State government budget forecast shows fiscal problems on the way

Yesterday, Minnesota Management and Budget (MMB) released their February Budget and Economic Forecast. The budget surplus of $1.5 billion for the coming biennium, forecast in December, has fallen to a forecast surplus of $1.0 billion, owning to lower revenues. A surplus is still pretty good news. But, looking a little further ahead, there is cause for concern.

Forecast revenue growth will slow as projected economic growth slows

MMB say that “The trend of slower [revenue] growth continues into the planning horizon with projected spending growth outpacing forecast revenue growth into FY 2022-23.” Biennial Growth in Total Revenues is forecast to fall from 3.2% in FY 18-19 to 2.3% in FY 22-23.

Lower tax revenues are only to be expected as economic growth slows. “The near-term outlook for U.S. economic growth has weakened since Minnesota’s Budget and Economic Forecast was prepared in November 2018”, MMB writes (the forecast does not include separate GDP growth estimates for Minnesota). Since November’s estimates, GDP growth projections have slumped from 2.7% and 2.1% for 2019 and 2020 respectively to 2.4% and 2.0%. Assuming that MMB and their consultants, IHS Markit, expect our state’s economic growth to match that of the US generally, we would expect to see tax revenue growth in Minnesota slow as US economic growth slows.

Spending is projected to rise at a faster rate than revenues

As forecast economic growth slows and tax revenue growth slows as a result, spending growth will have to slow also if the state’s finances are to remain balanced.

Sadly, this is not forecast to happen. From FY 2020-21 to FY 2022-23, the Annualized % Growth in forecast revenues is 2.3%, for projected spending the figure is 2.9%. As a result, a surplus of Forecast Revenues over Projected Spending of $538 million in FY 2020-21 is set to turn into a deficit of $11 million in FY 2022-23.

The state government could try and plug this gap by hiking tax rates. The evidence suggests that they would be unsuccessful.

If government spending is increasing at 2.9% annually and the economy is growing at only 1.6% or 1.4% (MMB’s estimates for US GDP growth in 2022 and 2023), the government will be swallowing up an ever greater share of the state’s income. At some point, this will become unsustainable. It would be better to get state spending under control before we reach that point.

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