Minnesota's Budget Surplus: Balancing Tax Cuts and Investments

I. Introduction

Last March, a group of legislators gathered at the State Capitol with a simple message: “Give it back!” The “it” refers to the state budget surplus, then projected to be nearly two billion dollars for the upcoming fiscal year (FY) 2016-17 biennium. These legislators urged Governor Dayton and their House and Senate colleagues to return the entire amount to taxpayers. With another budget surplus indicated in the February forecast, we are already hearing more cries of “give it back” from conservative policymakers and interest groups.

The “give it back” message is short, clear, and direct—precisely the type of slogan that plays well in today’s sound-bite culture. However, it is simple to the point of being simplistic, failing to take into account the demands that citizens place on state government—many of which are not being adequately met. The “give it back” campaign maximizes the short-term appeal of tax reductions, while shortchanging the long-term public good achieved through adequately funded public services and infrastructure.

The hallmark of the “give it back” campaign is that the entire surplus—with the possible exception of some additional spending for highways—should be dedicated to tax cuts. A balanced approach which involves new state investments along with tax reductions is not envisioned; “give it back” proponents want every penny of the surplus to be dedicated to tax cuts. Priorities other than tax reductions are not just given the back seat—they’re not even allowed in the car.

The implicit premise of the “give it back” campaign is that the state budget is already bloated and thus the only legitimate use for the budget surplus is tax cuts. This report consists of a threefold critique of this assertion through an examination of (1) state general fund revenues, (2) state general fund spending, and (3) funding levels for specific programs/policy areas, including K-12 education, higher education, city Local Government Aid, highways, and pre-kindergarten (pre-K) education. Funding for each of these categories comes from the state general fund, with the exception of highways, which are funded through constitutionally dedicated taxes outside of the general fund.

The baseline year for the analysis of state revenues and expenditures will be FY 2003. In that year, state general fund spending jumped by nearly $900 million (approximately seven percent) due to the complete state takeover of public school general education expenses. This growth in state spending—which was supported by a majority of legislators of both major political parties and signed into law by Governor Jesse Ventura—did not represent an expansion of government, but rather a shift of funding for an existing function away from local property taxes and into the state general fund. Using a year prior to FY 2003 as the baseline year for this analysis could wrongly conflate the growth in state general fund spending resulting from the tri-partisan takeover of general education costs with actual growth in the overall size of government.

When examining growth in public revenues and expenditures over time, it is necessary to adjust for growth in the state population (which creates increased demand for state services) and the effects of inflation (which erodes the purchasing power of each dollar of state revenue). Hence, revenue and expenditures trends will be examined in real (i.e., inflation-adjusted) dollars per capita. Unless otherwise noted, all dollar amounts referenced in this report will be expressed in constant FY 2016 dollars with the exception of state appropriations for higher education student instruction and state highway revenues, which, for reasons discussed below, will be expressed in constant FY 2015 dollars.

Per the recommendations of the State Council of Economic Advisors, state general fund inflation adjustments in this report—including each of the subcategories of expenditures with the exception of two subcategories described below—will be based on the Implicit Price Deflator for State and Local Government Purchases (S&L IPD). A recent North Star article discusses the S&L IPD in greater detail.[1]

The factors that drive the cost of higher education in Minnesota are different from the factors that drive the costs of state and local government services generally. This report will use a specialized index—known as the Higher Education Cost Adjustment (HECA)—to adjust state higher education instruction appropriations for the impact of inflation.

Highways in Minnesota are largely funded outside of the general fund through three constitutionally dedicated state taxes. As with higher education, inflation in highway costs is driven by a unique set of factors (including the price of asphalt and petroleum) that differ from the factors that drive inflation for state and local governments generally. Based upon the recommendation of the Minnesota Department of Transportation, dedicated highway tax revenue amounts referenced in this report will be adjusted for inflation using the state and local government gross investment structure price index (the S&L GIPI) as calculated by the U.S. Bureau of Economic Analysis.

Neither the HECA nor the S&L GIPI is available for years after FY 2015; consequently, the analysis of higher education instructional costs and highway revenues cited in this report will be expressed in constant FY 2015 dollars, unless otherwise noted.

When possible, this report will examine projected revenue and expenditure amounts for FY 2016 and 2017. Dollar amounts for years prior to FY 2016 are actual or final, while amounts for FY 2016 and 2017 are projections. Projections for FY 2016 and 2017 assume no changes to current state law.

The facts revealed in the forthcoming sections indicate that real per capita state general fund revenues and expenditures are modestly to significantly less today than they were thirteen years ago. Funding for several critical state investments have either declined appreciably or—in the case of pre-K education—are not adequate to meet current needs. In light of this reality, the call to return every dollar of the current state budget surplus in the form of tax cuts is contrary to the best interests of Minnesota’s economy and quality of life.

 

II. State General Fund Revenues Since FY 2003

The premise of the “give it back” campaign is that the size of the state general fund has increased significantly—if not dramatically—over time. But has the per capita purchasing power of the dollars going into the state general fund—after properly adjusting for inflation and population growth—truly increased since the watershed fiscal year of 2003? If not, then the entire foundation of the “give it back” campaign begins to crumble.

This section will examine general fund “current resources,” which refers to all revenues flowing into the state general fund over the course of a fiscal year, excluding any balance carried forward from the preceding fiscal year. Calculations of the long-term structural balance of the state general fund are based on current resources.

