October Update: We’ve Got Some Good News & Some Bad News

The October Revenue and Economic Update from Minnesota Management & Budget (MMB) contained some good news and some bad news. The good news is that fiscal year (FY) 2017 revenue collections surpassed July expectations. The bad news is that FY 2018 revenues continue to come in below levels anticipated in the February 2017 forecast and, more importantly, long-term forecasts for U.S. economic growth were revised downward, which raises the specter of lower than expected state revenue collections in coming years.

Last July, the general fund balance analysis from MMB anticipated a $179 million positive general fund budgetary balance for the current FY 2018-19 biennium. However, using data unavailable last July and taking into account the eventual need to provide funding for the legislature (which was line-item vetoed by Governor Dayton), an October 4 North Star article posited that the positive balance for FY 2018-19 projected by MMB earlier this year was now overly optimistic; in that article, North Star anticipated a negative budgetary balance of $104 million for FY 2018-19.

New information contained in the Revenue and Economic Update released on October 12 indicated that FY 2017 revenue collections, which were predicted to be $104 million below February forecast projections in the preceding July Revenue and Economic Update, are now projected to be a scant $1 million below February forecast projections. On the other hand, the extent to which year-to-date state revenue collections for FY 2018 fell short of February forecast projections increased from $50 million to $66 million with the release of the October update. As a result of these two changes, North Star now anticipates a negative budgetary balance for FY 2018-19 of just $17 million. That’s the good news.

The $103 million improvement in FY 2017 revenues from the July update to the October update does not affect the FY 2018 structural balance, since the structural balance–unlike the budgetary balance discussed above–is based on revenue coming into the general fund over the course of a biennium minus expenditures made during the biennium, excluding balances carried forward from the previous biennium. Consequently, North Star’s projections of the FY 2018-19 and FY 2020-21 structural deficit–originally published in an October 9 article–have changed little. The chart below summarizes our most current projections of the FY 2018-19 and FY 2020-21 structural deficits. Per the recommendations of the non-partisan Minnesota Council of Economic Advisors, these projections attempt to anticipate the full effect of inflation on FY 2020-21 revenues and expenditures.

The $730 million structural deficit projected for FY 2018-19 and the $1.35 billion deficit projected for FY 2020-21 (both of which assume funding for the state legislature)–while taking into account legislative changes enacted earlier this year–are still based on economic projections from the February 2017 forecast. The bad news from the October update is that these economic projections now appear to be somewhat too optimistic. Relative to last February, the state’s macroeconomic consultant IHS Markit now projects somewhat lower annual real U.S. Gross Domestic Product (GDP) growth through 2019. The following chart compares anticipated GDP growth from the February 2017 forecast to the more recent October 2017 update for the period from 2016 through 2021.

Insofar as the downward revision in projected U.S. economic growth is likely to translate into lower than projected state revenue collections, the above projections of forthcoming deficits is likely to be overly optimistic–or perhaps more aptly stated–not sufficiently pessimistic.

The next chapter in this unfolding saga of general fund finances will come early in December with the release of the November economic forecast. The forecast will not only contain updated economic assumptions and revenue projections based on the most current data, but also revised estimates of general fund expenditures. Particular attention should be paid not so much to the official forecast–which ignores sound budget practices by failing to consider most of the impact of inflation on state spending–but to MMB’s projections which fully take into account the likely impact of inflation on both state revenues and expenditures.

For the time being, however, the developments cited above call into further question the wisdom of generous tax cuts enacted earlier this year. The October 4 North Star article made the case that some of these tax cuts–including the state business property tax freeze, expanded estate tax exclusions, and the freeze of the cigarette tax–were not warranted. Based on end-of-session projections, the tax cuts enacted by the legislature in 2017 will reduce general fund revenues by $653 million in FY 2018-19 and $1.08 billion in FY 2020-21. With the state staring down the barrel of potentially large deficits in future biennia, one can only wonder if state policymakers are having misgivings about this bonanza of tax cuts.