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Inaccurate pandemic-era revenue forecasting might now be in Minnesota’s rearview mirror

Quarter-after-quarter, starting the spring of 2020, Minnesota’s economic and revenue forecasts were off — sometimes way off.

State Economist Laura Kalambokidis
State Economist Laura Kalambokidis: “There remains uncertainty, but it feels like it’s a more-normal level of uncertainty, more-normal types of uncertainty than what we were seeing a few years ago.”

It might have been one of the lesser-known casualties of the COVID-19 pandemic, but for the people responsible for predicting how much revenue governments would collect, it was significant: Economists struggled to accurately forecast Minnesota’s economy and revenue.

Quarter-after-quarter, starting the spring of 2020, economic and revenue forecasts were off — sometimes way off. In the first year, Minnesota’s fiscal situation lurched from a $1.51 billion surplus before the pandemic was declared, to a $2.42 billion deficit two months later to a $641 million surplus by year’s end.

“I feel like we’ve been on a year-long roller coaster; an unwelcome ride,” then-Minnesota Management and Budget Commissioner Jim Schowalter said in February of 2021 after announcing that the surplus had jumped to $1.67 billion.

But a tax collections report released by MMB Monday suggests the roller coaster ride might be at its end  — at least for the economists charged with telling state policy makers how much money current taxes will collect. In August, state taxes brought in $1.109 billion or $61 million more than expected. While sales taxes were below the forecast by just $1 million, the other large sources of revenue — the individual income tax and the corporate franchise tax — were a bit higher.

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Monday’s report continues a seven-month string of collection reports with numbers as close to no-change as could be expected by pre-pandemic standards. While the COVID pandemic produced wild swings in revenue forecasting, from a deep recession to a faster-than-predicted recovery and a continued economic growth, revenue forecasters prefer slow and steady and predictable.

Tax collections since the last official economic and revenue forecast in February have been just that. In seven months of payments to the state, current taxes raised $635 million more than forecast. Real money, for certain, but not as huge a discrepancy as was commonplace since the pandemic was declared in March 2020.

“There remains uncertainty, but it feels like it’s a more-normal level of uncertainty, more-normal types of uncertainty than what we were seeing a few years ago,” said Laura Kalambokidis, the chief economist for MMB. But she wasn’t ready to conclude that the forecasting storm that accompanied the pandemic is over.

“Having lived through that I know better than to sit back and say, ‘It looks like smooth sailing,’” Kalambokidis said. “Instead we have a little bit of breathing room to look forward to what might be coming next and work on our modeling, work on our understanding of the economy, work on our understanding of taxpayer behavior and responses to law changes.”

As the regular MMB caveat states — “monthly variations should be interpreted with great caution.” But the seven-month pattern of tax collections does suggest less volatility. After a February collections report that was $99 million below forecast, the monthly memos issued by Kalambokidis’ office have shown relatively minor but positive numbers each month, except May when they were a spot-on minus $7 million. This in a state government that collects an average of $2.5 billion a month.

All that is a relief for forecasters. And while it is not creating the types of windfall surpluses that some legislators have enjoyed, it makes for more-stable budgeting. 

That hasn’t been the case since the pandemic hit. Minnesota was hardly unique in its struggle to forecast an unprecedented economic event. It vexed economists for the federal government, other states and private companies. Pressured to produce an emergency forecast in May 2020, the MMB response of a recession was a best-guess for an unprecedented economic gut punch. And while a deep recession did occur, it was brief because the COVID recession hit different residents differently. Many people could work from home. Those who couldn’t and were out of work were helped by massive federal increases in direct payments and unemployment assistance that included people not normally covered by that system. People continued to spend. Income taxes, sales taxes and corporate taxes performed better than economists guessed they would when public health responses began.

But the steady march of larger-and-larger surpluses didn’t stop, making those early numbers seem like mere budget dust. Each forecast predicted more tax revenue than had been expected previously. Nearly every monthly tax collection report — money in the bank versus projections — was higher than the forecast. And then the next official economic and revenue forecast would put the previous number to shame: $7.75 billion in November of 2021, $9.25 billion in February of 2022, $17.6 billion in November of 2022 and $19 billion in February of this year, though that number was officially set at $17.5 because inflationary increases in spending were automatically taken out.

That continued climb has created an expectation that the economy would continue to outperform the costliest computer programs and the most-practiced forecasters. While a cause for giddiness among some lawmakers, such instability does not make for sound budgeting, either frightening them into cutting spending prematurely or tempting them to spend too much.

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As recently as February, there were economic concerns over the war in Ukraine and how it would affect energy and food prices. The Federal Reserve’s use of interest rate hikes to curb inflation was still in process with the risk of inflation still present. The impact of those factors on the national and state economies has become a bit more clear.

“It is good to be in a situation that feels like we have this normal degree of uncertainty,” Kalambokidis said. “We don’t know everything that is coming around the corner, but it feels like we know what corners we’re supposed to be monitoring.”

The pandemic changed the economy in ways economists are still trying to fully understand. Whether people decide to return to work, for example. How many hours they work.

“There are still aspects of this economy that we are still trying to understand,” she said. “They might not be fully understood until they make their way to the rear view mirror.” 

Recession? What Recession?

A year ago, the state’s global economic forecaster said that not only was a recession on the way, it had already started. IHS Markit told MMB that the national economy would fall into a mild recession beginning in the final quarter of 2022 and wouldn’t pull out until the third quarter of 2023. It didn’t happen, but forecasts of negative growth and higher unemployment filter down into how taxes will perform.

In its latest update issued in July, IHS Markit does not forecast a national recession but does continue to see only modest economic growth, 1.2% in 2024 and 1.5% in 2025. A new update from IHS Markit comes out Oct. 10, and the next twice-a-year state economic and revenue forecast comes out in December. It is that forecast that Gov. Tim Walz and the DFL-controlled Legislature will decide how much, if any, to spend on a supplemental spending and revenue plan. The state enters that forecast, however, with a $1.6 billion surplus, plus a rainy day fund of $2.852 billion.

The 2023 session of the Legislature increased biennial spending from $51.6 billion in the 2022-23 two year period to $71.5 billion for the two years that began July 1. Some of it is one-time spending to draw down the surplus. But some is ongoing spending that is able to continue for the next four years because of money from the tax hikes and an expected surplus for the budget that begins in mid-2025. That budget is projected to be $66.1 billion, according to MMB.

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Editor’s note: This story has been updated with an additional sentence adding national context about economic forecasting during the pandemic.