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Back in May, the Covid-19 pandemic was in its early stages in Minnesota. Gov. Walz had shut bars and restaurants on March 16th; the stay-at-home order was issued on March 25th. Economic forecasts were dire, indeed, Minnesota’s Gross Domestic Product (GDP) contracted by a staggering 10.6% between the fourth quarter of 2019 and the second quarter of 2020, worse than the national average.
A smaller economy means lower tax revenues. In May, Minnesota Management and Budget (MMB) released an Interim Budget Projection which forecast that revenues for FY2020* would come in at $21.6 billion and $4.7 billion for the first quarter of FY2021. A deficit of $2.4 billion was projected for FY 2021.
This isn’t how it has turned out. In July, MMB reported that net general fund receipts for FY 2020 had come in at $21.8 billion, $168 million (0.8%) ahead of the May forecast. And, this month, MMB announced that for the first quarter of FY2021, revenues were $5.3 billion, $593 million (12.7%) ahead of May’s forecast.
This is good news for the state government. But how is it happening?
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% 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% from January to April and, in June, was still 20% 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%, General Sales Tax beat it by 26.0% and Corporate Franchise Tax by 31.9%.
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 the decline in sales and corporate income tax revenues to be proportionate with the decline in, say, employment.
This good news for the state government hides the reality of bad news indeed for the state’s lower income earners. How do we help them?
John Phelan is an economist at the Center of the American Experiment.