State Budget Forecast: Another Deficit Around the Corner

Recent state budget news has been positive, but the new forecast continues to show a deficit for 2014-2015, and the federal fiscal cliff issue is not helping.
(Published Dec 6, 2012)

The state will end the current fiscal year in good shape—with revenues exceeding expenditures by $1.3 billion. However, the outlook for the upcoming biennium has hardly changed since the end of the 2012 legislative session, with a projected biennial deficit of $1.095 billion, according to the November 2012 Forecast released by Minnesota Management and Budget (MMB) on Dec. 5.

The forecast provides revenue and expenditure projections for the state’s general fund budget for the balance of the current fiscal year (FY) 2012-2013 biennium, which ends on June 30, 2013, as well as information on the upcoming FY 2014-2015 biennium. The 2013 Legislature will be crafting a budget for the FY 2014-2015 biennium when it convenes in January, and this forecast is an early indication of the state’s fiscal status.

The last official state budget forecast, issued in February and updated for 2012 legislative actions and the August special session, indicated that the state’s general fund was balanced for the remainder of the 2012-2013 fiscal biennium while the FY 2014-2015 biennium, which begins on July 1, 2013, was predicted to have an shortfall of $1.079 billion.

Under state law, the current forecast does not reflect inflationary pressure on state expenditures. If it did reflect that pressure, according to the forecast, that would increase expenditures, and the projected deficit over the FY 2014-2015 biennium would increase by an estimated $1.058 billion.

Good news for the short term
The short-term positive news for FY 2012-2013 was not unexpected. In recent months, state revenue collections have consistently but modestly exceeded forecasted levels. In the October 2012 Economic Update, MMB reported that the state closed FY 2012, the first half of the current biennium, with a general fund surplus of $299 million. For the first three months of FY 2013, revenue collections exceeded forecast by an additional $145 million.

The $1.3 billion FY 2012-2013 improvement identified in this budget forecast is already dedicated under current law to be used to reduce the approximately $2.4 billion in remaining delayed school aid payments. That school payment delay was part of the 2011 special session budget package that ended the state government shutdown and balanced the state’s general fund budget. In the 2011 special session budget, the Legislature and governor agreed that the first priority for a surplus would be to repay school districts. The accelerated school aid payments will begin in mid-December.

Projections for future not as bright
The forecast for the 2014-2015 biennium has changed relatively little since the end-of-session estimates based on the state’s February 2012 Forecast. Overall state revenues are expected to be down by $68 million or 0.2 percent.

Much of the reduction is attributable to high income taxpayers accelerating investment portfolio income in 2012 to take advantage of lower tax rates. This acceleration of income partially contributed to the increase in income tax collections during the FY 2012-2013 biennium noted above.

Projections for state spending have also been revised downward by a net of $100 million, largely due to reductions in projected costs for health and human service programs, property tax aids and credit programs, and debt service costs. The reductions in property tax aids and credits are largely the result of reduced state cost for homeowner property tax refund and targeting programs due to lower-than-projected homeowner property taxes over the forecast period.

Effects of the federal fiscal cliff
The FY 2014-2015 forecast does not include the impacts of sequestration cuts and expiring tax cuts at the federal level, commonly referred to as the “fiscal cliff.” Instead, the forecast assumes that Congress and President Obama will reach an agreement on a package to reduce the federal deficit and that the policy changes related to revenues and expenditures will be phased in beginning in 2014.

State Economist Tom Stinson indicated that due to the uncertainty surrounding the possibility of federal cuts and tax increases, MMB staff prepared an analysis of the potential economic implications should Congress and the president fail to reach an agreement.

Under that analysis, the U.S. real gross domestic product would fall in the first quarter of 2013 at an annual rate of 3.6 percent and in the second quarter of 2013 at an annual rate of 0.9 percent. According to Stinson, this scenario would reduce state revenues during the FY 2014-2015 biennium by an additional estimated $1.7 billion, leaving the projected biennial deficit at $2.8 billion.

The large and immediate negative impact of the fiscal cliff scenario on economic activity is due in part to the widely publicized automatic reductions in certain federal spending programs and the expiration of income and payroll tax cuts. However, another effect of the fiscal cliff is the impact on the federal alternative minimum tax (AMT).

According to the Internal Revenue Service, these changes to the AMT will increase the number of filers subject to the AMT from an estimated 4 million for the 2011 tax year to approximately 33 million filers, and the changes will immediately impact these tax filers for the 2012 tax year. With the 2012 tax filing deadline of April 15, 2013, the AMT expansion would have a dramatic and almost immediate impact on tax liability and a corresponding negative impact on the economy during the first quarter of 2013.

The budget documents highlight that even if Congress and the president reach agreement on deficit reduction before Jan. 1, an “aggressive fiscal policy” resolution to the fiscal cliff could materially reduce economic growth and state revenues during the 2014-2015 biennium and, therefore, increase the state's projected $1.054 billion deficit projection.

The next scheduled state budget forecast will occur around March 1. That forecast will be the final measure of state revenues and expenditures for legislators as they craft a 2014-2015 biennial state budget.

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