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ABOUT USThe Minnesota Budget Project is an initiative of the Minnesota Council of Nonprofits.
State Budget Deficits Continue Through 2007A Response to the February 2004 ForecastThe Forecast NumbersThe February Forecast released by the Minnesota Department of Finance shows little change in the economic and budget picture from what was described in the previous forecast in November. Many observers were relieved, as speculation before the Forecast’s release was for a worsening of the state’s short-term budget deficit. However, even though conditions were not much changed, the picture the Forecast paints is still bleak: the state faces continued deficits even as the economy is expected to improve. For the 2004-05 biennium, state general fund revenues are expected to be $160 million less than spending, an improvement from the $185 million deficit measured in November. The change comes from a $46 million reduction in estimated spending, which is partially offset by a $21 million decrease in revenues.[1]
In contrast, the structural deficit for the 2006-07 biennium has widened by $47 million from November’s estimate, and now is at $441 million. In this case, a $76 million reduction in predicted spending is not enough to overcome a $123 million decline in revenues from November estimates. If inflation were factored into the forecast, spending estimates would be $650 million higher, for a total deficit of $1.1 billion in the 2006-07 biennium. The $441 million 2006-07 deficit cannot be blamed on growth in spending. State spending is forecasted to increase by 2.5% per year in the 2006-07 biennium, with the only growth coming from larger caseloads and higher costs for health care and long-term care. All other major spending areas, including K-12 Education and Higher Education, are forecast to receive no significant funding increases in 2006-07. Revenues are forecast to grow by about 4% per year, including inflationary growth. Even though revenues are expected to grow faster than spending, it is not enough to close the budget gap, because the biennium starts with a shortfall in revenues. The Forecast reports that the state’s Budget Reserve is $631 million, which is equal to 2.2% of biennial spending. The target recommended by the state’s Council of Economic Advisors for the Budget Reserve is 5% of biennial spending, or $1.4 billion. Economy Expected to Improve, But Risks RemainThe economic model on which the Forecast is based has grown slightly more positive than in November. In fact, national annual economic growth as measured by Gross Domestic Product (GDP) in the 2004 calendar year is expected to be 4.8% — the strongest in 20 years — followed by 3.8% annual growth in 2005. This leads to hopes for an increase in job growth in the spring and summer. No one can predict the future with certainty, and therefore risks remain. These risks are of two types: risk that the economy and labor market will not perform as predicted, and risk that revenues may not be as forecasted, even if the economy matches predictions. These risks always exist, but are of particular importance at this time because the state has nearly exhausted all of its options for dealing with unexpected shortfalls. Risk #1: The Economy and Labor Market May Not Perform As PredictedGlobal Insight, the state’s economic advisors, gives a 60% probability that the economic scenario that is the basis of the forecast is correct. They give a 20% chance each to a scenario that is more optimistic (0.5% higher GDP growth in 2004 and 2005) and one that is more pessimistic (0.8% lower growth in 2004). Even the pessimistic scenario calls for quite strong economic performance. Whether this economic growth will bring about a long awaited improvement in the labor market remains to be seen. Minnesota’s job market has grown faster than in the U.S. as a whole, but unfortunately most job growth occurred last summer, with no significant improvements since then. Unemployment remains high, and from late December 2003 through the end of March 2004, an estimated 18,700 unemployed Minnesotans will have exhausted their Unemployment Insurance benefits without finding other jobs.[2] The number of new jobs predicted in the Forecast would be just enough to keep up with new entrants to the workforce and produce a small reduction in unemployment. Minnesota’s workforce will face challenges even if the job numbers improve. Over the next three years, the Forecast reports that there will be significant changes in Minnesota’s mix of jobs. This means that unemployed workers may need training to win employment in a different field, and new workers may have to choose different jobs than they would have picked in the past. The Forecast notes that the loss of jobs in the public sector has been a drag on growth. In addition to a net loss of 7,335 state and local government jobs lost last year,[3] additional reductions in public sector jobs in the first half of 2004 are expected to partially offset anticipated growth in the private sector. State and local government are expected to lose 6,000 jobs over the next three years. Risk #2: The Economy and Labor Market Perform As Predicted, But Revenues Fall Below ExpectationsThe Forecast notes that there is risk that, even if economic growth matches the forecast, state revenues could be below estimates. The authors of the Forecast faced challenges in modeling expected revenues from corporate taxes, capital gains, and sales taxes. The Department of Finance and State Economist have warned that if these items were not adjusted correctly, revenues could be off by significant amounts even if the economy performs as expected. Why Deficits PersistThe February Forecast expects that revenues will continue to be insufficient to fund the state’s commitments to services in the years covered by the Forecast. This would mean five straight years of deficits in Minnesota (FY 2002 to FY 2007). Unlike some of the budget challenges the state has faced in the past, the current deficit is not caused by the economy doing poorly. In contrast, as noted above, the Forecast expects the strongest economic growth in 20 years. The presence of ongoing budget holes even in a good economy points to a mismatch between the state’s system of raising revenues and the cost of meeting the state’s commitments. One contributing factor is the permanent tax cuts enacted during the five surplus years (1997 to 2001), which has reduced 2004-05 revenues by $5.5 billion.