Budget Deficits on the Horizon

With an official projected state budget surplus of $329 million in the current fiscal year (FY) 2018-19 biennium and $580 million in the upcoming FY 2020-21 biennium, some state lawmakers are giddy about the prospects of more tax cuts during the 2018 legislative session. However, there are at least three good reasons why Minnesota policymakers should be hesitant about indulging in permanent tax cuts.

First, expenditures made from the state general fund are expected to exceed revenues coming into the fund by nearly $1 billion during the current biennium. In other words, the general fund will have a structural deficit. The only reason that the state has a positive budget balance is because of the large unspent balance carried forward from the preceding biennium. However, the balance carried forward represents one-time revenue.

Second, the projected surplus in the upcoming FY 2020-21 biennium ignores the impact of inflation on approximately three-quarters of state general fund expenditures. This practice is “fundamentally misleading” and “inconsistent with both sound business practices and CBO [Congressional Budget Office] methods and potentially encourages legislators and the public to regard the state’s financial position more optimistically than the facts warrant,” according to the non-partisan Minnesota Council of Economic Advisors.*

After fully factoring in inflation, the $580 million budget surplus projected for FY 2020-21 becomes a $644 million deficit based on Minnesota Management & Budget (MMB) estimates from the February 2018 forecast. Meanwhile, the structural deficit (i.e., general fund revenue minus total expenditures, ignoring the balance carried forward from FY 2018-19) swells to $911 million.

Third, conservative projections of state spending growth after FY 2021 indicate that significant structural budget deficits could become the norm—even without permanent tax cuts. For example, if we assume that per capita general fund spending increases at the rate of inflation projected for state and local governments† and that state revenues increase at the annual rate projected by MMB for FY 2019 through FY 2021, the state will have a substantial structural budget deficit in two of the subsequent three biennia as shown in the chart below:


After enjoying a modest structural surplus in FY 2022-23, the state general fund is projected to see structural deficits in FY 2024-25 and FY 2026-27. If we extrapolate these findings further into the future, the structural deficit will continue to grow after FY 2026-27.

Our projections are actually optimistic because:

  • They make no special adjustment for increased health and human service expenses resulting from the aging state population.
  • They assume that the current economic recovery will continue indefinitely. As the current recovery ages, the likelihood of a recession increases—which would have the effect of reducing state revenues and swelling structural deficits. For example, if a recession occurs sometime between now and 2021, the state’s structural budget outlook worsens.
  • They use the official general fund expenditure projection for FY 2020-21 as a baseline. As noted above, the official projections exclude most of the effects of inflation on FY 2020-21 general fund spending. Including the full impact of inflation would increase projected spending in the FY 2020-21 baseline, which would have the effect of increasing projected spending in subsequent biennia. As a result, the modest FY 2022-23 structural surplus would become a deficit and the structural deficits in FY 2024-25 and FY 2026-27 would again worsen dramatically.

Needless to say, there is a degree of uncertainty in all general fund revenue and expenditure projections. This is especially true for projections which extend beyond the state’s current FY 2020-21 planning horizon. However, these projections are based on reasonable and realistic assumptions. It would be unwise for policymakers to assume that the state’s fiscal outlook will be considerably brighter than that indicated above.

Thanks to prudent fiscal management in recent years, the state is currently on a strong fiscal footing, with relatively well-funded budget reserves and cash flow accounts. Furthermore, the projected structural deficits illustrated above for FY 2024-25 and FY 2026-27 are modest and could be addressed through modest revenue and expenditure adjustments. However, that will not be the case if the state undermines its future revenue base through large permanent tax cuts.

 

*As quoted in the February 2018 forecast documented.

The inflation adjustment in this analysis is based on the Implicit Price Deflator for State and Local Government Purchases, which is the appropriate index to use when adjusting state expenditures for the effects of inflation.