Budget deficit nearly $1 billion, Minnesota has a revenue problem

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Today Minnesota’s budget picture became considerably bleaker with the release of the February budget forecast. The state’s budget deficit for the fiscal year 2008-09 biennium grew from a manageable $373 million-as projected in the November forecast-to $935 million.

The new budget deficit amounts to 2.7 percent of state general fund expenditures. To make matters worse, the current biennium is one-third over, so any budget cuts to address the deficit must be concentrated within the last two-thirds of the biennium. Assuming that one-third of general fund revenue for the biennium is already spent, the remaining two-thirds of biennial general fund spending must be cut by 4.0 percent in order to balance the state’s budget.

Governor Pawlenty has shown a fondness for solving the state’s budget problems by cutting aid to local governments. However, the state’s ability to solve its budget problems on the backs of local governments and local property taxpayers is reaching its limits. As demonstrated in a recent Minnesota 2020 report, the average homestead property tax in Minnesota has shot up by over 70 percent over the last six years. Even after adjusting for inflation, the increase is nearly 30 percent. Over the same period, real per capita local government revenue has declined by nine percent. Minnesotans are not likely to sit still for more property tax increases combined with more cuts to infrastructure and local services.

Another favored approach for balancing the state budget is to shift the cost of state services on to local governments. For example, since 2004 the state has shifted responsibility for incarcerating short-term felony offenders to counties and mandated that counties pay ten percent of medical assistance costs for nursing homes stays in excess of 90 days for people under age 65. State cost shifting has the same net effect as aid cuts: higher property taxes and less revenue to pay for other local services.

Another option for balancing the state budget is to shift a portion of state aid payments to school districts into the next fiscal biennium. This accounting maneuver leads to additional school costs in the form of short-term borrowing, but it also provides the state with a one-time shot of revenue within the current biennium.

The problem with aid shifts and other accounting gimmicks is that they do not solve the state’s budget predicament, but simply shift the problem into the future. The trouble with this approach is that the future already looks even worse than the present.

Based on the February forecast, the official state structural budget deficit for the upcoming 2010-11 biennium is $1.1 billion, which is 3.0 percent of state general fund spending. However, the official forecast of the structural deficit is built upon the fiction that-while state revenues increase with inflation-state spending does not.

If we adjust the spending forecast for inflation as measured by the Consumer Price Index, the structural deficit doubles from $1.1 billion to $2.1 billion, which is 5.7 percent of state general fund spending.

To make matters slightly worse, the CPI understates inflation in government expenditures over the next biennium. The state’s Council of Economic Advisors and others have recognized that the implicit price deflator (IPD) for state and local government purchases is a better measure of inflation for state government than is the CPI. If we adjust for inflation based on this IPD, the 2010-11 structural deficit increases by another $100 million to $2.2 billion, which amounts to 5.9 percent of total state general fund spending for the 2010-11 biennium.

While accounting shifts can help the state’s budget problems in the current biennium, they do nothing to address the long-term imbalance between revenues and expenditures in the state’s general fund.

In the long-term, there are only two approaches to resolving the state’s budget problems: (1) decrease spending or (2) increase revenue. The option of decreasing public spending through increased efficiency must always be on the table when addressing a budget deficit-especially one of the magnitude we now confront.

However, spending cuts must not be the only solution to the state’s budget woes. State general fund spending has already plummeted since the beginning of the decade.

Growth in general fund spending from the 2000-01 biennium to 2002-03 biennium was largely the state result of the state-paid elimination general education and operating transit property taxes. Since 2002-03, real per capita state general fund spending has fallen steadily. Real per capita state general fund spending will be 5.9 percent less in 2008-09 based on the February forecast and is projected to decline by another two percent in 2010-11.

If state spending trends are adjusted to account for the elimination of general education and transit property taxes-which was not an increase in government spending but simply a shift in funding responsibilities away from the property tax and into the state general fund-the true decline in public investment becomes even more apparent. Real per capita state general fund spending will be 13.3 percent less in 2008-09 than in 2000-01 and will drop by an additional two percent in 2010-11 based on February forecast projections.

Relying almost exclusively on spending cuts to balance past state budget deficits has taken a toll on the state. Current per pupil spending in Minnesota has fallen below the national average, with the consequence of increased class sizes and fewer course offerings. At the same time that school revenue declines, school property taxes increase. Minnesota’s transportation infrastructure is crumbling. Fewer police patrol our streets. Libraries are closed or have shorter hours. Minnesota job growth has fallen and unemployment has risen relative to the national average. In short, Minnesota’s economy and quality of life has deteriorated.

Spending reductions that can be achieved through increased efficiency should be pursued. However, extreme expenditure cuts ultimately do more harm than good by cutting the meat-not just the fat-out of public budgets. Minnesota needs a balanced approach to address its current state budget deficit-one in which the possibility of increased revenue is not precluded due to a “no new tax” fixation.