Decision time

With just a week until adjournment (no bills can be passed on 5/23), Governor Walz and the legislature face key budget decisions regarding the remaining $7 billion or so surplus (after refilling UI fund and adding more hero pay). It’s useful to think about how complex and fraught these issues are for legislators and the governor.

Specifically, how much of the surplus should be:

Spent or left for the 2023 legislative session?
Used for one-time versus ongoing or permanent items – e.g., used for rebates or one-time capital projects versus ongoing tax cuts or permanent spending?
Allocated for tax cuts (e.g., rate cuts) versus spending (e.g., tax expenditures or direct spending)?
Divided among differing priorities – e.g., education, housing, human services, general tax cuts, etc.?

Permanence and reliability of revenues

For issues #1 and #2, a key issue is how much of the surplus is structural or permanent and will support ongoing commitments. MMB has judged that a good portion is likely permanent. But there is uncertainty around assertions like that. Probably more than usual in this case.

Structural change? The tax system has changed little in the last 20 years or so; the 2013 addition of a higher top income tax rate provided a modest elasticity dividend and conformity to TCJA shuffled the deck with unclear effects. Pre-pandemic revenue growth was less than recently experienced. State tax revenue growth in 2015 – 2019 was essentially flat; the February forecast projects annual growth for 2020 – 2025 at 4.5%. Did the pandemic or the response to it permanently change the economy (1) to put it is on an enduring higher growth path or (2) change its structure to yield more state tax revenue (w/o changing the tax rules)? Making more than modest permanent commitments to either tax cuts or spending increases seem premised on some combination of those assumptions. That may prove true (I can think of reasons why it might be), but it is highly uncertain.

Recession coming? Aside from issues of whether some economic change is yielding materially higher state revenues, a related issue is whether a recession is looming. The stock market seems to think so or maybe not (Market Watch – additional 500-point S&P 500 drop needed to signal recession). Of course, as Paul Samuelson famously quipped, the stock market has predicted nine out of the last five recessions. In any case, the Fed has little experience reigning in inflation without causing a recession (maybe immediately after WWII). Although Minnesota’s reserve accounts are full, that is cold comfort. It certainly would not have been enough in three out of the last four recessions to prevent severe cuts, the only exception being the short pandemic recession.

Inflation. Inflation has ramped up a bit more since February. That will surely fuel some more cost of current services than no one seems focused on. The siren allure of new stuff makes it easy to ignore the risk that inflation poses to maintaining existing services.

Under the circumstances, prudence and caution would be in order. But neither is rewarded in the political realm. Avoiding unknown bad things happening does not get politicians attaboys, much less reelected. For what is worth, the April revenue report continues to show booming revenues ($1 b above forecast). So, that will not give anyone reason to hit pause.

Priorities dictated by partisan priors

One’s positions on #3 and #4 are heavily influenced by whether you wear a red or blue partisan jersey, and the two parties are miles apart on policy priorities.

Republicans favor tax cuts to downsize state government; they think it is too big and is doing much of the wrong stuff. When they address policy priorities, they spend through the tax code pushing tax credits for things like childcare or parental leave. Note: that’s not a considered judgment about which instrument is more effective or better suited to the task (see here for my take on that, written for House Research), but largely an ideological matter and a desire to make intervening in the private market look like a tax cut.

Democrats, by contrast, favor bigger state government and direct spending programs (e.g., for public education or similar) generally. But they will use tax expenditures as a second-best alternative if necessary to get a deal or appease voters’ perceptions of a preference for tax cuts.

Resolving these policy issues will not be easy, assuming the first order issue can be resolved – how many dollars to commit and how much of that should be temporary versus permanent.

Political tactics – roll the November dice?

To further complicate matters, tactical considerations affect the negotiations in a big way with everyone up for election in November. Both parties have a mixed set of policy and political goals that must be traded off within and between the partisan caucuses and the governor. Should I go for half a loaf now and give half a loaf to my opponents? How will that affect my and my opponents’ election prospects? Could I get a better deal, say three-quarters of a loaf or the whole loaf, in 2023?

Some potentially relevant tactical considerations or questions:

Both parties want to advance their policy priorities (duh).
They can do that best by winning control of all three power centers (Governor, House, and Senate) so they are unfettered by the other party’s wildly different views (duh again).
Failing to win all three, they absolutely do not want the other party to win all three, since that would allow them to dictate the agenda in 2023. Democrats think something like Scott Walker’s Wisconsin would takeover Minnesota government; GOPers likely assume some unholy combination of socialism and lawlessness would appear on the Minnesota prairie.
What are each side’s probabilities of winning total or maintaining partial control in November?
How is that affected by what the legislature does or doesn’t do in 2022? The participants (perhaps, deluding themselves) think legislative actions have strong ramifications for the November election.
Who will voters hold responsible if there is no deal? How much do they even care?
How will it affect their base voters and the other party’s base? Will it energize or demoralize them?
How will it affect swing voters (potentially quite differently than base voters)? Each party wants to energize it base and to attract swing voters. Frequently the two are at odds with each other but strong partisans often don’t believe that.
How will whatever they do or don’t do get spun by the regular media or on social media?
Is it all meaningless because national trends (inflation, the SCOTUS abortion decision, Ukraine, Biden’s unpopularity, etc.) are determinative?

