A budget reckoning

The rising cost of fiscal irresponsibility is unsustainable.

State lawmakers have a duty to taxpayers to set responsible budgets. The normalization of spending increases and tax hikes as the panacea for every societal concern that has characterized the DFL-controlled legislature in recent years has undermined that duty, eroding fiscal discipline. It has also stifled creativity and blocked the adoption of smart budgeting policies, leaving Minnesota taxpayers on the hook for mounting deficits and an uncertain financial future. This cannot continue.

The 2024 November budget forecast delivered some alarming news. Despite starting the 2023 legislative session with an $18 billion surplus, the Minnesota Management and Budget office (MMB) projected a potential deficit of over $5 billion for the 2028-29 budgeting cycle. This deficit has grown to $6 billion with the release of the 2025 February forecast. Even more troubling, the deficit is part of a broader fiscal issue.

MMB estimates that Minnesota will spend $71 billion but collect only $62 billion in revenues in the 2024-25 biennium. This leaves a structural imbalance of over $9 billion, mainly covered by part of the historic $18 billion surplus. Similarly, revenues collected in the 2026-27 biennium are over $3 billion less than spending. This gap grows further, reaching $6.5 billion in the 2028-29 biennium — or $4 billion after excluding discretionary inflation. With the $18 billion surplus depleted, and unable to cover extra spending, the 2028-29 biennium ends with a $6 billion budget deficit.

State budgeting is rife with risks and unknowns. To anyone who cared to investigate it, however, Minnesota’s looming budget woe was both predictable and avoidable. The historic surplus that funded the massive spending increase in the 2023 session was a one-time windfall tied to COVID-19 federal government spending. That federal gravy train was bound to run dry. By permanently raising spending using one-time revenues, lawmakers have left Minnesota taxpayers holding the bag.

Now the state is in a particularly vulnerable position since, unlike budgetary deficits caused by temporary fluctuations and which typically resolve as conditions change, structural deficits indicate that the tax system’s ability to support the state government is fundamentally compromised. Without systemic changes, these deficits could persist and likely worsen — even with improved economic conditions. In the November 2024 forecast, MMB assumed a positive outlook for both the national and state economies. Still, Minnesota ended the 2028-29 biennium with a $5.1 billion deficit despite increasing revenues. If the February 2025 forecast is any indication of what’s to come and no spending cuts pass, maintaining the current trajectory will get progressively more challenging, especially considering rising inflation and uncertainty surrounding federal policy. Immediate action is needed in the 2025 legislative session to get the state budget under control.

For long-term budget sustainability, lawmakers need to cut spending starting in the 2026 fiscal year and bring the budget baseline to where it was before the 2024 fiscal year. Lawmakers must pay special attention to Health and Human Services (HHS) and E-12 education. These are the largest and fastest-growing spending categories, contributing most of the anticipated general fund growth. Minnesota’s general fund spending per person in 2024 was the state’s highest since at least 1960 and a quarter higher than in 2023. Adjusted for inflation and population growth, spending for the entire period between 2025 and 2029 is estimated to be higher than at any point in state history before 2024. There is ample room for lawmakers to cut spending without jeopardizing essential services.

The deficit: A structural problem

The COVID-19 pandemic brought with it numerous temporary changes, chief among them unprecedented federal spending directed at individuals, businesses, and state and local governments. Starting with the Consolidated Appropriations Act (CAA) — a $900 billion stimulus package — the federal government provided over $4 trillion on COVID-specific relief programs between 2020 and 2021. Partly due to this stimulus and the short-lived nature of the pandemic-induced recession, state tax revenues did not dip as had been originally anticipated. On the contrary, states saw massive temporary surpluses. According to the Reserve Bank of Dallas, “high tax receipts relative to pre-pandemic trends” provided over $350 billion in excess state savings from the first quarter of 2020 to the second quarter of 2023. This trend was not expected to continue permanently.

