A Good Problem

At the time of writing, Minnesota has a $9.253 billion surplus for Fiscal Year 2022-23. This marks the ninth year Minnesota has ran a surplus:

This surplus, however, is higher than any Minnesota has had in its history. Why is the surplus over 5.5 times higher than it was last year?

Primary Factors

Most of this increase came from unexpectedly high tax collections:

But where did this come from? Part of the surplus came from COVID-19 restrictions coupled with Minnesota’s progressive tax code. Additionally, most of the increase in income tax collections is deceptive; Minnesota passed legislation to conform with changes to Federal tax law enacted by the Tax Cuts and Jobs Act. One of those changes allows passthrough entities to pay a state passthrough entity tax, which they can deduct from their state tax liability starting in 2021. The Minnesota Department of Management and Budget cites this tax change:

So far in FY 2022, net income tax receipts are $1.206 billion (16.0 percent) more than forecast, but we estimate that nearly all of that variance is due to a timing shift arising from elective Pass- Through Entity (PTE) estimated tax payments. Starting in TY 2021, pass-through businesses, typically S-Corporations and partnerships, may choose to pay a state-level PTE tax, which is deductible on their federal returns and credited against Minnesota individual income tax. While there is no net state revenue impact of the PTE, it can change the timing of receipts. In the November 2021 Budget and Economic Forecast, we assumed that some pass-through businesses would start making estimated payments on the PTE as early as December 2021, so the payments could be deducted from their 2021 federal income tax. We now estimate that end-of-year PTE payments by partnerships exceeded our forecast and are responsible for about $1.2 billion of the $1.206 billion fiscal-year-to-date individual income tax variance. We expect the credits for these payments to reduce TY 2021 individual income tax liability by the same amount, lowering final payments and raising refunds during CY 2022.

Note that PTE payments are co-mingled in the collections data with minimum fees and payments made by pass-through businesses to satisfy their non-resident partners and shareholders income tax obligations. We have inferred the amounts of PTE payments from these collections, but we will not observe the actual amounts until TY 2021 tax returns have been filed and processed. This will likely not be complete until Spring 2023. PTE estimated payments will be remitted by the PTEs, themselves, and are expected to reduce estimated tax by individuals. This transition in the first year may create significant timing-related revenue variances in estimated payments of PTEs and individuals.

This suggests that part of the surplus isn’t structural. The other main factor is unexpected economic expansion—Minnesota’s unemployment rate is 3.1% and corporate profits, as well as nominal wages, are growing fast.

Why Worry?

Unfortunately, our overheated economy must slow down; inflation outpacing real wage growth isn’t good for anyone in the medium to long-run. Both Fannie Mae and Deutsche Bank predict a mild recession for the US economy in 2023, resulting from tightening monetary policy and the Russo-Ukrainian war. Recessions lead to reductions in tax collections and higher real interest rates increase borrowing costs. Minnesota can’t account for inflation in budget forecasting, which is particularly misleading now. We can’t afford to capriciously change its fiscal policy given the economic uncertainty we’re in.

Prudence is a Virtue

The state legislature must sieze this opportunity to increase Minnesota’s long-term fiscal stability. Minnesota has already been doing a good job reducing its liabilities—we went from 36th highest funded pensions in the nation to 8th in 2 years (2017 to 2019). We’re also one of only 11 states with enough money to cover our liabilities and expenditures. Improper fiscal policy can wipe out all of these gains quickly. The Senate GOP and some DFL Senators passed a bill cutting taxes by $8.4 billion dollars over 3 years. This is poor policy that will likely increase inflation and cause the state to run a budget deficit. Governor Walz and some DFLers have their own, less problematic proposal: send checks to every Minnesota taxpayer. While this doesn’t unsustainably cut tax revenue, it’s still inflationary and a suboptimal use for the surplus. Minnesota House DFLers have a plan just as bad as the GOP: spend 7.4 billion dollars of the surplus on new spending.

Instead of unsustainable tax cuts and spending, the legislature must focus on using this money to reduce liabilities that the state faces. The highest priority item right now is for the House to pass the Unemployment Trust Fund replenishment bill. It passed 55-11 in the Senate, but some House DFLers are delaying the bill because they’re worried about corporations getting a freebie. Minnesota has already waited 5 weeks after the deadline to pay the Federal government back on the loan it issued for the Unemployment Trust Fund. Every day we wait, we waste $50,000 in interest payments. Furthermore, businesses and non-profits are now facing higher taxes because of this procrastination.

The remaining surplus ought to pay for debt service and uphold the Minnesota Department of Management and Budget’s budget reserve target of 4.8 percent of the current biennium’s general fund non-dedicated revenues. Additionally, the state legislature must make our public pension system fully solvent and reduce other structural liabilities: while the aggregate funding ratio for all public pension funds was 80.6% as of 2020, that number must reach 100%. The state legislature is back in session this week, and only time will tell if they are willing to put their political pet projects aside to do the right thing.