News & Updates

The projected budget surplus for the upcoming FY 2018-19 biennium increased by $250 million to $1.65 billion, based on Minnesota Management & Budget’s (MMB) February forecast, released today. The surplus for FY 2020-21 biennium—the start of which is still 28 months away—increased by $684 million; however, inflation remains the 800-pound gorilla in the room, as its impact is largely ignored in general fund expenditure forecasts. Uncertainties regarding the national economy and federal fiscal policy also cast a pall over rosy forecast projections.

State general fund revenue collections during the FY 2018-19 biennium (which will begin on July 1, 2017) increased by $321 million over the preceding November 2016 forecast, driven by a substantial improvement in projected state individual income tax collections and much smaller improvements in corporate income and sales tax collections. The FY 2018-19 surplus was also buoyed by improved revenue collections during the current FY 2016-17 biennium, which is primarily responsible for an $87 million increase in the balance carried forward into FY 2018-19. These improvements in the February forecast were partially offset by a $156 million increase in projected spending in FY 2018-19, resulting in a net increase of $250 million in the projected FY 2018-19 surplus relative to last November’s forecast.

Revenue collections in FY 2020-21 are also expected to improve to the tune of approximately $900 million, and are the driver behind the large increase in the officially projected surplus in that biennium. MMB attributes the increase in projected revenues over the next four years to an improved outlook for the U.S. economy:

The outlook for U.S. economic growth has improved since the November forecast. The recent economic data has been mostly positive, showing improvements in personal income, business spending on equipment and structures, employment, and consumer spending.

A commonly used metric for the long-term health of the state general fund is the “structural balance,” which is a comparison of all the revenue coming into the state general fund over the course of a biennium (ignoring balances carried forward from the preceding biennium) to general fund spending over the same period. The February forecast projected structural balance is $922 million for FY 2018-19 and $2.124 billion for FY 2020-21.

The state should proceed with caution, however, because these rosy projections are driven in large part by the statutory requirement that MMB take into account inflation on the revenue side of the state ledger, but largely ignore it on the expenditure side. As a result, these spending projections do not reflect the full cost of maintaining state services at a constant level. Fortunately, MMB does provide an unofficial projection that takes into account inflationary pressures that are omitted from the official forecast.

Estimated inflation in areas of the general fund not factored into the official forecast for FY 2018-19 is just over $1.1 billion—greater than the entire projected structural surplus. In other words, after taking into account the estimated impact of inflation, the projected FY 2018-19 structural surplus of $922 million becomes a structural deficit of $187 million.

The MMB inflation estimates cited here are informal and do not reflect the rigor that MMB would employ if these estimates were actually part of the official state budget forecast. Nonetheless, these are the best estimates currently available as to the impact of inflation excluded from the official general fund forecast—and these estimates clearly indicate that the general fund surplus for the FY 2018-19 biennium could dissipate rapidly once we take inflation into account. Furthermore, the anticipated surplus for FY 2020-21 also becomes a deficit once the estimated effects of inflation in that biennium are factored in.

The non-partisan State Council of Economic Advisors (CEA), whose members represent a range of different economic schools of thought, have long recommended that the impact of inflation be fully taken into account in the state’s budget forecast. A statement from the CEA published in the February forecast document notes that:

As it has done every year since 2003, the CEA recommends that budget planning estimates for the next biennium include expected inflation in both spending and revenue projections. The CEA noted that Minnesota’s current practice of excluding projected changes in the prices of goods and services from a majority of the spending estimate is fundamentally misleading. It is 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. The omission of inflation in the spending estimates in the November 2016 Budget and Economic Forecast understated the cost of current services as provided by law in FY 2018-19 by roughly $1.3 billion, and thus made the amount of projected revenues above the cost of providing services to appear to be larger than it actually is. This distortion will increase if and when inflation accelerates from current historically low levels.

Inflation is not the only downside risk to February forecast projections. MMB notes ongoing uncertainty regarding federal trade (including the possibility of a trade war), immigration, and health care policy to be sources of risk as well. Furthermore, as the current recovery ages, the likelihood of another recession increases, and the anemic nature of the current recovery—with national GDP growth below long-term averages—makes the national economy more vulnerable to any economic shock. Beginning in 2018, the CEA believes that most of the economic risks inherent in this forecast “are primarily on the downside.”

A careful reading of the February forecast document indicates that the projected surpluses may be illusory and could disappear entirely after fully taking inflation into account. Caution is in order as policymakers consider large tax cuts of the type many conservative groups have been advocating.

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