The table below shows state general fund current resources from FY 2003 through the last year of the current biennium (FY 2017). Specifically, the table shows actual and projected current resources in nominal dollars (i.e., dollars unadjusted for inflation), current resources converted to constant FY 2016 dollars, annual state population estimates, and current resources in constant FY 2016 dollars per capita. Amounts in red are based on Minnesota Management & Budget (MMB) February forecast or State Demographer projections.

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From FY 2003 to the end of the most recently completed fiscal year (FY 2015), general fund current resources certainly did increase in nominal dollars. However, after accounting for the impact of inflation upon the purchasing power of the dollars the state collects and growth in the state’s population, real per capita general fund current resources declined by 2.4 percent over this period.

Current Resources

In FY 2003 state general fund current resources were $3,828 per capita. Current resources per capita fluctuated over the next three years before beginning a long downward slide, ultimately bottoming out at $3,066 in FY 2010—$762 per capita (19.9 percent) less than in FY 2003. During the lean years of FY 2009, 2010, and 2011, the state received significant federal stimulus dollars to help offset the decline in current resources and prevent massive budget cuts and layoffs.

Since the nadir of FY 2010, current resources have rebounded significantly due to a recovering economy and significant personal income and other tax increases enacted in 2013. However, FY 2015 current resources were $3,736 per capita—$154 per capita (4.0 percent) less than average per capita resources during the five year period preceding the Great Recession (FY 2003 to 2007). Even with the growth in revenues projected over the current biennium, FY 2017 current resources per capita will remain 3.1 percent below the FY 2003 to FY 2007 average.

The bottom line is that current general fund revenues are high only relative to the depths of the Great Recession. Real per capita general fund current resources in FY 2015 and projected revenues during the current biennium will remain below average annual current resources per capita over the five years preceding the Great Recession even before any new tax cuts are enacted.

 

III. State General Fund Expenditures Since FY 2003

Conservatives frequently complain about a state government that “constantly grows and spends more.” Along with growth in state revenues, the growth in state expenditures is a cornerstone of the “give it back” campaign. This section will examine the trend in real per capita state general fund expenditures to see if reality coincides with the claim of rampant spending growth.

An examination of general fund expenditures over time is complicated by the fact that these amounts fluctuate for reasons unrelated to the actual amount that state government is spending within a given fiscal year. Since FY 2003, three factors apart from the actual level of spending have contributed to year-to-year fluctuations in state general fund expenditures. These include:

  • K-12 funding shifts. During periods of budget deficits, state policymakers frequently respond by delaying a percentage of state aid payments to public schools until the following fiscal year.[2] While this shift does not reduce the amount that public schools are “entitled” to spend, it may require them to spend down budget reserves or engage in short-term borrowing. The primary effect of the K-12 funding shift is to reduce state spending on a one-time basis in the fiscal year in which the shift initially occurs. When the state’s fiscal situation improves, policymakers typically “buy back” the school funding shift, hence restoring the pre-existing aid payment schedule. Just as the initial funding shift creates an artificial one-time reduction in state expenditures, the “buy back” of the shift creates an artificial one-time expenditure increase. Net K-12 payment shifts occurred in FY 2003, 2004, 2010, 2011, and 2012, while shift buy-backs occurred in FY 2005, 2006, 2013, and 2014.
  • Federal stimulus dollars. As a result of the Great Recession, the federal government provided short-term revenues to state governments in order to offset the large loss in state tax revenues and to prevent deep budget cuts and layoffs. In Minnesota, the spending funded by the federal stimulus dollars was still occurring, but the dollars to pay for this spending were not provided through the state general fund, thus producing short-term reductions in general fund expenditures. However, because the spending was still occurring, the reduction in general fund spending resulting from federal stimulus dollars—and the subsequent increase in general fund spending when federal dollars sunsetted and spending was once again fully funded out of the general fund—is more illusory than real. Federal stimulus dollars received by the State of Minnesota were concentrated in FY 2009, 2010, and 2011.
  • Tobacco bond sale. As part of the deal to end the 2011 state government shutdown, state policymakers agreed to sell a future stream of state revenue resulting from the 1998 tobacco settlement for the sake of a one-time upfront cash infusion through the issuance of “tobacco settlement revenue bonds.” This revenue was used to reduce state general fund debt service spending in the FY 2012-13 biennium. Once again, the apparent spending reduction resulting from this accounting maneuver was illusory insofar as the debt service spending was still occurring, but was funded with non-general fund dollars on a temporary basis. Refinancing of these bonds resulted in a modest spending adjustment in FY 2014-15.

The spending amounts used in this section are adjusted to correct for artificial fluctuations resulting from K-12 funding shifts, federal stimulus dollars, and the sale of tobacco bonds. In recent years, MMB has used a similar approach to provide a more “apples to apples” comparison of general fund expenditures over time. The table below shows adjusted state general fund total expenditures from FY 2003 through the end of the current biennium (FY 2017). Specifically, the table shows actual and projected general fund total expenditures in nominal dollars and constant FY 2016 dollars, annual state population estimates, and total expenditures per capita in constant FY 2016 dollars. Amounts in red are based on MMB or State Demographer projections.

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As was the case with general fund current resources, general fund total expenditures in nominal dollars did increase over the period from FY 2003 to FY 2015. However, after adjusting for erosion in the purchasing power of state dollars due to inflation and growth in Minnesota’s population, real general fund spending declined by $499 per capita or 11.9 percent over this twelve year span.

