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It turns out Minnesota didn’t actually lose any tax money during the COVID recession

Minnesota officials need not worry that Congress might claw back some of money the state got under the American Rescue Plan, though. As far as the feds are concerned, state government still lost revenue during the last budget period.

MMB Commissioner Jim Schowalter on the U.S. Treasury's methodology for its calculation of state revenue losses: “Minnesota, like other states, is trying to figure out what it means.”
MMB Commissioner Jim Schowalter on the U.S. Treasury's methodology for its calculation of state revenue losses: “Minnesota, like other states, is trying to figure out what it means.”

It was pushed by governors, legislators and mayors as soon as President Joe Biden took over the White House: the ability of those governments to replace tax revenue lost during the COVID-induced recession had to be part of any federal relief law passed by the new Congress.

It worked. Unlike two previous federal COVID relief bills — passed while Donald Trump was president — states and local governments were permitted to use some of the money from the American Rescue Plan to refill treasuries hammered by the pandemic.

Minnesota alone was to receive $2.88 billion, and this past spring the state was told that of that total, around $2 billion could be considered replacement for revenues lost due to the recession.

But now that Minnesota has closed the financial books on the two fiscal years that made up the 2019-21 budget period, state accountants have reported that rather than losing $2 billion in tax revenue during the COVID-19 recession, Minnesota’s collections actually grew by more than $2 billion.

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The number is pegged at either $2.2 or $2.7 billion, and the numbers depend on which of two starting points is used. In February of 2019, the state office of Management and Budget produced what is termed the February forecast. That’s the document that estimates how much state government costs over two fiscal years and how much state taxes would raise. Those estimates were then used by the Legislature to adopt the 2020-2021 state budget. At the time, the document said there would be $47.704 billion to spend.

The second possible starting point is the budget approved by the House and Senate and signed by Gov. Tim Walz in June of 2019. That budget counted on having $48.156 billion to spend: a larger number because lawmakers reinstated the health care Provider Tax that had been scheduled to sunset.

Either way, the numbers both show: Minnesota didn’t lose tax money to the recession.

Pew Charitable Trusts/Urban Institute
“Looking through a fiscal year lens, Minnesota’s initial $2 billion tax revenue drop drove an overall 3.3% decline in fiscal 2020 compared to a year earlier,” said Justin Theal, an officer with the state fiscal health team at The Pew Charitable Trusts. “But ensuing monthly gains led to an 8.8% increase in fiscal 2021. So, when you look beneath the surface of the state’s biennium figures, Minnesota experienced a decline in fiscal 2020 and then that drop was more than made up for by gains in fiscal 2021.”

Indeed, the state’s financial situation looked bleak when the first of two budget years ended on June 30, 2020. That was in the depths of the recession and followed a rare updated forecast from MMB that predicted Minnesota would face a $4.7 billion deficit when the Legislature reconvened in early 2021.

But that forecast was the low point of the pandemic, reflecting what turned out to be a faulty economic assumption — that more people would be out of work and the income taxes and sales taxes would suffer as a result. In reality, only certain segments of the economy saw job losses — heavily in hospitality businesses — while those who kept working in person or at home spent more of their money on taxable items. In addition, the federal CARES act poured billions of dollars into the state via direct stimulus checks, enhanced jobless benefits and loans to businesses.

State Rep. Paul Marquart
State Rep. Paul Marquart
“If you were to take me back to April of 2020, when the forecast said we were gonna potentially have a four-and-a-half billion dollar deficit, I’d be hugely surprised that the state didn’t end up losing money,” said Rep. Paul Marquart, the Dilworth DFLer who chairs the House Taxes Committee.

“Typically, when we go into recession like in 2008 and 09 have hit the wealthy and stock market so you see income go down and 40 percent of that is capital gains,” Marquart said. “But this time it was so disproportionate. You have a lot of businesses and individuals who did very well. The wealthy didn’t get hit as hard.”

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Rep. Pat Garofalo, the Farmington Republican who is his party’s lead on the House Ways and Means Committee, said the impact of federal spending in the April 2020 CARES Act as well as subsequent federal pandemic responses, buoyed the economy.

State Rep. Pat Garofalo
State Rep. Pat Garofalo
“It turns out a couple trillion dollars is still a lot of money,” Garofalo said. “I don’t think people fully realize how much money the federal government threw into our economy. It generated a lot of economic activity and at minimum maintained economic activity. The bottom line is they threw billions of dollars at the economy to stop it from experiencing a recession.”

Minnesota was not unique. Most states were overly pessimistic in forecasting the economic and revenue impacts of COVID. And most have recovered more quickly than expected. A recent analysis by Pew found that a majority of states are back to pre-pandemic levels of tax collections and most are adding to their rainy day funds, something that is usually a sign of flush times, not a recession. 

