Minnesota has both a revenue problem and a
Van Wychen said people looking at Minnesota budget issues tend to
fall into two camps: the revenue-problem camp and the spending-problem
camp. "Actually, we can have both a revenue problem and a spending
problem at the same time," he said. "In Minnesota, we do have both."
Van Wychen contends that the spending
problem is not so much born of extravagance or wastefulness, but
rather is due to demographics and soaring health care costs, both
factors over which the state has limited control.
Because his expertise is primarily in taxes
and revenue, the discussion focused on the revenue side. Van Wychen
made the following points:
In the mid- to late 1990s, Minnesota had too
Every state revenue forecast from the mid-1990s until February 2001
reported a surplus. State lawmakers responded by cutting taxes. Some
were temporary and some were permanent. In 1999 and 2000, the
legislature enacted significant permanent income tax reductions.
At the same time, the state reduced local
property taxes by shifting expenses to the state general fund. In
the mid-1990s, we used the state surpluses to reduce education
property taxes. This culminated with the elimination of the general
education property tax in 2001. That same year we also eliminated the
property tax for operating expenses for transit.
In retrospect, the state appears to have
over-extended itself with the volume of tax cuts during the surplus
"There's nothing wrong with enacting tax cuts when you have
surpluses, provided you're also willing to consider tax increases when
you have deficits," Van Wychen said. "Unfortunately, that wasn't the
In order to measure how state revenue has
changed over the past decade, we need to take inflation and population
growth into account.
- Inflation is the decline in purchasing power of the dollar. In
his analysis, Van Wychen used a measure known as the implicit price
deflator (IPD) for state and local government purchases, which he
called a better measure of inflation for the kinds of things state
and local governments buy than the more commonly cited consumer
price index (CPI).The IPD for state and local government purchases
is a weighted average of all the things state and local governments
purchase. It is heavily weighted by wages and salaries in state and
local government, but also includes estimates for the entire range
of government purchases.
Some people believe that extravagant
wages and pensions have caused the IPD to grow faster than the
CPI. However, the "employment cost index" (ECI) from the U.S.
Bureau of Labor Statistics, a measure of the cost of wages and
benefits, shows that this is not the case. Over the last decade,
the state and local government ECI has not grown significantly
faster than the private sector ECI and has actually grown less
rapidly than the private sector ECI over the last four years.
The big reason for the more rapid growth
in the IPD relative to the CPI is rising benefit costs (especially
health care), which comprises a larger share of state and local
government budgets than the typical household budget.
- Population growth is critical, he said, because as
population grows, the state economy grows, the number of taxpayers
grows, as does the number of people using public services and
infrastructure. Minnesota's population growth over the last decade
has averaged 0.7 percent per year.
If we ignore inflation and population
growth, we might conclude that Minnesota doesn't have a revenue
problem. In nominal dollars (i.e., not adjusted for inflation and
population growth), state general fund revenue (specifically, current
resources) has increased by more than a third over the last decade,
from $25 billion in the FY 2002-2003 biennium to $35 billion in FY
2012-2013.It's projected to grow to $39 billion in FY 2016-2017.
But, after taking inflation and population
into account, average real per capita general fund revenue from FY
2010-1017 ($3,203) will be 14 percent less than from FY 2000-2007
($3,734). It stayed nearly flat from FY 2000 to FY 2007 and then took
a sharp nose-dive through the next two biennia, due mainly to the
Great Recession, although the revenue decline in Minnesota actually
began before the Great Recession began. Revenues have recovered a bit
since then, but we're nowhere near the level of real per capita state
income at the beginning of the last decade.
Based on these facts, Van Wychen said, it's
clear that Minnesota has a revenue problem.
For most of the last decade, Minnesota
stumbled from deficit to deficit. With few exceptions, tax increases
were off the table from 2003 to 2011, the years when Tim Pawlenty was
governor. This left us with "shifts and gimmicks" and spending
reductions as the primary mechanisms for dealing with the recurring
Because "shifts and gimmicks" are generally
one-time in nature, they don't solve the state revenue problem, but
merely postpone it.