These are just some of the factors and questions decision makers will be mulling over. The complexity and unknowability are obvious. Resolving these issues is difficult even with one party control, because legislative caucuses are not monoliths that agree on policies and tactics. Far from that, they disagree and vigorously debate them internally. There are three separate decisional entities, five for a bonding bill which requires supermajority approval.

Given all this, it is impressive that anything gets done. In a budget year, continued functioning of government compels action. In an off year like 2022, it does not. Of course, doing nothing (deadlock) is always easier than compromising.

No predictions

I have no special insights or expertise to predict what will happen. When I was working and daily talking with legislators and partisan staff, my predictions were close to as good as chance. Now I am sufficiently out of touch that a monkey throwing darts (unfettered by thinking he knows something) would likely be more accurate.

Other states

Many states, regardless of partisan control, are cutting taxes. Damn the torpedoes, full speed ahead.

Alan Rappeport, States Turn to Tax Cuts as Inflation Stays Hot (NYT, May 10, 2022) details cuts enacted and proposed in other states with Republican, Democratic, and split control. The article quotes Jason Furman, Obama administration economist, as opining the cuts are evidence federal pandemic aid to state was too large and that the cuts will contribute to inflation (probably true on both scores). Effects on inflation are irrelevant to state politicians fighting for their political survival and policy agendas, of course.
See the Tax Foundation’s useful tracker of 2022 state tax changes, misleadingly labeled “tax reform.” Two common trends appear to be flattening rates (w/o expanding bases) and exempting more pension and retirement income. Neither qualifies as reform, in my book. Throwing money at retirees is happening in many states.
According to TPC, states are reporting weaker revenue growth for FY 2022. It characterizes FY 2022 and 2023 state forecasts as “alarmingly weak.” For fiscal year 2023, it says “personal income tax revenues are expected to increase by only 0.4 percent, while corporate income tax revenues are expected to decrease by 8.6 percent. and sales tax revenue growth is only expected to be 1.9 percent. As a result, total tax revenues are expected to increase by just 0.1 percent.” It notes this growth is in nominal terms a big concern with the current inflation rate. As noted above, the anemic growth pattern has not shown up here, where both the forecast and collections keep growing (albeit subject to the confusion resulting from the new PTE tax option). Minnesota’s forecast tax revenue growth for FY2023 over FY2023 is over 5%, but the drops to 2.5% and 1.9% for the two succeeding years.
Connecticut, a deep blue state, enacted a $600 million tax cut (claimed to be the biggest ever in the state). But also claims (per governor’s statement) to be contributing $3.3 billion to reduced unfunded pension liabilities. Count me skeptical without seeing the details, because it is characterized as an “anticipated contribution[.]” If accurate, it would be a truly unusual act of fiscal responsibility and might unexpectedly validate Mitch McConnel’s expressed concern that federal pandemic aid would turn into a blue state public pension bailout (?!).

Horner whiffs

Tom Horner, Republican (I think) and former independent candidate for governor, has an op-ed in the Strib, For an aging state in an aging country, future could be bleak (May 10, 2022). He points out that a big challenge facing the state and the legislature is the declining population of college-aged young adults. He chastises the legislature for ignoring the problem. In his words:

It’s not just that legislators have ignored the reality of losing young adults, it’s that they are oblivious to its implications. Look at the proposals coming from St. Paul. Public safety? Hire more cops. Education? Hire more teachers. Child care? Hire more caregivers.
Meanwhile, Republicans promote deep, permanent tax cuts while Democrats push large, permanent spending increases.
What world are they living in? Certainly not the Minnesota of 2022.
Tom Horner, For an aging state in an aging country, future could be bleak, Star Tribune (5/10/2022)

He proposes using the budget surplus to redesign and better deliver public services, all good general ideas but lacking in specificity. So, what’s my issue with the piece? Why do I consider it a policy strike-out?

He failed to call out Republicans for a core and hugely expensive piece of their tax cut – full exemption of social security. That is the first thing he should have done emphatically – especially since he is a Republican (former if not current) and I assume he has somewhat more influence in that quarter. It’s like a Hypocritic Policy Oath – first do no harm. As noted in the quote above, he expressed a general concern about the GOP’s permanent tax cuts. But if any of the current legislative proposals is antithetical to his premise, exempting social security from taxation is it. And both parties are proposing it, just in different amounts and configurations.

If we want to attract/retain young people, why would we raise their relative cost of public services? Exempting social security income from taxation (whether totally or just somewhat more) means Minnesota will tax young, working people more heavily for existing public services. That is so because the lost revenue could have paid for an across-the-board tax cut that would have benefited workers as well as retirees. Instead, we’d surcharge them to benefit more affluent seniors (lower income recipients are already exempt). Never mind that seniors already consume a disproportionate share of public services (think nursing homes and home health care). Preferentially taxing seniors who can easily pay is policy malpractice, even if it is politically shrewd.

If there is a tax bill, some version of an expanded social security exemption will be in it. Given Horner’s basic premise, strongly pointing out the wrong headedness of that should have been the first thing he did. Instead, he promoted a bucket of amorphous services – not helpful when bills are already written and have been passed by one or both houses.