Constitutional and Statutory Spending Limits Used in Other States Should Help Guide How Much Minnesota Budgets to Spend

The February Budget and Economic Forecast delivered the final budget projections lawmakers need to set their budget targets.  The forecast shows Minnesota will spend $39.300 billion in the current 2014-15 budget.  Under current law, spending will increase to $41.128 billion in the 2016-17 budget, which will leave $1.869 billion surplus.  Together, the forecasted spending and surplus add up to $42.997 billion in available funds for spending, tax relief and other purposes in the 2016-17 budget.

Drawing from these projections, Governor Dayton and the Minnesota House and Senate have all set their respective targets for general fund spending.  Governor Dayton proposes spending $42.786 billion, which is about $500 million more than the Senate’s $42.272 billion target.  The House set a much lower $39.949 billion target.  (Note: These targets are for general fund spending which is only a portion—about 55 percent—of total government spending. Other major spending items with funding primarily tied to user fees, like transportation and natural resources, operate largely outside the general fund budget.) 

After setting their general fund spending targets, the governor and each of the legislative bodies had some additional funds to allocate from the $43 billion available.  Dayton proposes to spend nearly all of it, but does propose $178.4 million tax relief and revenue reductions.  The Senate proposes $459.8 billion in tax relief and allocating $250 million to the budget reserve.  Finally, the House propose a considerably higher $2 billion in tax relief.  In addition, the House would put $100 million in the reserve, $612 million toward transportation and leave another $319 million to be allocated later. 

There’s the summary.  For the rest of the blog I’d like to dig a little deeper into how to assess what the budget target for the 2016-17 biennium should be.  This largely draws from work I did to prepare testimony on the targets for the House Ways and Means Committee.

In committee, I proposed a total $40.2 billion target.  This target includes recommendations to put $600 million in reserve, which leaves $39.6 billion for general fund spending. 

How did I arrive at those numbers?

Setting a budget target requires some careful consideration.  One issue is determining the right base from which to set the budget.  Ideally, the budget would just start from a base tied to the prior budget’s spending level.  But there are at least two considerations that might alter this base.  First, there are often one-time budget actions that distort the prior spending levels, either by inflating or deflating spending.  Second, there can be dramatic increases or decreases in the previous budget that should not be assumed to carry forward, especially after elections change the power dynamics.  Both of these considerations impact the current budget.

Account for one-time spending.  Spending in the current biennium is inflated by $813 million spent to pay back the K-12 shift from previous budgets.  The K-12 shift was a budget tool used to help fund prior budget deficits—basically a loan taken against K-12 schools.  While paying back the K-12 shift was necessary spending, it did not go to support government services provided in the current budget.   With the “loan” paid and the budget crisis behind us, it would be highly inappropriate to assume that level of funding used to pay the loan should continue.   Therefore, $813 million should be subtracted from the 2014-15 base. 

Account for dramatic changes to budget levels and political dynamics.  The 2014-15 budget represents the first budget set under one-party DFL rule since 1989.  As shown in the figure below, the result was a dramatic increase of $502 in general fund spending per person and $1,181 in spending per person across all funds.  This is based on Minnesota Management and Budget Consolidated Fund Statements, adjusted only for inflation and population.

But the graph above actually hides the size of the increase.  First, it doesn’t account for the previously noted K-12 shift payment.  Second, it doesn’t account for the fact that most of the spending increases start in 2015, midway through the budget.  Delaying a spending increase (or a tax reduction) to the middle of the budget cycle is a tried and true way to hide its full impact on future budgets because only half the increase hits the budget.  In the case of the 2014-15 budget, general fund spending increased by a whopping $1.4 billion (7.6 percent) between 2014 and 2015.  The average Minnesota family certainly didn’t experience this bump in spending. 

The 2014 election then ushered in a new divided political dynamic.  Based on the election results, voters appear to question the wisdom of this spending surge.  In light of this, it’s certainly reasonable to consider what a budget target would look like without the 2015 surge. 

With those considerations in mind, it is appropriate to subtract the $813 million K-12 shift from the 2014 spending base.  In addition, 2014 spending levels should also be considered as an appropriate base to account for the dramatic spending increases the DFL imposed in 2015.   However, the DFL did hold power and so the 2015 spending level cannot be ignored either.

That brings us to basing the current budget on two different base spending levels.  The 2015 spending level would have been $18.54 billion if 2014 levels had carried forward adjusted for inflation and population growth minus the K-12 shift.  The actual 2015 spending level is $19.95 billion. 

A range of targets based on inflation, population growth and personal income growth.  With the 2014 and 2015 spending level bases, it’s time to consider what an appropriate target should be.  According to the National Conference of State Legislatures, 26 states operate under an expenditure limitation where spending increases are tied to personal income growth or a combination of inflation and population growth.  While Minnesota does not impose an expenditure limitation, these limitations offer a good starting point for setting a budget target. 

However, there’s some controversy over which expenditure limitation offers the best approach.  Many states use growth in personal income because adjustments for inflation, population and the size of the economy are all embedded within the number.  But this assumes state government should grow as fast as the overall economy when we should be aiming to shrink government’s share of the overall economy.  Letting the public sector get too large undermines future prosperity.  (Cato’s Dan Mitchell explains why here.)

States more focused on shrinking the size of government limit spending to inflation plus population growth.  For many states, this is an appropriate target for a period of time.  But as the Manhattan Institute’s Josh Barro points out, a strict limit based on inflation and population growth would “shrink government as a share of the economy, every year, forever, meaning that government cannot maintain current service levels without voter overrides.”  As a result, states with these limits, like Colorado, end up running into problems.

So on one hand, a spending limit based on personal income is in many ways no limit at all because it lets government freely grow with the economy.  On the other hand, a strict inflation plus population growth limit ultimately leads to cuts the public won’t support. 

With that understood, it seems reasonable to conclude that a budget target should generally land somewhere in a range representing these two major types of spending limits.  And where it lands depends greatly on the state’s current spending level.  As an already high tax, high service state, Minnesota should generally land close to the inflation plus population growth side.  However, in light of the dramatic $1.4 billion increase in 2015, a reduction relative to inflation and population growth is in order.

The table below provides a range of spending targets based on different types of spending limits.  Calculations are made from both the 2014 and 2015 base. 

Expenditure Limit Type	Targets Based on 2015 Spending Level	Targets Based on 2014 Spending Level
Average Inflation for past 3 years and population growth	$40,995,571,000	$38,999,742,000
Projected inflation and population growth	$41,635,661,000	$38,839,036,000
Average of personal income growth over last 5 years	$41,498,044,000	$39,570,622,000
Average of personal income growth over last 10 years	$42,182,569,000	$40,662,162,000
2014-15 General Fund Budget Minus K-12 Shift Payment		$38,487,576,000
2016-17 General Fund Budget, February 2015 Forecast		$41,128,000,000
2016-17 Governor’s Budget Recommendation		$42,175,084,000

Based on these numbers, I decided $39.6 billion would be a reasonable target.  Understanding elections matter and a Republican controlled House isn’t going to be able to come close to negotiating a complete and immediate reversal from the last budget, I didn’t think it would be reasonable to start from $39 billion.  So, I went a little higher and landed on the next estimate in the range, about $300 million less than the current House target.