[4] This is not to say that if there had been no tax cuts, the state would have not faced deficits over the past few years. What the state’s fiscal situation would be in the absence of these cuts depends on how the resources that went to tax cuts would have been allocated instead. However, it can be argued that these tax cuts were excessive, as at the time it was claimed that they could be made without causing future deficits, which clearly has not been the case. In addition, use of one-time solutions in the 2002 and 2003 Legislative Sessions meant that budget holes were closed in the short-term, but long-term problems remained. Prior to 2002, policymakers agreed that although the Constitution only requires that the budget be balanced by the end of the biennium, it was a good financial practice to create a balanced budget in the next biennium as well (the so-called “out years”). This sound fiscal policy was abandoned once deficits appeared in 2002. In the 2002 Legislative Session, one-time solutions such as reserves, transfers, and shifts made up 81% of the plan passed to address the 2002-03 deficit, with service cuts making up most of the remainder. In addition, a 2004-05 deficit measured at $1.5 billion was left to be tackled in the next session. In the 2003 Legislative Session, the 2004-05 deficit grew to $4.2 billion, and this time, reserves, shifts, and transfers were 37% of the overall solution and spending cuts 46%.[5] And while the 2006-07 budget appeared to be balanced at the end of the 2003 session, this was short lived: the November 2003 Forecast showed a $394 million structural deficit for 2006-07, which has grown to $441 million. Next StepsWhile it is not required that the 2004-05 budget be brought into balance by the end of the 2003 Legislative Session, the Governor has proposed a solution for the 2004-05 deficit in his supplemental budget, and it is expected that the Legislature will try to find some resolution for the short-term budget deficit this session. Although the use of reserves has been part of past deficit solutions, this session policymakers have stated a reluctance to use the state’s $631 million Budget Reserve. Sound budget principles state that reserves should be built up during good economic times, not depleted. Drawing on the reserves at this time would further damage the state’s credit rating. The Forecast notes that policymakers may be more reluctant to tap into the Budget Reserve this time because many of the state’s other tools for managing risk – such as the cash flow account, unspent balances, and timing shifts — were largely used up in addressing deficits in prior sessions. The loss of other risk management tools is also the reason why the size of the Budget Reserve — although it is not much smaller than it was during the surplus years — is of greater concern than in the past. One of the principles for budget balancing that we have advocated over the past several legislative sessions is that budget solutions should be informed by past decisions. In this case, policymakers should be aware that solving this year’s deficit through more service cuts will compound the consequences from significant reductions made in the 2003 Legislative Session. Last year, $2.1 billion in service cuts were made to address the 2004-05 budget deficit. Initial information demonstrates that these decisions have had a serious, negative impact on the lives of Minnesotans, including:
Many expect the consequences to be worse in 2004 and 2005, as local governments and nonprofit agencies across the state were often able to postpone the brunt of the impact through use of reserves or other one-time measures.[10] As in the last two legislative sessions, we continue to call on policymakers to take a more balanced approach to solving the deficit. The pattern of short-term budget fixes demonstrates the extreme difficulty of addressing large deficits and finding a long-term solution under the “no new taxes” conditions set by the Governor and many members of the Legislature. The deep service cuts that have been made, which have created a serious hardship for many Minnesotans, have been insufficient to solve the budget deficit. Instead, past budget solutions have used one-time measures including reserves, timing shifts, and other budget gimmicks to plug budget holes in the short-term. They have also raised revenues through a patchwork of increased fees, tuition, and copayments, and recaptured dedicated funds and revenue sources. This means that Minnesotans are indeed paying more for government services, but the “no new taxes” pledge technically remains unbroken. It is time for a serious discussion about what reforms are needed so that the state can fairly raise the funds needed to sustain government services and balance the budget in the long term. Click on the footnote number to return to text. [1] Except where otherwise noted, all data in this document are from the Minnesota Department of Finance, February 2004 Economic Forecast,. The opinions expressed in this document are the author’s. [2] Center on Budget and Policy Priorities, More Than One Million of the Unemployed Have Now Been Denied Aid Due to End of Federal Program: Exhaustions Continue At Unprecedented Pace. [3] Change in jobs from December 2002 to December 2003, Minnesota Department of Employment and Economic Development, Current Employment Statistics. [4] House Fiscal Analysis, Tax Cuts and Rebates: The Fiscal Impact of Five Years of Tax Cuts. [5] Author’s calculations based on data from House Fiscal Analysis. See Minnesota Budget Project, Budget Decisions in the 2002 Legislative Session. [6] Minnesota Department of Human Services. [7] Children’s Defense Fund-Minnesota and Child Care WORKS, Feeling the Pain: The Emerging Impact of Minnesota’s $86 million cut to Child Care. [8] Minnesota Department of Human Services. [9] House Fiscal Analysis, Summary of the Fiscal Actions of the 2003 Legislature, and Minnesota Higher Education Services Office, Impact of Changes in Minnesota State Grants Implemented in Fiscal Year 2004. [10] For more on this issue, see Minnesota Budget Project, Consequences: The Impact of Minnesota’s Government Budget Cuts. March 2004 |
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