Minnesota Earns High Marks for Fiscal Responsibility

Last week, Standard & Poor’s (S&P) upgraded Minnesota’s  general obligation (GO) bond rating to “AAA”—its highest ranking. Minnesota became one of only thirteen states to enjoy a AAA GO rating from at least two of the “big three” credit rating agencies (S&P, Fitch, and Moody’s). The improvement in Minnesota’s credit rating not only has the immediate benefit of reduced borrowing costs, but marks an improvement in the state’s financial health resulting from responsible and progressive fiscal policies.

Seven years ago, the state’s fiscal health was far more precarious. In 2011, a 20-day state government shutdown ensued when Governor Mark Dayton and conservative legislative leaders failed to reach agreement on a state budget. To end the shutdown, Dayton acquiesced to a conservative budget which included a pair of arcane accounting maneuvers. These maneuvers had the net effect of reducing state spending by delaying aid payments to public schools (thereby compelling school districts to engage in short-term borrowing or spend down their budget reserves) and by selling a future stream of state revenue from the 1998 tobacco settlement for the sake of a one-time upfront cash infusion.

The accounting gimmicks applied in 2011 did not solve the state’s budget problems, but merely postponed them. At the end of the 2011 special session, the state general fund was officially projected to have a $600 million structural budget deficit in fiscal year (FY) 2012-13 and a $1.9 billion deficit in FY 2014-15. (If the forecast had included the full effect of inflation—per the recommendation of the non-partisan Minnesota Council of Economic Advisors—the projected structural deficit would have been about $2.6 billion, according to the November 2011 forecast.) In addition, the state budget reserve for both biennia was projected to be zero.


In the aftermath of this fiscal debacle, both S&P and Fitch downgraded Minnesota’s GO credit rating, citing the “state’s reliance on non-recurring gap-closing measures” (i.e., accounting gimmicks). Moody’s stripped the state of its AAA rating eight years earlier, largely in response to accounting gimmicks employed at the dawn of Minnesota’s “no new tax” era. In the wake of the 2011 conservative budget triumphs, Minnesota was without a AAA rating from any of the big three rating agencies for the first time in recent history.


Minnesota’s fiscal health began to improve in 2013, when Governor Dayton and new legislative majorities enacted significant state tax increases. While conservatives complained mightily about the tax hike, a close examination of Minnesota Department of Revenue tax incidence data shows that the net effect of the 2013 and 2014 tax changes probably reduced or held constant the combined state and local taxes paid by most Minnesotans. While income taxes increased for the 2% of Minnesotans with the highest incomes, these households still have among the lowest state and local effective tax rate of any group in the state, according to the 2017 Minnesota Tax Incidence Study.

With new revenue generated from the 2013 tax act, the state balanced the state budget without the use of accounting gimmicks, paid back school funding shifts enacted in previous years, and rebuilt its depleted budget reserve. In addition, the state restored a portion of funding cuts to local governments—including school districts†—and higher education, and targeted significant new property tax relief to homeowners and renters.

In response to these changes, Fitch restored Minnesota’s AAA rating in 2016, noting “strong control over revenues and spending that, in conjunction with a sophisticated approach to reserve funding, leaves the state exceptionally well positioned to manage throughout the economic cycle while maintaining a high level of financial flexibility.” Last week, S&P followed suit: “The upgrade [to AAA] reflects the state’s improved financial performance, return to strong budget management and structural budget balance, and the 2018 Omnibus Retirement Act, which is expected to decrease pension liabilities through benefit reform and increased contributions.”

Minnesota’s restored AAA rating is not simply the result of the improved national economy. From 2011 to 2017, only eight states enjoyed an improvement in their credit rating from S&P, while nine had their credit rating downgraded. For example, Kansas—which strictly adhered to conservative supply-side fiscal doctrines—was downgraded twice by S&P since 2011.

Competent fiscal management—the cornerstone of which was a needed increase in state revenue—enabled Minnesota to achieve a financial turnaround. With responsibly balanced budgets, a strengthened budget reserve, and stabilized public pension funds, the state is on sound financial footing and deserving of the high marks from credit agencies.

 

*The structural budget balance refers to the difference between total revenue coming into the general fund during a biennium (excluding the balance carried forward from the previous biennium) minus total general fund expenditures. When expenditures exceed revenue, the general fund has a structural deficit. The structural balance is used as a barometer of the long-term health of general fund finances.

Revenue generated from the progressive tax increases enacted in 2013 enable the state restore about half of the decline in real per pupil state operating aid to school districts that occurred over the preceding decade, as documented in a 2017 North Star report.