Minnesota's Surplus of Optimism

January 17, 2012

Minnesota's Office of Management and Budget announced last month a forecast of an $876 million surplus for the upcoming two-year budget, sending lawmakers into a frenzy about how to spend the newfound cash. Recall that just six short months ago, the Minnesota government was shut down in a budget stand-off. At the time, the estimated deficit was $5 billion. (The budget for 2011-2013 is $35 billion.) While at first sight, this looks like a sharp reversal of fortunes, I'd argue that the change is largely illusory, uncertain, and short-lived.

The government bridged the deficit last July without concern for the state's long-term fiscal outlook.  The budget increased outlays on health services, education, and public works projects and  shifted much of the cost forward onto future taxpayers. More specifically, it delayed over $700 million in payments to schools and issued $640 million of tobacco bonds. 

The issuance of tobacco bonds was an expensive stopgap. The state expects to receive a stream of payments in perpetuity from the tobacco settlement, and it issued debt by selling the right to those payments to bondholders. The cost of the principal, interest, and costs of bringing the debt to market add up: the state now owes an estimated $1.2 billion.

The budget bills gave many analysts reason to expect more budget deficits to come. Fitch downgraded Minnesota's debt rating from AAA to AA+ soon after the bills passed:

The downgrade reflects the state's reliance on non-recurring gap-closing measures over the course of the recession, the difficulties in reaching consensus on a plan to address the resulting large budget gap for the biennium that began on July 1, the likelihood that the final budget agreement will again include non-recurring solutions, and an increasingly contentious budgeting environment in the state in recent years.

Today, Minnesota's legislators see a windfall gain before them. But they may be fooling themselves. Economists expect a large shortfall in the two-year budgetary period beginning in 2013.  Budget Commissioner Jim Showalter cautions that the forecast is uncertain. NPR points to a one-time revenue source: the government received $101 million more in transfers from the federal government than anticipated.

Despite this, many of the state's politicians do not appear to see problems ahead. The House Speaker and the Senate Majority Leader claim credit for what they see as grounds for optimism. Several legislators propose a large bond issue to fund public works and other projects (including a new football stadium). Still, many observers argue that the surplus should be saved and used to pay back various debts. Current law mandates it, but we should be skeptical that the law will bind the government.

Whatever the legislature decides in the next session, the case is instructive and relevant to other states. Besides Minnesota, 47 states have seen estimates of tax revenue rise in the third quarter of last year. Certainly not all of them should presume that today's rise foretells surpluses ahead. Budget forecasts can turn sharply and surpluses can distract attention from the long-term fiscal outlook. As always, revenues and expenditures can be bridged through creative accounting.

As to what course of action Minnesota and similarly situated states should consider, perhaps Adam Smith had it right in 1776: "What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom." Whether or not Minnesota's legislators choose to follow Smith's advice, at least they will take a step toward setting their own 'family' in order: In accord with the budget bill, the Senate will be forced to cut its own operating expenses by 5% over the next year and a half.

For more on Minnesota, click here.

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