For Minnesota pre-pandemic, the gap between current (collected) revenues and spending ranged between a deficit of $600 million to a surplus of $1 billion. Between 2021 and 2023, however, these balances grew multiple times higher, and were consistently positive, ranging from $3.1 to $6 billion. In 2022, current revenues were nearly a quarter higher than total general fund spending ($24.7 billion). In the February 2023 forecast, MMB estimated that these higher-than-normal surpluses would start winding down beginning in the 2023 fiscal year. With that trajectory, spending was expected to stay below revenues for the projected period between 2024 and 2027. But by overcommitting one-time surplus funds to long-term spending programs in the 2023 session, lawmakers turned these potential surpluses into deficits.

Under the current spending trajectory, spending exceeds collected revenues every year beginning in fiscal year 2024. Although this gap narrows in the 2026 fiscal year, it starts to grow in 2027 and is higher than previous estimates. As per the February 2025 forecast, the structural deficit reaches over $2 billion in the 2029 fiscal year, up from the $1.9 billion November 2024 estimate. With one-time funds depleted by the 2026-27 biennium, they can no longer mask the growing fiscal imbalance. The real issue started when lawmakers increased the state budget from $52 billion in the 2022-23 biennium to $70 billion in the 2024-25 biennium — a 35 percent hike in nominal terms — resulting in spending exceeding revenues for years to come.

HHS and E-12 education are the main drivers of growth

HHS and E-12 education were the two biggest beneficiaries of 2023 budgetary spending growth. Lawmakers appropriated over $6 billion in new HHS spending for the 2024 to 2027 period. E-12 education came in second, receiving $5.5 billion. Mainly due to these spending hikes, and slightly due to high expected inflation, by 2029, HHS spending will be 46 percent higher than it was in the 2023 fiscal year. Historically, HHS has lagged E-12 education. It is now projected to exceed E-12 education in 2029 as the biggest state spending category. In that year, HHS spending will be about four times what it was in 1990. Between 2023 and 2029, HHS will contribute 94 percent of total growth in general fund spending, with E-12 spending contributing 40 percent.

Other spending categories will shrink in dollar terms and as a share of the budget, owing to the outsized impact of HHS and E-12 education. Revenues are expected to grow in the entire period between 2026 and 2029, but HHS and E-12 not only consume this growth but exceed it. While revenues grow by $8.9 billion in FY 2026-29 compared to FY 2024-25, HHS and E-22 education grow by $12.6 billion — 141 percent of revenue growth. Together, E-12 and HHS will constitute over 76 percent of the state budget by 2029 compared to 53 percent in 1990. Any solutions for long-term budget sustainability must substantially reform E-12 and HHS, but even more particularly HHS, which poses a disproportionately larger challenge to the state budget than E-12 education.

Lawmakers should:

1. Reset the budget baseline

While Pres. Donald Trump’s tariffs, expected high inflation, and uncertainty over federal policy have worsened the budget outlook compared to the November 2024 forecast, Minnesota’s budget deficit is mainly a result of spending hikes enacted in the 2023 legislative session. In the November 2024 forecast for example, the 2026-27 baseline budget was $7.6 billion higher than the February 2023 forecast. Changes between November 2024 and February 2025 have raised that gap to over $8 billion, but they represent only about 10 percent of the total difference. Spending changes between the November 2024 and February 2025 forecast have increased the FY 2028-29 baseline budge by about $1 billion, or just one percent.

Minnesota’s budget deficit is a deep-seated fiscal issue mainly because of out-of-control spending, as was illustrated by the November 2024 forecast. The fact there is a structural deficit every year between 2024 and 2029 is further proof that the health of the state budget was already frail prior to Trump’s second term. In the 2025 legislative session, therefore, lawmakers need to cut spending starting in the 2026-27 biennium and effectively bring the annual baseline budget to where it was before the 2024 fiscal year. This will lower the starting figure for all future estimates, lessening pressure on revenue. It will also provide lawmakers flexibility to deal with any federal uncertainties.

2. Pay special attention to HHS and E-12 education

HHS: HHS spending growth has mainly occurred in the Medicaid program — known in Minnesota as Medical Assistance (MA). MA growth is especially notable in Long-Term Care (LTC) waivers — programs that provide home- and community-based services (HCBS) to individuals who would otherwise require care in institutional settings, such as nursing homes. In the February 2025 forecast, MMB estimates that LTC waivers will grow by $1.9 billion from FY 2024-25 to FY 2026-27, contributing over half of total general fund MA spending growth. This is up from the $1.8 billion increase estimated in the November 2024 forecast. HHS spending will grow by $3.1 billion in the 2028-29 biennium from the 2026-27 biennium — representing nearly half of all general fund spending growth ($6.5 billion dollars). MA contributes $2.9 billion or 93 percent of total HHS growth and LTC waivers contribute over $1.4 billion or 49 percent of total MA growth.