Total Expenditures

In constant 2016 dollars, adjusted general fund spending was $4,184 in FY 2003—the first year of the state takeover of K-12 general education costs. Adjusted expenditures declined by $519 per capita (12.4 percent) over the next three years, dropping to $3,666 by FY 2006. From FY 2006 to FY 2009, adjusted expenditures changed little, fluctuating around $3,700 per capita. A second period of falling per capita expenditures commenced in FY 2010; from FY 2009 to FY 2013, adjusted per capita expenditures declined by $348 per capita (9.4 percent), as federal stimulus dollars helped to cushion—but did not prevent—another drop in general fund spending. During the entire decade from FY 2003 to 2013, adjusted state general fund expenditures declined by $843 per capita (20.1 percent).

During the 2013 legislative session, policymakers made significant new investments in K-12 education (including all-day kindergarten), higher education, property tax relief, public safety, infrastructure, affordable housing and healthcare, and job training. As a result, adjusted general fund spending increased from $3,341 per capita in FY 2013 to $3,686 per capita by FY 2015. FY 2016 and FY 2017 general fund expenditures per capita are projected to remain at approximately the FY 2015 level, assuming no change in current law spending levels. Despite the spending increases in FY 2014 and 2015, adjusted per capita expenditures in FY 2016 and 2017 are projected to remain approximately $500 per capita (11.5 percent) less than in the peak year of FY 2003.

The trend line in real per capita adjusted general fund expenditures does not neatly track with general fund current resources due to unspent fund balances, accounting maneuvers such as the K-12 funding shifts and tobacco bond sales mentioned above, and various other factors. However, one thing is clear: current and projected general fund revenues and adjusted total expenditures per capita are less than they were in FY 2003. In light of this, the wisdom of returning the entire projected surplus in the form of tax cuts is questionable at best, as this will only prevent the state from restoring even a portion of past spending reductions.

 

IV. Spending in Selected Policy Areas

As noted in the preceding section, real per capita state general fund expenditures have declined significantly over the last twelve years. This section will examine state funding within specific categories, including K-12 education, higher education, city Local Government Aid, highways, and pre-kindergarten education.

K-12 Education

The largest single category of state general fund spending is K-12 education. As noted in the Introduction, in fiscal year 2003 nearly all general education spending in Minnesota was shifted into the state general fund and away from local property taxes, leading to a large increase in state support for K-12 education. Since FY 2003, real per pupil state aid for K-12 education has declined significantly.

The following analysis of inflation-adjusted state support for Minnesota school districts will focus on operating revenue and state aid as reported by the Minnesota Department of Education (MDE).[3] To adjust for changes in the number of students served over-time, this analysis will examine state aid per pupil.[4]

The table below shows state aid to Minnesota school districts from FY 2003 through FY 2015, with projections for FY 2016 and 2017 based on current law. Specifically, the table shows actual and projected state aid in nominal dollars, state aid converted to constant FY 2016 dollars, the statewide pupil count as measured by average daily membership, and constant FY 2016 state aid per pupil. Amounts in red are MDE projections.

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In nominal dollars, state aid to Minnesota school districts increased by 9.5 percent from FY 2003 to FY 2012. However, a 9.5 percent increase in state aid is not sufficient to keep pace with a nearly 40 percent rate of inflation as measured by the S&L IPD. After factoring in inflation, state aid to school districts declined each year from FY 2003 to FY 2012. Even the modest decline in the number of K-12 students was not sufficient to offset the sharp decline in real state aid; from FY 2003 to FY 2012, aid per pupil fell from $10,422 to $8,519—a decline of $1,903 per pupil.

School Aid

From FY 2012 to FY 2015, per pupil state aid increased, as school districts began to recoup a portion of the state aid lost over the preceding decade. During this three year period, aid increased from $8,519 to $9,280 per pupil. The largest increase occurred from FY 2014 to FY 2015 and was paid for with revenue generated through tax increases enacted during the 2013 legislative session. Real per pupil state aid is projected to increase by 1.2 percent from FY 2015 to FY 2016 and remain virtually unchanged from FY 2016 to FY 2017.

While real per pupil school aid has increased relative to the depths of FY 2012, projected FY 2017 aid remains $1,008 per pupil, or 9.7 percent, less than it was in FY 2003. To compound matters, state general fund expenditures for K-12 education now includes the cost of statewide all-day kindergarten, which was not the case in FY 2003.

The decline in real per pupil state aid to Minnesota school districts since FY 2003 has contributed to a major increase in school property taxes; from FY 2003 to FY 2015, real per pupil school property tax levies doubled, while real per pupil school district operating revenue declined by 1.7 percent. In other words, the increase in school property taxes over this period was not providing a net increase in real school revenue, but was merely backfilling the decline in school funding resulting from the loss of state aid.

Higher Education

Public investment in higher education since 1960 is credited with contributing to Minnesota’s strong per capita income growth and economic performance relative to other states. State general fund support for public higher education—including the University of Minnesota and state colleges and universities—has supplemented revenue from tuition and other sources. In fact, one of the rationales for providing general fund support for public higher education is to hold tuition costs down so that more Minnesotans can afford a quality post-secondary education. The analysis in this section is based on state general fund spending for higher education instruction[5] and full time equivalent (FTE) student counts provided by the Minnesota Office of Higher Education.

The table below shows state general fund support for higher education instruction from FY 2003 through FY 2015 in nominal and constant FY 2015 dollars, higher education FTE students, and general fund instructional spending per FTE in constant FY 2015 dollars.

