As revenues hold up, the case for tax hikes diminishes even further

With a budget deficit of $1.3 billion forecast for the 2022-2023 biennium, Gov. Walz opted to close it with tax hikes in his recent budget. But it might get closed without any tax changes if current numbers for tax collections hold up.

Yesterday, Minnesota Management & Budget released numbers for January’s tax collections and they contained good news for the state government:

Net general fund revenues totaled $2.403 billion in January, $296 million (14.1 percent) more than forecast [in November]. Net receipts from the individual income, sales, and corporate taxes were above the forecast, while net other tax receipts matched the forecast. For fiscal year 2021, year to date receipts are now $13.727 billion, $459 million (3.5 percent) more than forecast.

Quite simply, state tax revenues have held up much better than was forecast in May, when COVID-19 was expected to blow a hole in budgets. As I wrote in October:

The first point to note is that the state’s income tax is the government’s single largest source of revenue. According to MMB’s July release, it accounted for 50.6 percent of state revenues in FY2020, as shown in Figure 1.

Figure 1: Minnesota state government sources of revenue, FY2020

Source: Minnesota Management and Budget

It is also the case that, with its progressive state income tax, higher earners pay more of this state income tax than lower earners. And, finally, it is the case that higher earners have been much less negatively impacted by the COVID-19 recession than lower earners. As I wrote in August:

For workers earning over $32 per hour ($66,560 annually), employment fell slightly but is now back above the levels of January. For workers earning less than $14 per hour ($29,120 annually), by contrast, employment fell by 32 perfect from January to April and, in June, was still 20 percent below the January level.

Given these numbers, the better-than-expected revenue numbers shouldn’t surprise us. With the economic pain so concentrated on those who earn less and pay less tax, we would not expect the the decline in income tax revenues to be proportionate with the decline in, say, employment.

Other taxes have held up too. Indeed, while income tax revenue for the first quarter of FY2021 beat the May forecast by 6.0 percent, General Sales Tax beat it by 26.0 percent and Corporate Franchise Tax by 31.9 percent.

Again, this is probably due to the concentration of economic pain among lower income earners. Economists something split spending into two categories: autonomous consumption and induced consumption. Autonomous consumption is the level of consumption which does not depend on income; even with zero income you still need to buy enough food to eat — either through borrowing or running down savings. Induced consumption is consumption that is influenced by levels of income; with rising income, people can spend more.

From this it follows that higher income earners will account for a disproportionate share of consumption spending of the sort that drives sales tax revenues and, by extension, corporate tax revenues. Again, with the economic pain so concentrated on those who earn less and pay less tax, we would not expect the decline in sales and corporate income tax revenues to be proportionate with the decline in, say, employment.

A new forecast for 2022-2023 is due later this month. There is pretty widespread agreement that it will see that $1.3 billion deficit disappear. If it does vanish, so will any vestige of an excuse Gov. Walz has to hike taxes.

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