Ignore the big numbers — surpluses can quickly become deficits

Permanent tax cuts could lead to whiplash deficits, cuts in public programs

March 21, 2023 6:00 am

Photo illustration by Andrew Harrer/Bloomberg.

Budget season is heating up at the state Capitol, and with a surplus commonly pegged at $17.5 billion, there is a general sense that Minnesota has money to spare. Flush as the state may seem, we’d be mistaken to underestimate long-term spending needs and the budgetary challenges that could arise from ongoing tax cuts. 

The phrase “historic surplus” has been repeated so many times over the past year that it might be difficult to imagine Minnesota running into fiscal challenges. But permanent tax cuts in a momentary surplus is the classic set up for deficits, and the current discourse suggests reason for concern. 

To start, common references to the surplus itself are somewhat misguided. Of the $17.5 billion headline number, $12.5 billion is “one-time” money saved up from previous years. It comes from unusual circumstances relating to the COVID-19 pandemic, and it cannot sustainably fund ongoing programs, like schools, health care and child care. 

The remaining $6.6 billion ($5.3 billion once accounted for inflation) is the amount the state would expect to save over the coming biennium if expenditures stayed flat. At about 12% of current spending, that is a meaningful sum, but it is just a projection. The Department of Revenue’s February update already showed tax receipts 7.2% below expectation and if the U.S economy slows or enters a recession, revenues would fall further and Minnesota could easily end up with a shortfall. 

Moreover, summing accrued and anticipated savings doesn’t make a ton of sense and neither does the notion that revenues exceeding current spending equates to a surplus. 

In a recent report for North Star Policy Action, I discuss how public spending must generally keep pace with the growth of the economy. That is how we ensure public sector wages remain competitive and public services meet popular expectations. Minnesota budget authorities expect total state personal income to grow by about 10% between the 2022-23 and 2024-25 biennia, so the $6.6 billion of projected revenue growth is scarcely more than what’s necessary to keep up with current programs. 

Already, Minnesota’s total state and local expenditures have fallen as a share of the state economy in recent decades. If Minnesota spent on public goods and services at the same rate it did throughout the 1990s, we would have not just an additional $6.6 billion, but $13 billion more to spend in the 2024-25 budget. Further cuts would widen that gap.

And of course the state’s funding needs are clear: Higher wages for care workers; accessible and affordable child care; increased staffing and wages for public school workers; and expansions of public health care. Those are just a few examples of the worthwhile investments that could bolster basic services, enhance the economy, and improve the quality of life for all Minnesotans.

Then there are lower profile imperatives, like water infrastructure, correctional staff at state prisons and underfunded public pensions that will require additional state funds.

Simply put: It would be foolish to bet that Minnesota will need less public investment over time, but that is the wager we would be making with a permanent tax cut. There is a real danger that our current, momentary surplus will convince policymakers to enact permanent changes that will lead to trouble.

The proposed Social Security tax exemption is the highest profile example. At 20% of the ongoing surplus, exempting the remaining portion of Social Security benefits would be extremely detrimental to Minnesota’s long-run budgetary outlook. Revenues from the partial taxation of Social Security benefits represent nearly 4% of the state’s income tax receipts and are projected to grow rapidly, rising from $1.26 billion in 2024-25 to $1.5 billion by 2026-27. 

Exempting Social Security benefits means not just lowering revenues but also shrinking the tax base from which those revenues come. With policies like this, the state does not just dig itself a hole, but gives itself a smaller shovel to dig out with. 

This is precisely the sort of policy that leads to whiplash deficits and tax increases, and that is why conservatives like it; it makes the job of delivering strong, successful public programs permanently harder. And when new revenues are needed, conservatives can rail against the tax increases that their preferred policies necessitated.

There is undoubtedly an appetite at the Capitol for some amount of tax cuts. Resolving that is a political question beyond my expertise, but the budgetary reality is that ongoing revenue losses threaten to push Minnesota further off the path of an adequately funded government.

With mostly one-time money, the DFL could instead focus on one-time rebates, which Gov. Tim Walz has repeatedly proposed. Unfortunately, ongoing tax relief has held center stage in the budget debate so far. 

That’s a real mistake. 

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Eric Harris Bernstein
Eric Harris Bernstein

Eric Bernstein is a policy analyst focused on state tax and budgetary policy. Since the summer of 2020, he has been policy director for We Make Minnesota — a coalition of labor and community groups organizing to raise state revenue for investment in health care, education, racial equity, sustainable environmental stewardship and other public priorities.