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In nominal dollars, general fund support for higher education instruction fluctuated from FY 2003 to FY 2013, but ultimately declined by 2.7 percent over this period. After factoring in inflation and FTE growth, the decline in real dollars per FTE student was more abrupt. From FY 2003 to 2005, general fund higher education instructional spending fell by $766 per FTE, but most of this decline was recovered over the next three years, as spending increased by $666 per FTE. General fund support for higher education instruction per FTE fell significantly each year from FY 2009 to FY 2013, dropping by $2,426 per FTE during the period from FY 2008 to FY 2013. Over the entire period from FY 2003 to FY 2013, general fund higher education instructional spending per FTE fell by a third—from $7,609 to $5,082.

Higher Ed

With an infusion of new revenue generated by the 2013 tax act, per FTE state spending on higher education instruction increased significantly in FY 2014 and 2015. From FY 2013 to FY 2015, state general fund higher education instructional expenditures increased by $906 per FTE. This increase in state support allowed for a temporary freeze in student tuition and new investment in public institutions of higher education.

As was the case with state support for K-12 education, state spending on higher education has increased significantly relative to the depths of FY 2012 and 2013. However, as was also the case with K-12 education, general fund support for higher education is still significantly below FY 2003 level. General fund spending on higher education in FY 2015 was $5,988 per FTE—$1,621 (21.3 percent) less than in FY 2003. As a result, the price of attending public institutions of higher education in Minnesota is much higher today than it was at the beginning of the century. For example, average annual tuition and fees at the University of Minnesota-Twin Cities is 59 percent higher today than it was during the 2002-03 academic year even after adjusting for inflation.[6]

City Local Government Aid

The State of Minnesota has provided general purpose aid—referred to as Local Government Aid (LGA)—to Minnesota local governments since 1972. Since FY 2003, cities have been the only level of local government to receive LGA (although other forms of general purpose aid are directed to counties, school districts, and townships). The overall trend in real per capita city LGA since FY 2003 has been sharply downward. The following analysis of inflation-adjusted city LGA per capita is based on historical totals from the Minnesota Department of Revenue combined with projections from Minnesota Management & Budget.

The table below shows state LGA payments to Minnesota cities from FY 2003 through FY 2015, with projections for FY 2016 and 2017 based on current law. Specifically, the table shows actual and projected LGA in nominal dollars, LGA converted to constant FY 2016 dollars, estimated statewide city population, and city LGA per capita in constant FY 2016 dollars. Amounts in red are based on certified (as opposed to final) LGA amounts or city population projections. Amounts are shown in the state fiscal year in which the LGA payment is made.[7]

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From FY 2003 to FY 2014, LGA payments to Minnesota cities declined by 24.3 percent—even prior to adjusting for inflation. In real dollars, the decline is of course even more abrupt—a whopping 48.0 percent. If we further adjust for growth in city population over this period, the decline in LGA per capita is a staggering 52.9 percent. In other words, the real per person purchasing power of the state aid dollars that cities were receiving through the LGA program declined by over half during this eleven year span.

LGA

The downward slide in real per capita LGA was interrupted in FY 2007 and FY 2010, but the LGA increases in these years were short lived, as subsequent state budget difficulties led to even deeper cuts. During the 2013 legislative session, Governor Mark Dayton and the legislature agreed to significant reforms to the formula used to distribute LGA among cities along with an $80 million increase in the LGA appropriation. This increase produced the largest single year increase in general purpose aid to Minnesota cities in nearly a generation.[8]

However, the significant LGA increase in FY 2015 replaced only 15 percent of the total reduction in real per capita LGA that occurred over the preceding eleven years. In fact, real per capita LGA in FY 2015 is still 45.2 percent less than it was in FY 2003.

In FY 2016 and subsequent years, nominal dollar funding for LGA is frozen at the FY 2015 level based on current law. Thus—without legislative intervention—inflation and city population growth will lead to a slow erosion in real per capita LGA funding in future years.

As with school districts, the decline in state aid to cities has contributed to significant growth in city taxes and a reduction in real per capita city revenue, as cities cut budgets and increased property taxes in order to deal with declining aid. From tax payable year 2002 (corresponding to state FY 2003) to 2015, real per capita city property taxes have increased by 22.6 percent, while real per capita city revenue base has declined by 7.9 percent.[9]

Highway Funding

Of the specific policy/program areas examined in this section, highways are the only one not funded from the state general fund. Funding for Minnesota highways comes primarily from three constitutionally dedicated state taxes: a motor fuels tax, a tax on motor vehicle registration, and a motor vehicle sales tax (MVST). The largest of these—the motor fuels tax—is imposed at a per gallon rate. The registration tax, also known as the “tab fee,” is imposed on vehicles domiciled in Minnesota. The MVST is imposed at a rate of 6.5 percent applied to the sale price of new and used motor vehicles. These three sources generate nearly 100 percent of Minnesota Highway User Tax Distribution (HUTD) Fund revenues, which is used to pay for state and local road costs throughout the state.

The following analysis of per lane mile revenue generated from these three taxes is based on highway users tax distribution fund summary information prepared by the Minnesota Department of Transportation and lane mile information reported by the Federal Highway Administration (FHWA). The lane mileage presented in the table below is from the calendar year preceding the fiscal year listed in the table. For example, the lane miles listed for FY 2003 is based on calendar year 2002 data. (The first six months of each fiscal year falls within the preceding calendar year.) The most recent calendar year for which lane mile information is available is 2013 (corresponding to FY 2014 in this analysis). For purposes of calculating FY 2015 tax revenue per lane mile, it is assumed that the number of lane miles does not increase relative to the preceding year.

