House leadership recently released budget targets that focus the projected $900 million state budget surplus on tax cuts and increased transportation spending—two areas in which state policymakers failed to enact major legislation during the 2015 session. The bonding target in the House budget is $600 million.

The House budget targets would provide no increase in state funding for K-12 education, higher education, or health & human services, even though a recent North Star report demonstrated that current state funding for K-12 and higher education is significantly below the FY 2003 level, after adjusting for inflation and enrollment growth. Minor spending increases in environment & natural resources and jobs & energy are paid for by cuts to state government, agriculture, public safety, and debt service spending.

The precise division of the $900 million surplus between tax cuts and increased transportation spending is not specified in the House’s budget resolution. Because no consensus was reached during the 2015 session regarding the tax and transportation omnibus bills, these two conference committees are still “open.” Last year’s House and Senate tax bills currently reside in the tax conference committee, awaiting the resumption of negotiations before the end of the current legislative session.

According to a May 2015 fiscal analysis prepared by non-partisan legislative fiscal staff, the 2015 House tax bill would have cut taxes in the current FY 2016-17 biennium by over $2 billion.* That analysis assumed that the House tax bill would have been enacted during the 2015 session; the level of FY 2016-17 tax reductions would be much lower if an updated version of the House tax bill were enacted today because we are already over one-third of the way through the FY 2016-17 biennium. If we assume that the projected effects of the House tax bill are simply postponed by one year because that bill would be enacted in 2016 instead of 2015, the revenue loss in FY 2017 would be nearly $900 million,† which would leave precious little left over for transportation.

Consequently, if substantial resources are to be left over for new transportation spending in the current biennium, the level of the tax cuts proposed in last year’s House omnibus tax bill will have to be significantly reduced. Furthermore, the level of tax cuts in future years under the 2015 House tax bill will have to be dramatically reduced, even if we set aside no additional resources for transportation. For example, the May 2015 analysis projected that the 2015 House tax bill would reduce tax revenue by approximately $2.8 billion during the second and third years of implementation; the projected surplus for the next biennium is only $1.2 billion.

To further complicate matters, the above analysis assumes that the impact of inflation on state general fund spending will be virtually zero.‡ As the non-partisan Minnesota Council of Economic Advisors has repeatedly pointed out, discounting the effects of inflation on state expenditures will result in exaggerated estimates of the size of future surpluses (or understated estimates of future deficits). If we properly take into account the effects of inflation on state spending, the projected $1.2 billion surplus in the next biennium will be greatly reduced. This will require even greater curtailments to the level of tax cuts proposed by the House in 2015.

The implication of this is that—given the spending parameters of the newly released House budget targets—House leaders will need to dramatically pare down their 2015 tax cut wish list (assuming, of course, that they do not engage in accounting shifts). This paring will occur not in response to the competing budget priorities of Governor Dayton and the Senate (these pressures will come to bear later during negotiations over final budget targets), but in response the uncompromising reality of the state’s financial situation.

*A recent North Star article projected what the current state budget balance would be if the House or Senate omnibus tax bills or the Governor’s tax proposal had been enacted during the 2015 legislative session.

†If the 2015 House tax bill were to be enacted in during the 2016 legislative session, effective dates and other provisions of the bill would have to be modified, which—along with changes in the state’s economy—could alter the revenue loss resulting from the bill during the first full fiscal year of implementation.

‡With the exception of a subset of health & human services spending, current state law requires that the official state budget forecast ignore the impact of inflation on state expenditures. However, the effects of inflation are included when projecting state revenues.