February forecast brings welcome news, but uncertainty still reigns

Feb 28, 2018

Today the state’s Minnesota Management and Budget released the February Budget and Economic Forecast. The February forecast compares what the state would be expected to spend on schools, roads, and other public services under existing laws and current projections for economic growth, and how much revenue the state would expect to bring in. This forecast will set the stage for making budget and tax decisions in the current legislative session.

Today’s forecast showed a $329 million surplus for FY 2018-19, the current budget cycle, and $313 million for FY 2020-21. These numbers are an improvement over what was shown in the November forecast. Since November, federal policymakers reauthorized funding for the Children’s Health Insurance Program (CHIP) and enacted a major tax bill. And at the state level, policymakers passed funding for the Legislature just this past week. Today’s projections takes into account these recent changes.

Here are our top takeaways:

  1. The forecast projects a $329 million surplus for FY 2018-19. That equals less than one percent of the total two-year budget, which runs through June 30, 2019.
  2. The February forecast also projects a future structural balance. Today’s report shows a $313 million positive balance for the upcoming FY 2020-21 biennium. However…
  3. The future balance does not take into account what it takes to maintain current levels of state services. Keeping up with inflationary costs on Minnesota’s current commitments would cost another $1.2 billion in FY 2020-21. In other words, these projections are built on the assumption of flat funding for many areas of the budget.
  4. The forecast expects stronger short-term economic growth than projected in the November 2017 forecast. Every forecast includes a best guess at what the national economy will do over the next few years, and today’s report expects the economy to continue growing. National GDP growth is expected to be faster: 2.7 percent in both 2018 and 2019, rather than the 2.5 and 2.2 percent expected in November. However, this boost is short lived. By 2021, economic growth is expected to drop below November’s estimates to 1.9 percent. These figures include a modest annual increase 0.1 to 0.3 percentage points through 2021 from the expected economic impact of the federal tax bill.
  5. There are a number of sources of uncertainty. IHS Markit, Minnesota’s economic consultant, assigns a 65 percent probability to their baseline economic forecast, a 20 percent probability to a more pessimistic scenario, and a 15 percent probability to a more optimistic scenario. In addition, this forecast includes projected revenue increases that are anticipated to occur as a result of the federal tax bill; however, predicting how people and businesses will respond to the federal tax bill is tricky and we’re in some uncharted territory. And while federal policymakers have put proposals on the table that would deeply cut federal funding to the state, the forecast does not assume any changes to the federal budget that have not yet been enacted.
  6. This is one-time good news. It’s important to note that the surplus is largely due to temporary, not ongoing, factors. The federal tax bill is expected to bring short-term economic growth, but that impact is expected to be followed by slower economic growth in future years.

What do these numbers mean for the tax and budget choices that policymakers will be facing during the 2018 Legislative Session?

Governor Mark Dayton’s supplemental budget proposal for FY 2018-19 is expected to be released mid-March, and the Legislature will make choices this session about how to respond to both the news in the state forecast and the federal tax bill passed last year. Since policymakers passed the state budget for the FY 2018-19 biennium last year, any budget and tax changes passed this year will be supplemental to what’s already in law.

Policymakers must keep in mind that underlying the positive forecast figures is a higher than usual uncertainty, and they must avoid using temporary boosts in state revenues to fund ongoing commitments. Failing to heed these cautions could create funding shortfalls in the future and weaken the state’s ability to respond to potential cuts in federal funding or an economic downturn.

These principles are especially important to bring into the task of responding to the federal tax bill. This sweeping and complicated piece of legislation traveled quickly through Congress and passed days before Christmas, which means tax policy experts and the public are still working to understand the implications. Because Minnesota’s individual income tax and corporate tax systems use federal tax law as their starting point, Minnesota policymakers have to decide whether to follow those new federal changes.

Their response should be grounded in Minnesota values, including treating all taxpayers fairly and the importance of fiscal responsibility and maintaining the revenues needed to sustainably fund the state’s priorities. Initial analysis shows that fully conforming to the federal tax bill would raise revenues from both the individual income tax and corporate taxes. But the impact would vary – some Minnesotans would face tax increases, such as families with dependents and people receiving property tax refunds, while others would see tax cuts. Taking targeted action to avoid raising taxes on low- and middle-income taxpayers should be a priority. Minnesota also can’t afford to enact large additional state tax cuts for those who will be receiving the largest federal tax cuts: profitable corporations and the highest-income households. Doing so would reverse the state’s progress toward a tax system that is more equitable to Minnesotans of all income levels.

Given the high level of uncertainty – about the economy and future federal funding – now is a good time to strengthen our state’s budget reserve. In fact, if this surplus had occurred in November, under state law about $117 million would have gone into the reserve. That addition would bring the reserve to 79 percent of the level recommended by Minnesota Management and Budget to be able to get through most recessions that might come our way.

In a time of great uncertainty, policymakers have an opportunity to work toward making our state a place where everyone can thrive.

-Clark Goldenrod