- School aid shifts delay payments to school districts
until the next biennium, thereby creating a one-time reduction in
state expenditures, making it easier to balance the budget in the
- Liquidation of endowments created with revenue from the 1998
tobacco settlement included the draining of medical education and
tobacco-use-prevention endowments to help balance the budget early
in the Pawlenty years.
- In 2011, the state sold tobacco bonds to be paid off with future
state tobacco revenue, resulting in a one-time infusion of $643
million, which we used to balance the budget in the current biennium
(2012-2013). This was essentially a sale of a future state revenue
stream for the sake of a one-time upfront cash fix.
- Beginning in 2002, the state ignored the impact of inflation in
expenditure forecasts, but continued to account for it in revenue
forecasts. Before that, state forecasts counted inflation on both
the revenue and expenditure sides of the state budget. Ignoring
inflation made expenditures appear artificially low relative to
revenues and helped create the illusion of a smaller deficit in
future biennia than was actually the case.
"We capture the impact of inflation on
revenues, but we discount the impact of inflation in about 70
percent of expenditures," Van Wychen said. "We do measure
inflation for health care costs. The State Council of Economic
Advisors has argued that we should account for inflation in other
categories of state expenditures, except in the area of debt
service." The nonpartisan State Budget Trends Study Commission
made the same recommendation in 2010.
According to the official state budget
forecast, the state will have a $782 million surplus by FY
2016-2017. However, he said, we'll still have a deficit of $1.5
billion if we fully account for inflation on both the revenue and
expenditure sides of the state ledger.
Spending cuts are the other strategy used
over the last 10 years.
Adjusted for accounting gimmicks and state takeovers, state general
fund spending has fallen over the last decade by $5 billion in
constant 2013 dollars. On a per capita basis, this translates to an 18
percent decline, from approximately $4,000 in FY 2002-2003 to
approximately $3,275 in the current biennium.
- In inflation-adjusted dollars, per pupil state aid for K-12
education has fallen by 13 percent.
- State funding for higher education has fallen by 35 percent.
- Funding for property tax aids and credits has fallen by 43
"All of these things translate into larger
class sizes, fewer course offerings, higher tuition at state colleges
and universities, a deteriorating transportation system, higher local
property taxes and much less funding for local services and
infrastructure," Van Wychen said. "All of these things are a threat to
Minnesota's long-term prosperity."
Minnesota can afford some modest increases
in state tax revenue.
"How does Minnesota solve its revenue problem?" Van Wychen asked.
"We don't need to go back to the revenue levels of the first half of
the last decade. We can't afford to do that and by smarter spending,
we don't need to. However, we can afford some modest increases in
state tax revenue."
The "price of government" index has been
The "price of government" equals total state and local government
own-source revenue as a percentage of statewide personal income; it is
calculated by Minnesota Management & Budget and is used to measure the
size of government in Minnesota. It excludes revenues from the federal
government. During most of the 1990s, this index was above 17 percent.
Since 2000, it's been between 15 and 16 percent. Under current law,
it's projected to drop to 14.3 percent by 2017, an all-time low.
Van Wychen said under Gov. Mark Dayton's
original budget submitted in January 2013, the price of government
would average 15.5 percent over the next four years, which is
dramatically less than the 1990s and slightly less than over the
previous four years and slightly less than during the Gov. Pawlenty
years. The price of government under Dayton's revised budget should be
even less than 15.5 percent, since new revenue from expanding the
sales tax base was removed.
Both state general fund spending and revenue
will increase under the Dayton budget over the next four years.
In the next biennium, state general fund spending will increase by
seven percent in nominal dollars and 2.4 percent in real per capita
But this is considerably less than the
projected growth in the economy.
By the FY 2016-2017 biennium, under Dayton's proposed budget,
Minnesota will recapture only one-third of real per capita decline in
general fund revenue and spending over the last decade. (While all of
the details of the new budget agreement recently announced by Governor
Dayton and legislative leaders are not yet available, it will likely
restore only about one-third or less of the real per capita general
fund revenue and spending decline over the last decade.)
Dedicated revenues take away legislators'
In response to a question, Van Wychen said it's generally not a
good idea to pull things out of the general fund and give them
dedicated revenues. "The Legislature needs to have the flexibility to
respond to changing conditions and not get locked into dedicated
revenues," he said.