For reasons noted in the Introduction, the highway revenues are adjusted for inflation using the state and local government gross investment structure price index as calculated by the U.S. Bureau of Economic Analysis. Because this price index is not available for years after FY 2015, the following analysis of highway revenues will not extend beyond FY 2015 and will be expressed in constant FY 2015 dollars.

The table below shows total revenue from the three principal taxes dedicated to pay for road costs in Minnesota. Specifically, the table shows the revenue generated by these three taxes in nominal and constant FY 2015 dollars, statewide lane miles, and total tax revenue in constant FY 2015 dollars per lane mile. Amounts in red are projections.

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From FY 2003 to FY 2007, revenue from the three state taxes constitutionally dedicated to fund highways not only failed to keep pace with inflation in road construction and maintenance costs, but actually declined in nominal dollars. In constant FY 2015 dollars, revenue from these three taxes declined by $2,748 per lane mile from FY 2003 to FY 2008—a drop of nearly one-third. This steep decline in dedicated highway tax revenue is undoubtedly due in large part to rising petroleum prices, which contributed to reduced gasoline consumption (thereby generating less revenue through the per gallon gas tax) and increased inflation in road maintenance and construction costs.

Highway

Since 2008, the revenue generated from the motor fuels tax, the motor vehicle registration tax, and MVST has increased steadily thanks in large part to an 8.5 cent per gallon gas tax increase approved during the 2008 legislative session, which was phased-in over the period from 2008 to 2013. In addition, petroleum prices also leveled off from their peak in 2008, contributing to a reduced rate of inflation in highway maintenance and construction costs.

The increase in dedicated tax revenue per lane mile from FY 2008 to FY 2015 was sufficient to replace only about half of the decline that occurred from FY 2003 to FY 2008. Even with the 2008 gas tax increase, dedicated highway tax revenue per lane in FY 2015 is $1,356, or 16.3 percent, less than in FY 2003.

The steep decline in dedicated tax revenue for Minnesota highways has had at least two significant consequences. First, Minnesota has increasingly relied on debt financing to support the state highway system, as noted in a 2008 report from the Office of the Legislative Auditor[10]; since 2008, the level of debt financing has continued to increase. Second, the condition of Minnesota’s road system has deteriorated; within the next three years, one in five Minnesota roads will pass their useful life. The bipartisan Minnesota Transportation Finance Advisory Committee determined that Minnesota faces a $6 billion highway funding deficit over the next six years.[11]

Poor road conditions cost Twin Cities drivers $249 a year per vehicle based on 2013 data; [12] if we assume similar expenses for vehicles across the state, Minnesota motorists spend over $1.2 billion dollars a year in vehicle repairs as a result of bad roads. Meanwhile, traffic congestion costs businesses $300 million a year in additional freight transportation costs in the Twin Cities metropolitan area alone.[13] On top of all this, Twin Cities commuters spend an estimated 34 hours stuck in traffic each year and endure additional costs of $695 per commuter as a result of traffic congestion.[14] These costs in terms of lost time and money will only increase in future years if additional highway investments are not made. Minnesota’s failure to maintain its road infrastructure comes at a significant cost to the state’s economy and quality of life.

Pre-Kindergarten

Minnesota’s efforts to provide pre-kindergarten (pre-K) education for all four year olds have been sporadic and unsystematic. Pre-K education opportunities vary significantly from district to district, with some districts providing no programming at all in this area. The level of state support for pre-K is difficult or impossible to determine. While some districts use a portion of state general education aid, community education aid, or other state aid to fund pre-K, pre-K funding by source is not routinely tracked at the district level.

While the level of state support for pre-K is not known, there is no doubt regarding the benefit of pre-K education. According to a recent report from the Educator Policy Innovation Center (EPIC):

The growing body of research is conclusive: High-quality pre-K provides dramatic and lifelong benefits to children and solid economic and social benefits to the communities in which they live. Children who participate in pre-K see educational advantages right from the beginning—quantifiable improvements in reading and math scores to be sure—but also more fundamental and lasting effects such as higher high school graduation rates, lower rates of teen pregnancy, higher income levels, and more stability in their family lives… States that invest in high-quality pre-K programs also see both immediate and long-term benefits. The early interventions result in fewer students in need of special education services, for example. The longer-term benefits include an increased tax base, lower crime rates, lower divorce rates and reduced social service costs.[15]

The bottom line, according to the EPIC report, is that “Investment in high-quality pre-K more than pays for itself in the long run.”

