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Should the state’s forecast include inflation?

This morning, I had the pleasure of speaking before the House Ways and Means Committee on HF150, which would require that the inflation rate be included in the state economic forecast. My remarks were based on the information below.

Inflation is low and expected to remain so

Inflation is a problem because it erodes the purchasing power of a unit of currency over time. At high rates of inflation, it can do so over short periods of time. Even at low rates, it can do so over long periods.

But this is not Weimar Germany. It is not Zimbabwe. It is not Venezuela. It is not even America of the 1970s when inflation hit 13% in 1980. Since 1983, inflation in the United States has averaged 2.7% annually. In the last ten years, it has averaged 1.6% (See Figure 1).

Figure 1: Inflation, consumer prices for the United States, Annual, Not Seasonally Adjusted

Source: Federal Reserve Bank of St. Louis

And this is expected to continue. As of Friday (2/21/20), according to the Federal Reserve Bank of St. Louis, the 5-Year Forward Inflation Expectation Rate is 1.63% (See Figure 2).

Figure 2: 5-Year Forward Inflation Expectation Rate, Daily, Not Seasonally Adjusted

Source: Federal Reserve Bank of St. Louis

Remember, high inflation over short periods can erode the purchasing power of money. But, with inflation at the low levels we have seen over the past 37 years, the two year period of the biennium just is not long enough for this to be a significant factor.

Because of that, little money is involved

Because inflation is so low and the forecast period is short, we aren’t actually talking about much money here.

At the end of the 2019 legislative session, Minnesota Management and Budget forecast the state government’s total General Fund Fiscal Year Total spending for 2020 to come in at $24 billion. If, in the meantime, there has been inflation of 1.6%, then, in 2019 dollars, that spending will be $23.6 billion. In effect, the state government’s spending will be 1.6% – or $383 million – lower in real terms than forecast in 2019. For 2021, with a forecast spend of $24.5 billion and inflation of 3.2% since 2019, the state government’s spending will be 3.2% – or $785 million – lower in real terms than forecast in 2019.

The state government is already spending – and wasting – record amounts

But, to repeat, in 2020 this is real terms spending reduction of 1.6%. It is a reduction of 3.2% in 2021. Over the biennium, that adds up to a reduction of real terms spending of 2.4% ((383 million + 785 million)/(24 billion + 24.5 billion)). Are we really supposed to believe that Minnesota’s state government is such a leanly efficient beast that its spending couldn’t be 2.4% lower over the biennium without returning us to the horse and buggy days?

That is hard to accept from a state government that:

  • Wasted $100 million of Minnesotans hard earned money on a driver’s licensing system that didn’t actually produce driver’s licenses.
  • Fired the I.T. chief who knew about MNLARS defects before its rollouts then paid him $45,000 not to sue for wrongful dismissal.
  • Failed to send $30 million of bills to MinnesotaCare enrollees then refused to even try to collect the unpaid premiums.
  • Has lost untold millions to day care fraud.
  • Has seen its DHS improperly pay $48 million to providers.
  • Paid an IRRRB official $166,000 in early retirement, then hired them back a month later.
  • Paid the DHS Inspector General $42,000 to sit around at home for three months before an investigation began.
  • Overpaid Native tribes to the tune of $29 million.

And that is just the last couple of years.

Not surprisingly, Minnesotans don’t think so. In the fall 2019 issue of our magazine, Thinking Minnesota, we asked Minnesotans “What percentage of state spending is wasteful?” Among Republicans, the answer was 36.5%. Among Independents, the answer was 25.4%. Among Democrats the answer was 24.4%. Overall, Minnesotans believe that 28.2% of state government spending is wasteful. In their view, the state government should have no problem whatsoever finding savings of 2.4%.

I would like to put this into some context.

Between 2010 and 2019, Minnesota’s state government General Fund spending increased – in real terms because we’re looking over a decade – by 35%. Spending in 2019 was higher than ever before in the state’s history (See Figure 3).

Figure 3: Total General Fund spending, 2010 to 2019, billions 2019$

Source: Minnesota Management and Budget and Center of the American Experiment

Of course, the state’s population has grown over that period, but only by 6.2%. As a result, in per capita terms, adjusted for inflation, state government spending increased by 27% between 2010 and 2019. Once again, in real terms, Minnesota’s state government has never spent more money per resident than it does right now (See Figure 4).

Figure 4: Total General Fund spending per capita, 2010 to 2019, 2019$

Source: Minnesota Management and Budget and Bureau of Economic Analysis

Indeed, in 2019 dollars, even accounting for inflation, 2020 and 2021 are set to be the state government’s highest spending years in history. When we look at Fiscal Years 2022 and 2023, the numbers from the Budget and Economic Forecast show that, even accounting for inflation, those years will set new records for state government spending.

So, again, the idea that savings of 2.4% over the biennium are unthinkable just doesn’t add up.

John Phelan is an economist at the Center of the American Experiment.