Solving the state's structural budget
problem should be measured by whether the state has the resources to
do the things it needs to do to optimize economic performance and
achieve other policy goals. Responding to a question, he said
solving the problem shouldn't be measured by the price of government
alone, but by the adequacy of revenues.
Redesign and reform are part of the solution
to the state's budget problems.
In response to a question about redesigning services, Van Wychen
said the goal of reform is to reduce expenditures and to be more
efficient. He said the Dayton administration has attempted to slow the
growth in expenditures in the health care area by contracting with
nonprofits. "We're not going to solve this problem entirely by taxing
ourselves back to the level we saw a decade ago," he said.
"To fully restore real per capita funding
levels to where we were at the first half of the last decade, we'd
have to have triple the tax increases that Gov. Dayton and the Senate
are proposing," he said. "That's not going to happen. We can't afford
Local Government Aid funds (LGA) should be
adjusted by inflation and population.
Responding to a question about local spending, Van Wychen said
that back in the late 1980s, LGA encouraged local spending, since the
formula was based on local property tax levies plus state aids; this
arrangement gave cities an incentive to levy more in order to get more
aid in future years. In 1989, the Legislature changed the formula to
base it on cities' demographics, not past levy and spending patterns.
For nearly a quarter century, the direct connection between local
spending decisions and state LGA payments has been severed. Cities no
longer have an incentive to spend and levy more in order to get more
"If local governments decide to spend more
now, every marginal dollar comes from property taxes," he said. "There
is greater accountability, because they have to tax themselves."
An interviewer commented that LGA has still
created a very easy out for public officials to say there isn't enough
state aid, so we must raise local property taxes. He said there is no
sense elected local officials are truly responsible for property
taxes. "LGA divorces accountability and people don't know who to
blame," the interviewer said.
Van Wychen responded that the accountability
problem arises when the state makes disproportionately large cuts to
LGA. The solution to the accountability problem is to provide for
stable and adequate funding for LGA. The current House and Senate tax
bills include important LGA reforms that will make the aid
distribution among cities more equitable in future years and provide a
significant appropriation increase in 2014 to replace a portion of
past state aid cuts; however, only the House bill adjusts the
appropriation in future years to keep pace with inflation and
population growth. "Adjusting for inflation and population growth is
critical, because if all inflationary pressures and population growth
have to be borne by the property tax, that leg of the three-legged
revenue stool (income, sales and property taxes) will grow," he said.
While LGA funding cuts should be expected when there is an unforeseen
state revenue shortfall, these cuts should not be disproportionate to
the cuts seen in other parts of the state budget.
State government alone may not be able to
solve the problem of rapid growth in health and human services
In response to a question, Van Wychen said some people have looked at
health and human services and are seeing that growth will soak up a
large proportion of the state budget and the overall economy. "There
is a real need to get some sort of handle on health care costs," he
said. "We may need more federal involvement. State government may not
be able to completely solve the problem."
Businesses don't pay property taxes on
personal property in Minnesota.
In discussing business property taxes, Van Wychen pointed out that
in Minnesota, with one exception, we don't tax personal property. In
manufacturing, 50 to 70 percent of a business's value is in personal
value and that's exempt here. Most other states do tax business
personal property, he said. The fact that Minnesota does not tax
personal property provides Minnesota businesses with a tax reduction
that helps to offset the higher taxes resulting from Minnesota's
property classification system.
Increase competitiveness by reinvesting in
An interviewer asked how Minnesota could increase its
competitiveness. "We must start reinvesting in education," Van Wychen
responded. He said real K-12 per pupil state aid has dropped by 13
percent over the last decade, so that Minnesota is now at the national
average in per pupil spending onK-12 education. "In higher education,
the situation is even worse," he said. "If we're going to compete we
need to focus on workforce development." Some of the investments in
education won't immediately improve Minnesota's workforce, but will
bear fruit down the road. For example, Van Wychen said, "All-day
kindergarten won't improve our workforce for another 15 years or so."
Van Wychen concluded by saying Minnesota can
afford a reasonable increase in state tax revenues. "The Governor,
House, and Senate are proposing modest and reasonable increases in
state revenue and spending; these are replacing only a small portion
of the revenue and spending declines over the past decade," he said.