Pre-K is also an effective way to address Minnesota’s troublesome achievement gap. Researchers have found that institutionalized pre-school education increases cognitive abilities and learning-appropriate behavior and, that as pre-school participation rates approach universal coverage, average test scores improve and inequality in eighth grade science and math scores diminishes. [16] The findings are reinforced by a 2012 white paper published by the Stand for Children Leadership Center (SCLC), which found that “Pre-kindergarten programs that provide high-quality early-learning experiences for young children, followed by full-day kindergarten and other elementary reforms that sustain early learning gains, are a critical tool for improving student achievement and narrowing achievement gaps.”[17]

The benefits of pre-K education are not restricted to low-income children, although they are likely the greatest beneficiaries. A review of research summarized in the EPIC report found that:

When we examine the achievement gap even more discretely, we find that high-quality universal pre-K benefits children across racial and socioeconomic spectrums. Not only does it reduce gaps between racial and socioeconomic groups, but it also benefits children from middle and higher income families, making a universal program the greatest public good.[18]

It should be noted, however, that quality pre-K education is more than simply providing day care. As a precautionary note, the SCLC white paper observes that:

Even when children do attend pre-K, many are not getting the high-quality preparation they need to later succeed in school. A 2005 study of state-funded pre-K in 11 states found that 57 percent of classrooms ranked in the lowest level of instructional quality and none ranked in the highest level. A California study that included Head Start, state pre-K, and private preschool classrooms found that 16 percent fail to meet even “adequate” standards of quality, meaning they may be actively harming child development.[19]

In other words, the warehousing of four year olds in an unregulated environment staffed with inadequately trained teachers will not produce quality outcomes. As noted in the SCLC white paper:

High-quality pre-K programs are not cheap. Environmental and structural features linked to pre-K quality—well-educated teachers, small class sizes, facilities designed specifically to meet the needs of young children—cost money. Estimates vary, but in general, policymakers should assume that per-pupil costs for high-quality full-day pre-K are roughly comparable to those for K-12 public schools. Many existing state pre-K programs do not spend enough money to match the outcomes of the most-effective programs.[20]

However, in the long run the benefits of quality pre-K education justify the costs:

Research suggests that the benefits of quality pre-K programs—in terms of improved student learning and life outcomes—are sufficient to justify the high costs. Studies of high-quality pre-K programs estimate that over the course of children’s lives, these programs save the public between $3 and $10 for every $1 spent, because students who attend pre-K are less likely to be held back a grade, placed in special-education, or participate in criminal activity, and have increased educational attainment and earnings as adults.[21]

Finally, state-funded pre-K education would provide significant savings for families that currently pay for child care for their pre-K children. According to a 2014 survey, the median cost of child care for pre-school children in licensed child care centers varies across the state, ranging from a low of $125 per week in some counties to a high of $248 per week in others.[22] Families with one four-year-old child currently in such a facility would save from $4,500 to $8,900 annually if they could instead enroll their child in a quality state-funded pre-K program, assuming a 36-week school year.

Given the priority that Minnesotans have assigned to closing the achievement gap, the strong return on investment that quality pre-K provides to children across racial and socioeconomic groups, and the reduction in child care costs that would accrue to families with pre-K children, state investment in quality universal pre-kindergarten makes sense for Minnesota.

 

While real per pupil state aid to Minnesota school districts, per capita state aid to Minnesota cities, per student funding for higher education, and dedicated highway tax revenue per lane mile have increased relative to the depths of the Great Recession, each remain significantly below the level they were at in fiscal year 2003. This has resulted in budget cuts for schools and other local governments, higher property taxes, soaring higher education tuition, and deteriorating roads. Meanwhile, the state has failed to invest adequately in early childhood education. Minnesota’s economy and quality of life will be well served if public policy focuses on investing in these and other critical state needs.

 

V. Conclusion

Conservatives have been quick to use the projected state budget surplus as a launching point for the next phase of the “give it back” campaign, arguing that “…when we have a budget surplus, it means we collected more money than government needs.” Of course, the logical corollary of this assertion is that a budget deficit means that we have collected less taxes than government needs—a conclusion that would no doubt make every conservative blanch and certainly nothing we heard from policymakers during the recently concluded era of recurring budget shortfalls.

In reality, the presence of a budget surplus simply means that state policymakers imperfectly predicted the future levels of state revenues and expenditures and/or that a positive balance was carried forward from the preceding biennium. For example, the current budget surplus is the result of two developments:

  • For the period from FY 2015 to 2017, revenues were $227 million greater than expected at the end of the 2015 legislative session, while expenditures were $496 million less than expected.
  • During the 2015 legislative session policymakers could not agree on the appropriate mix of spending increases and tax reductions and thus left $865 million on the general fund’s bottom line.

The $227 million increase in projected revenues, the $496 million reduction in projected spending, and the $865 million left on the bottom line—combined with $687 million transferred to the state budget reserve and other state accounts—accounts for the projected $900 million positive budgetary balance indicated for the current biennium in the February 2016 budget forecast.

The presence of a budget surplus by itself does not reveal whether taxes and other revenues are too high or whether expenditures are too low; it simply means that there is a mismatch between revenues and expenditures. Nor does the mere existence of a surplus necessarily guide us to the appropriate policy response to the surplus, be it tax cuts, expenditure increases, or a combination of both. The answer to this question requires a deeper dive into the reality of the state’s economy and quality of life and the relative impact of taxes and public investments on both.

The facts revealed in this report clearly indicate that tax cuts are not the only legitimate use of the state budget surplus. A number of public investments also have a legitimate claim on a portion of the projected general fund budget surplus.

For example, real per pupil state aid has fallen by eleven percent from FY 2003—the first year of the state takeover of general education costs—to the most recently completed fiscal year (FY 2015). As a result, real per pupil school property taxes have doubled while total real per pupil school operating revenue has declined by just under two percent. The sharp decline in real per pupil state aid to Minnesota school districts occurred at the same time that school costs were rising due to an increased concentration of immigrant and other special need students.