Lawmakers should consider repealing or modifying 2023 changes that permanently raised general fund MA spending, especially on LTC waivers. These include inflation and rate adjustments for LTC waivers. Other changes outside of LTC waivers to also examine for savings include: the elimination of MA enrollee contributions, extension of continuous eligibility beyond federal requirements for children, and the removal of asset tests for employed people with disabilities. Changes made in other programs, such as cash assistance, should also be revisited.

Compared to most states, Minnesota has higher-than-average income eligibility limits for MA and other HHS programs. This, when coupled with higher-than-average spending levels per recipient, will continue to strain the tax system. Lawmakers should also consider tightening income eligibility limits as well as strengthening income verification processes for HHS programs, particularly MA, to reduce strain on the budget.

Since they are labor-intensive, long-term care services are generally susceptible to rising costs — a phenomenon known as Baumol’s cost disease. Unlike capital-intensive industries, which see wages rise because of increased productivity, service industries do not experience similar productivity gains. Still, wages in the service sector must rise to keep up with rising wages in other more productive industries, leading to increasing service costs. Given this dynamic, both rising costs in long-term care and labor shortages are anticipated to persist. Addressing this challenge will require legislative innovation to ensure long-term budget sustainability.

In his budget recommendation published on Jan. 16, Gov. Tim Walz proposed curbing the growth in disability waivers. This is a step in the right direction. In addition to problematic spending and tax increases, however, Walz’s budget proposal fails to eliminate the structural deficit in both the 2026-27 and 2028-29 biennia, sustaining the risk of future budget shortfalls.

E-12 Education: For E-12 education, MMB expects most spending increases to come from special education and the general formula allowance. Of the $1.7 billion increase in E-12 education for the 2028-29 biennium, 96 percent is from inflation increases to the general formula allowance and special education. Lawmakers should consider adjusting or eliminating special education cost inflation adjustments and eliminating the two percent lower bound inflation adjustment for the general formula allowance. Alternatively, legislators could eliminate the automatic general formula allowance inflation adjustment and require lawmakers to authorize future spending increases.

3. Set a rule limiting spending growth

In addition to addressing the looming deficit, lawmakers should consider adopting a constitutionally binding rule limiting the rate of spending growth. Colorado’s Taxpayer’s Bill of Rights (TABOR), for instance, limits yearly revenue growth and, accordingly, state spending to the rate of population growth plus inflation, sending any excess revenues back to taxpayers. Minnesota could go in a similar direction, constitutionally limiting spending growth. This would ensure that public spending keeps up with the rising cost of living without increasing the tax burden on Minnesotans.

Tax hikes are not an option

Minnesotans already pay among the highest taxes in the country. This is a drag on the state’s economy. Minnesota’s rate of business formation is among the lowest in the country. Businesses in Minnesota are also choosing to invest and expand in other states, partly due to our high taxes. While Minnesota has a higher-than-average GDP per capita, Minnesota’s cumulative GDP per capita growth between 1990 and 2023 has lagged the national average since 2018. In 2014, Minnesota’s GDP per capita was nearly $4,700 higher than the national average, but that gap has shrunk to less than $500 in 2023. Tax hikes will worsen these trends without addressing the actual cause of the budget deficit: out-of-control spending.

Changing demographics, rising federal debt, and increasing medical costs will continue to pressure the state budget beyond the 2029 fiscal year. An aging population will drive demand for expensive services like long-term care while shrinking the tax base. Federal debt could lead to reduced funding for joint programs like MA — an option already under consideration — shifting more costs to the state. Meanwhile, rising medical prices will further inflate public health care spending. This heightens the need for spending cuts, particularly in fast-growing DHS programs. Given that spending is already at historic highs and tax increases were enacted in 2023, further spending or tax hikes in 2025 would be fiscally reckless.