Predicted revenue declines never materialized

More than anything, it was that special May 2020 revenue forecast — requested by key legislators — that led to the confusion. “No one knew how COVID would affect people, much less the economy,” Marquart said. 

State budget staff could tell soon after the forecast was released that predicted declines in state tax collections were not materializing. By the time MMB produced the next regular forecast, in late 2020, the projected deficit had fallen to $1.27 billion. Then, in February 2021, it had been replaced with a $1.6 billion surplus.

Turns out that year-old forecast was pretty close; it was just the May estimate that was an aberration. “We thought it was going (to decline) and there were a lot of moving pieces there. But it didn’t in the end,” said Bryan Dahl, director of budget planning for MMB. “You’ll find, if you do the math, in the end we’re going to exceed what we thought we were going to collect in February of 2019.”

Still, when the American Rescue Plan was being debated in Congress, MMB Commissioner Jim Schowalter could still point to a $450 million negative difference between what had been expected in revenue and what was then predicted to come in. Gov. Tim Walz and the DFL House caucus both proposed large tax increases, partly to fill those gaps and partly as a political message to make the wealthy “pay their fair share.” 

But even that $450 million shortfall was erased as state tax collections continued to exceed forecasts, culminating with a May tax collections report that said the state brought in $1.8 billion more in one month than it had predicted in February. By then, DFLers had dropped their tax hike plans in reaction to the tax collection numbers — but also as an admission that it was never going to be accepted by Republicans who control the Senate.

Actual tax collections in the first year of the biennium were $23.15 billion; in the second year they were $26,568 billion. Add in what the state accountant terms “transfers and prior period adjustments” — estimated to be $656 million — and the state collected $50.374 billion over the two years, more than it expected and more than enough to cover the budget approved in the spring of 2019.

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‘The state did not lose revenue, but there were people hurt’

But Walz and lawmakers need not worry that President Biden and the Congress might claw back some of the money designed to replace lost revenue. Guidance for the states prepared by the U.S. Treasury continues to say the state of Minnesota lost revenue and can still use more than half of its ARP allocation for that purpose.

The calculation is meaningful for this reason: while ARP required that the money it sent be spent on very specific economic, social and health care responses to the pandemic, once it is transferred to state general funds to replace lost revenue, it can be spent however a legislature and governor want. 

In the global agreement reached in May by Walz, House Speaker Melissa Hortman and then-Senate Majority Leader Paul Gazelka, $1.1 billion in ARP money is to be transferred to the state’s general fund: $550 million for the current budget and $550 million for the next budget that will begin July 1, 2023.

Dahl said the U.S. Treasury uses a different methodology for its calculation of state revenue losses: a “counterfactual” analysis. That means that states are to start with the fiscal year before the pandemic hit and then make assumptions of how revenue would have grown had the pandemic not occurred

“In other words, the counterfactual trend starts with the last full fiscal year prior to the COVID-19 public health emergency and then assumes growth at a constant rate in the subsequent years,” the U.S. Treasury stated.

That methodology caught Schowalter by surprise in the spring, when he spoke to lawmakers about how much of the state’s ARP money could be considered lost revenue, something he termed a “flexible revenue enhancement.”

“Minnesota, like other states, is trying to figure out what it means,” Schowalter told the House-Senate taxes conference committee in May.

But just because the state government didn’t lose money, doesn’t mean a lot of people and businesses weren’t hurt, Garofalo said. He continues to push for using federal funds to help businesses, especially in hospitality industries, that still haven’t come back from state-ordered shut downs.

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“In the history of the state of Minnesota, the government has never had as much money as it does now,” Garofalo said. “The state did not lose revenue, but there were people hurt. A lot of this stuff when they’re throwing money at the states is more along the lines of ‘here’s some money to help people.’”

“The damage that was caused by the pandemic was more narrow than expected. It doesn’t mitigate the fact that there were people who were economically destroyed by this. It just wasn’t as widespread.”

While no one in state government said the federal money should be rejected — at least not very loudly — there are partisan differences over how it should be spent, a split exhibited during the ongoing meetings of the special committee trying, and failing, to decide how to send $250 million to frontline workers. There will also be a push to spend some of the federal money not yet appropriated to repay the federal government for $1.1 billion borrowed for unemployment insurance payments.

The 2021 Legislature will have $1.25 billion in unspent federal ARP money, and the November surplus could be in the multi-billion dollar range. Marquart said it might still be best to spend it on one-time purchases, since it doesn’t appear to be something that will keep appearing in future budgets. He cited local infrastructure needs, buying out so-called budget shifts that were used in the past to balance budgets and perhaps helping repay the unemployment trust fund debt.