School districts were not the only level of local government to feel the impact of a sharp decline in state investment. Real per capita city Local Government Aid fell by 45.2 percent from FY 2003 to FY 2015, contributing to a 22.6 percent increase in real per capita city property taxes and a 7.9 percent decline in real per capita city revenue. Although not documented in this report, counties too have seen a significant decline in real per capita state aid since FY 2003, corresponding with a sharp increase in county property taxes and a drop in real per capita revenue. The decline in state aid and the shrinkage in local government budgets since 2003 have corresponded with increased spending demands arising from an aging population, increased immigration, evolving domestic security concerns, and other factors.

State support for public institutions of higher education has also been in steep decline, falling by 21.3 percent in real dollars per full-time equivalent student since FY 2003. While an infusion of state support enacted during the 2013 legislative session temporarily halted the perennial trend of escalating tuition, the cost of obtaining a post-secondary degree has soared at the University of Minnesota and at state colleges and universities. For example, average annual tuition and fees at the University of Minnesota-Twin Cities is 59 percent higher today than it was during the 2002-03 academic year after adjusting for inflation. Pricing a post-secondary education out of the reach of Minnesota students is a poor strategy for creating a competitive information-age economy.

The revenue generated for Minnesota highways from the state’s three dedicated taxes—the motor fuels tax, motor vehicle registration tax, and motor vehicle sales tax—has declined by 16.3 percent per lane mile from FY 2003 to FY 2015, despite the gas tax increase enacted in 2008. As a result, the state is confronting a $6 billion highway funding deficit over the next six years, as road conditions deteriorate and traffic congestion worsens. All of this imposes additional strain on Minnesota’s economy and people due to lost time and lost productivity. Furthermore, this report does not delve into unmet public transit needs in the state as documented by the bipartisan Minnesota Transportation Finance Advisory Committee, which create additional demands for increased state transportation spending.

The failure of the state to adequately fund pre-kindergarten education for all Minnesota four year olds represents a lost opportunity, given the tremendous bang for the buck resulting from these investments. Credible research not only demonstrates that pre-K education can help close Minnesota’s achievement gap, but will provide benefits to middle- and upper-income children as well. The long term benefits for the state resulting from pre-K include higher high school graduation rates, lower rates of teen pregnancy, greater family stability, lower crime rates, higher income levels, increased tax base, reduced social service costs, and a reduction in child care costs for families with pre-K children. It would be foolish to further delay increased state investment in pre-K, given that the long-term benefits far outweigh the upfront cost.

Some have disputed the inadequacy of public investments in these areas, arguing that state government spending has swelled significantly. For example, conservatives have argued that there has been 25 percent growth in state spending since 2012—presumably a reference to the growth in total general fund expenditures from FY 2012 to the current fiscal year of 2016.

However, this reckoning ignores the fact that FY 2012 general fund expenditures were artificially deflated by over three-quarters of a billion dollars due to accounting gimmicks used by state policymakers to balance the state budget in that year—specifically, an increase in the K-12 funding shift and the sale of tobacco bonds used to reduce state debt service spending.[23] Because of this, the level of FY 2012 spending was artificially deflated and alleged spending growth from FY 2012 to FY 2016 was artificially inflated.

Furthermore, many claims of excessive growth in state spending fail to take into account the impact of inflation or growth in the state’s population. After adjusting for the impact of accounting shifts, population growth, and inflation, state general fund spending is projected to increase by $288 per capita or 8.5 percent from FY 2012 to FY 2016.

A $288 increase in real per capita state general fund expenditures over four years is significant, but it needs to considered in the context of the dive in general fund spending that occurred over the preceding decade. From FY 2003 to FY 2012, real general fund spending declined by $791 per capita. Even after the $288 per capita increase in real general fund spending anticipated to occur from FY 2012 to FY 2016, FY 2016 spending will still be $503 per capita or twelve percent less than it was in FY 2003.

So while real per capita general fund spending is higher than at its nadir following the Great Recession, it remains significantly below the FY 2003 level. In fact, the real per capita general fund spending increase that has occurred relative to the depths of FY 2012 and 2013 was sufficient to recover less than half of what was lost over the preceding decade. A similar pattern is seen in terms of per pupil school aid, per capita city LGA, per student state aid for higher education, and dedicated highway tax revenue per lane mile: despite spending increases that have occurred over the last few years, funding in real dollars remains significantly below the FY 2003 level in each of these areas.

While current real per capita general fund spending is projected to remain significantly below the FY 2003 level, revenues are only slightly less than in FY 2003. For example, annual per capita general fund current resources in the last year of the current biennium (i.e., FY 2017) will be only 1.5 percent less than in FY 2003 based on projections of current law. However, this assumes that absolutely none of the projected general fund surplus will be used to reduce state taxes or other general fund revenue.

Many claims of excessive growth in state government measure the growth in state taxes and spending relative to circa FY 2012, when tax revenues and spending levels were seriously depressed due to the combined effects of the Great Recession and ten years of anti-tax, anti-investment fiscal policy. The consequences of this lack of investment are clear: underfunded schools, strained local government budgets, soaring property taxes, skyrocketing tuition, deteriorating highway infrastructure, and a state budget that lurched from one fiscal crisis to the next, ultimately costing the state its AAA credit rating. Yet another consequence was the opportunity lost by failing to make wise investments in areas such as pre-K education. There is no justifiable reason why state tax and spending levels should be perpetually locked at these depressed levels.

