota officials think that more than two-thirds of the federal direct grant to the state could be used for that purpose. While state budget officials are still consulting with the Treasury Department for further guidance, commissioner of Minnesota Management and Budget James Schowalter said in a statement Friday that, “Based on preliminary estimates, lost revenue due to the public health emergency could be as high as $2 billion.”

How to spend the ARP money was part of a broad budget agreement that Walz, House Speaker Melissa Hortman and Senate Majority Leader Paul Gazelka have been negotiating for weeks. That agreement — on targets for various areas of state spending — had to come before conference committees can finish their omnibus bills, which also contain dozens of policy decisions.

On Monday morning, Walz and the two legislative leaders announced a deal on the budget numbers, a deal that will transfer $1.1 billion of the ARP money to the general fund to help balance the budget while leaving $500 million in a fund for Walz to spend in response to the health and economic impacts of the pandemic.

A $2 billion ‘flexible revenue enhancement’?

The amount of money potentially available to replace lost state tax revenue under the ARP is both mind-boggling and significant. One reason is that once funds are transferred from American Rescue Plan accounts to the state general fund, none of the hundreds of pages federal restrictions outlined by Treasury apply: The money becomes the state’s — to be spent however the Legislature and governor want.

During a meeting of the House-Senate Taxes Conference Committee early last week, Schowalter called the use of funds for lost tax revenue “a flexible revenue enhancement.”

One example of that flexibility is the contentious issues of spending on infrastructure. An early proposal from Republicans who control the state Senate argued that $1 billion of the ARP allocation should be spent on road and bridge projects, something not permitted under the federal law. 

Gov. Tim Walz said the guidance from the federal government is helpful because it says, “No, you can’t build that with this money,’ That will help.”

Walz repeated last week that Fiscal Recovery Funds, the portion of the $1.9 billion American Rescue Plan law that goes to state and local governments, should be focused on public health and education and toward helping those most hurt economically by the recession, especially working families and small businesses. 

But general fund money can be spent however a majority of the Legislature wishes, subject to Walz’s signature of veto. 

Concerns about interpreting the rules correctly

Permission to use federal money for the recovery of lost revenue is a significant difference — perhaps the most significant difference — between the $1.87 billion Minnesota received under the federal CARES Act passed by Congress in the spring of 2020 and the $2.88 billion the state is receiving under the American Rescue Plan. 

Under the CARES act, Congress specifically said the money could not be used to replace tax revenues lost to the recession that came about due to COVID-19. At the time, states were watching tax collections fall as the economy reacted to business closures and layoffs. While not available to refill state treasuries, the federal money was able to be used for the public health battle against the pandemic and to respond to economic hardships.

In contrast, when states were seeing tax collections recover over the winter, that the recession was more short-lived than economists had predicted, the ARP lifted that provision. The guidance release last week described the reasoning as “helping to ensure that governments can continue to provide needed services and avoid cuts or layoffs.”

During another appearance before the Taxes Conference Committee, this time on Friday, Schowalter admitted to some concerns that his staff were interpreting the federal rules on lost revenue correctly. “Minnesota, like other states, is trying to figure out what it means,” Schowalter said. 

During a call Thursday with the National Association of State Budget Officers, a group made up of his peers from other states, Schowalter realized how many different views there were. “Frankly, it scared us as much as it illuminated because everyone is coming at this a little differently,” he said.

Who gets to spend the money?

The massive amount of money available for revenue replacement also played into one of the primary budget fights between Walz and legislative Republicans, a debate over not only where the money goes — but who gets to decide. Though it was designed to allocate relatively small amounts of federal dollars that come in when the Legislature is not in session (money from FEMA following a natural disaster, say), the state’s Legislative Advisory Commission statute is now being tapped to allocate billions and billions of dollars of federal aid.

Under the LAC process, a committee of legislators can “review and grant requests by state departments and state agencies” for funding. But after a review period, a governor needn’t get permission from the LAC to spend the money however he or she wants.

The interplay between state budgeting law and the new ARP money could have raises complex, if nerdy, questions. To transfer money from ARP funds to the state general fund requires either an act of the Legislature or a request by Walz using the Legislative Advisory Commission after the regular session is adjourned.  

GOP Rep. Greg Davids told Schowalter last week he thought the governor is running out the clock on the regular session, knowing that if a budget deal was reached — one that decided how to spend ARP money — the governor would again have a free hand, even if going that route would have further poisoned budget talks between Walz, the House DFL majority and the Senate GOP majority. The deal announced Monday morning sidesteps that conflict, though the deal leaves $1.23 billion of the ARP money unspent, with any decisions about allocating the money left to the 2022 session.

Interpretation likely to play role in budget negotiations

In the months since the passage of the American Rescue Plan, states were guessing how to calculate lost tax revenue. Minnesota simply looked at the difference between how much the February 2020 revenue forecast was predicting would be collected in the following year and how much the February 2021 forecast foresaw. That number was $461 million. But once the fiscal year is buttoned up, sometime in August, the state could end up showing no actual tax losses based on what it was expecting from state taxes before the pandemic struck.

Despite that, the state can claim that it lost upwards of $2 billion in tax revenue, budget officials have told senior lawmakers.

Schowalter did not accept a request for an interview and it is not clear how the Treasury guidance was applied to get the $2 billion estimate. But an educated guess provided by the Minnesota Center for Fiscal Excellence, a nonprofit organization that produces business-focused analyses of state budgets and taxes. “Based on our own interpretation of the guidance and plugging some numbers into the federal formula, our crude calculation of ‘lost revenue’ in the eyes of  Treasury could be something more on the order of $1.9 billion,” wrote executive director Mark Haveman.

The chairs of the legislative budget committees said the new interpretation will play a role in end-of-session budget negotiations. But there are likely to be partisan differences as to whether and how much of the federal money should be used for lost revenue versus programs more directly related to the intent of the federal law. “The question is, you have two years to capture that, do you want to use it all in one fell swoop the first year and then you’ve got this big cliff in your general fund spending and a whole bunch of expectations,” said Senate Finance Committee Chair Julie Rosen, R-Fairmont.

But moving the money to the general fund “loosens those guidelines up,” said Rosen. “There were a lot of stipulations with the ARP funds before. It couldn’t be used for transportation, it couldn’t be used for pensions.”

Rosen has a bill to require the new funds to be spent by the Legislature, subject to Walz signature on legislation. “Would it be good for a governor to say, ‘I have better judgement than 201 legislators?” Rosen said. “I think that’s a very scary scenario.” 

Walz had been saying he wants to work with lawmakers to appropriate the ARP money in the regular budget process. Monday’s deal bears that out.

House Ways and Means Committee Chair Rena Moran, DFL-St. Paul, said the federal money will play a big role in putting together a compromise budget. “Now that we have this (Treasury) guidance and now that it is more flexible, I think it allows us to utilize the federal dollars for much of the harm that has been done by COVID 19,” Moran said. “That’s our priority in the House.” 

She said she thinks the state will be able to show that it lost revenue over 14 months of the pandemic. “I thank the federal government who realize the impact COVID had around the country,” Moran said. “Minnesota is very fortunate to have $2.8 billion right now that can help us to not just plan for today but into the future.”

The direct aid to the state government is only a portion of what the state will receive from the American Rescue Plan. Local governments are getting $2.1 billion directly, school districts are getting $1.3 billion, higher education $550 million and transit agencies $350 million. Altogether, Minnesota will benefit from more than $9 billion from the law.

This story has been updated.