File this one in the good news-bad new folder: Minnesota’s tax collections continue to exceed revenue forecasts, something that could add to the state’s still-record surpluses. But for the first time since the brief pandemic recession, and certainly since the Great Recession, the state’s economists are now projecting a recession beginning in the final quarter of 2022.
The U.S. and Minnesota are already in the final quarter of 2022. As in, right now.
The quarterly revenue and economic update is a combination of monthly tax collections and an update of the economic factors that help the state look into the future. Collections are easier because they report money paid by taxpayers and deposited in state accounts.
In the first three months of the current fiscal year that began July 1, collections are up $289 million – or 4.3% – from what was expected when the Minnesota Department of Management and Budget (MMB) crafted its major forecast in February.
All major tax categories were above forecast, MMB reported.
The same report closed the state’s books on fiscal year 2022 that ended June 30. Tax collections for that 12-month period are now reported to be 10.6% more than projected or $2.918 billion more than forecast.
Some of the extra $3.2 billion total in state tax collections will ultimately be returned to taxpayers. The recently adopted pass-through entity tax paid by business partnerships, so-called S-corporations and limited liability companies that are owned by partners. The state allows those businesses to shift tax liability from the owners to the corporation in order to increase deductibility of state and local taxes on federal tax returns.
Some $800 million in taxes have been paid to the state but will ultimately be refunded to those businesses.
Still, the $2.4 billion remaining is on top of a record surplus built since the pandemic recession ended in the summer of 2020.
But what is good news – collections in excess of forecast are a lot better than collections below forecast – was tempered by news from the state’s macro economic consultant, IHS Markit. That consultant “now incorporates a three-quarter recession beginning the fourth quarter of 2022.” That forecast expects U.S. gross domestic product to grow 1.7% this calendar year but decline 0.5% next calendar year.
Those tepid and negative growth estimates compare negatively to what IHS Markit told the state to expect when the February forecast was 3.7% growth this year and 2.7% next year. The reasons? Higher than anticipated inflation and interest rate increases by the Federal Reserve and a resulting tightening in financial markets. In the February forecast, IHS Markit estimated the U.S. inflation rate to be 4.5% this year and 3% next year. It now estimates that inflation, as measured by the headline consumer price index, will be 7.5% this year and 3% next year.
“IHS expects this will be a mild recession by historical standards with a weak recovery beginning in the third quarter of 2023,” the MMB report states. While unemployment remains low, the forecaster now expects it to increase due to the predicted recession.
The national jobless rate was 3.5% in September and IHS Markit projects it to increase to 6% late next year before beginning to decline.
What impact that will have on state tax collections will not be determined until the next official forecast is released in early December. It is that forecast that will indicate whether the pending recession will reduce state tax collections, by how much and whether it will exceed the surplus.
Monthly tax collections are a way of measuring the accuracy of the last official forecast released in February. Collections – money received from taxpayers and deposited in state accounts – have exceeded forecasts each month since February.
State economists also look at collections to gauge whether the economy is souring due to inflation pressures or supply chain challenges. So far, it hasn’t.
When the Minnesota Legislature adjourned without completing a deal to distribute the state surplus, there were two pots of money in play. Left unspent for the current two-year budget period that ends June 30, 2023, was $7.05 billion. The last official forecast of state revenue projected that tax collections would continue to exceed approved spending and the available surplus would be $12.1 billion over the rest of this budget period and the two years spanning the next budget.
As a point of reference, the state general fund budget is $53.3 billion over two years.
All of these numbers, official though they are, will change at the next state economic and revenue forecast completed by MMB. Those numbers, released in early December, will drive the next governor’s budget request and the next Legislature’s early work. But even that forecast will be supplanted next February by an additional forecast that will determine what can actually be spent via a new two-year budget and by tax reductions.