On the other hand, the findings of this report should not be construed as an argument for automatically increasing the level of real per capita general fund spending—either in total or in any of the categories examined—to the FY 2003 level. Policymakers must always be open to the potential of achieving comparable or even superior outcomes at reduced costs. To observe that real per capita state general fund spending in total and within specific categories has dropped below FY 2003 levels does not necessarily imply that expenditures must be returned to these levels.

However, the findings of this report clearly demonstrate that claims alleging excessive growth in state government in recent years typically ignore at least one of the following: inflation, population growth, accounting shifts, and/or the sharp decline in real per capita state general fund spending that occurred before, during, and shortly after the Great Recession. Real per capita state general fund expenditures in total and across several categories are significantly less today than in FY 2003.

Minnesotans should reject a faux fiscal conservatism that reflexively prevents any increase in state expenditures, even when it can be demonstrated that a partial restoration of past spending cuts can help restore the quality of public services and infrastructure and that new investments in strategic areas can yield significant long-term benefits that will enhance Minnesota’s economy and quality of life. Instead, Minnesotans should look for a balanced approach to the current projected budget surplus that weighs the appeal of tax cuts against the practical benefits arising from intelligent public investments.

 

Read the executive summary.

 

[1] North Star Policy Institute, The “Real” Story Behind State & Local Government Inflation, March 2016.

[2] The school funding shift is accomplished through two different mechanisms: (1) an aid payment shift (in which the state delays an increased portion of the school aid appropriation) and (2) a levy recognition shift (in which school districts are required to “recognize” property tax receipts before they actually materialize, hence allowing the state to delay aid payments to schools by an equivalent amount). Both shift mechanisms produce a one-time reduction in state spending.

[3] Specifically, the categories of revenue included in this analysis are general education, special education, career technical, integration, alternative facilities, deferred maintenance, telecommunications, and operating capital technology revenues, and other miscellaneous categories. Combined these categories comprise nearly all school operating revenue. The data used here are from MDE’s 2015 end-of-session financial trends spreadsheet for FY 2003 to FY 2017. (The 2015 end-of-session spreadsheet is the most current available.)

[4] Pupil counts used to determine per pupil amounts are based on average daily membership (ADM).

[5] The amounts used here include only state general fund spending on higher education instruction and excludes spending on research facilities, agricultural extensions, and other non-instruction related purposes.

[6] Based on U.S. Bureau of Labor Statistic data compiled by the Minnesota Office of Higher Education, adjusted for inflation using the Higher Education Cost Adjustment.

[7] Because LGA payments are made within the first half of the fiscal year (specifically, July and December), the aid paid within the fiscal year are received by cities in the preceding calendar year. For example, LGA payment made within FY 2003 were received by cities in July and December of 2002.

[8] In nominal dollar and real per capita dollars, the FY 2003 LGA increase exceeded the FY 2015 LGA increase. However, FY 2003 LGA increase was more than offset by the elimination of another general purpose aid received by cities: Homestead and Agricultural Credit Aid (HACA). After factoring in the LGA increase, the elimination of HACA, and the advent of the Market Value Homestead Credit, the increase in general purpose aid to cities in FY 2003 was significantly less than the FY 2015 increase. FY 1991 was the last time in which the increase in general purpose aid to Minnesota cities exceeded the FY 2015 increase.

[9] This calculation is based on a comparison of city “revenue base” (i.e., levies plus state aid) in calendar year 2002 and 2015. Based on the most recent Price of Government report from MMB, the decline in per capita city revenue over this period is in excess of ten percent after adjusting for inflation.

[10] Office of the Legislative Auditor, Evaluation Report: State Highways and Bridges, February 2008.

[11] Transportation Finance Advisory Committee, Minnesota Moving Ahead: Transportation Fund and Financing for the next 20 Years, December 2012.

[12] “Additional vehicle operating costs due to driving on roads in substandard conditions” is from appendix C of a 2015 TRIP (a national transportation research group) report entitled Bumpy Roads Ahead: America’s Roughest Rides and Strategies to Make our Roads Smoother.

[13] National Center for Freight & Infrastructure Research & Education, Development of an Areawide Estimate of Truck Freight Value in the Urban Mobility Report, June 2012.

[14] Texas A&M Transportation Institute, TTI’s 2012 Urban Mobility Report, December 2012.

[15] Educator Policy Innovation Center, The best start for students: Why Minnesota needs universal pre-kindergarten, January 2016.

[16] Frede, Ellen, & Barnett, W. Steven, Why Pre-K is Critical to Closing the Achievement Gap, Principal (publication of the National Association of Elementary School Principals), May/June 2011.

[17] Mead, Sara, Quality Pre-K: Starting Early to Close Achievement Gaps and Boost Student Achievement, Stand for Children Leadership Center, June 2012.

[18] Educator Policy Innovation Center, The best start for students: Why Minnesota needs universal pre-kindergarten, January 2016.

[19] Mead, Sara, Quality Pre-K: Starting Early to Close Achievement Gaps and Boost Student Achievement, Stand for Children Leadership Center, June 2012.

[20] Ibid.

[21] Ibid.

[22] Minnesota Department of Human Services, Results of the 2014 Child Care Market Rate Survey: Minnesota Child Care Provider Business Update, 2015. A majority of the state’s population and a majority of the state’s four year olds reside in counties with the highest weekly child care center costs (i.e., $248 per week).

[23] The impact of school funding shifts and the sale of tobacco bonds upon general fund expenditures were discussed in chapter III.