A skeptic's view of the state surplus

"The news isn't all bad," my newspaper-reading partner consoled as I bemoaned the latest headlines from Ukraine. "Look at that state surplus — $9.25 billion!"

"Hmmpf," I countered. "I don't believe it's that big — and legislators shouldn't either."

Permit me to explain my skepticism, and while I'm at it, to voice some ambivalence about the merits of temptingly big surplus forecasts in state government.

To be clear: I'm casting no aspersion on the competence of the state agency professionals and their big-league consultants who prepare budget forecasts twice each year, in November and February. They're good at what they do, and they follow state forecasting law religiously.

But that law required that this forecast be based on the state of the economic world in about mid-February. On Feb. 24, Russian forces invaded Ukraine, and the world changed.

Management and Budget Commissioner Jim Schowalter and State Economist Laura Kalambokidis acknowledged as much on Feb. 28 as they rolled out the surplus projection. Already on Day Four of the pounding of places Minnesotans were just learning to pronounce — Mariupol, Kharkiv, Zaporizhzhia — Schowalter and Kalambokidis were making "forecast risk" and "uncertainty" their mantras.

Capitol reporters have heard similar lines from this duo before. But seldom have they been uttered with such emphasis.

"We just don't know how this is going to play out," Kalambokidis told me last week. "This feels like a time when things could change a lot, in ways that we just can't predict."

It's easy to see why. The fine print of the new state budget forecast said it rested on an assumption that inflation would ease this year and retreat to 1.9% next year. Only a few days later, the U.S. Labor Department reported its latest year-over-year consumer inflation rate — 7.9%. Any easing of inflation suddenly seems a lot farther off.

Oil prices have soared in the past four weeks, and prices for other commodities are following suit. Some manufacturing supply chains that were already slow have stalled. That combination is bound to put the brakes on economic growth. If it's prolonged, it means recession.

A little recession can mean a lot of trouble for this state's government. More than many states, Minnesota relies on individual and corporate income taxes and sales taxes on durable goods. Those revenue streams are highly responsive to economic swings.

Minnesota's money managers are well aware of this phenomenon. It's why — to their credit — they've pushed so hard to build the state's budget reserve fund to today's $2.66 billion, a record high.

But in a state with a $52 billion biennial budget and a pattern of volatile revenues, that's not a big cushion. So observed Bill Marx, whom I called to congratulate on his recent retirement as the state House's chief fiscal analyst. He spent even more years than I did (45!) toiling inside the Capitol.

"Think about how much the numbers have been bouncing around, just since the pandemic began," Marx said. He noted that less than two years ago, as the pandemic took its fearsome hold, a $4 billion deficit was forecast.

"We have a nice reserve. That's helpful. But it's nowhere near enough to cover the changes we could see in the economy," he said.

Marx is the keeper of a handy list of forecast ups and downs since 1988. For us state budget geeks, it chronicles a history that the 2022 Legislature should strive to avoid repeating. The last time the state was as flush with cash as it appears to be now was 1999-2001. Major income tax cuts and business property tax relief were enacted in those years.

What ensued? Eleven of the next 18 forecasts showed deficits. The red ink didn't disappear until state income taxes were raised in 2013.

That history is why I'm not doing cartwheels (not that retired editorial writers ever do) about the latest state forecast. This much money will tempt politicians to cut taxes too deeply or increase spending more than can be sustained. Fixing matters later inevitably means a squeeze on schools, elder care, public safety and all the rest that state government funds. It's always more politically palatable to cut spending than to raise taxes.

Legislators have been warned that upward of $4 billion of the projected surplus is one-time money, not suitable for use in lasting ways. But such warnings are easily ignored amid the partisan pressures and wishful thinking of an election year.

There's one more bit of wishful thinking in state forecasts that looks especially ill-advised now. It's the removal of inflation from projections of most state spending. That 20-year-old trick was politically inspired to make state surpluses appear larger and deficits smaller than they would be if the true cost of maintaining existing state services were tallied.

Omitting inflation from one side of the budget ledger is a tolerable fiction when inflation is low. When inflation is high, it's so misleading as to be unworthy of a state committed to transparency in government.

The state's budgeteers reported that if inflation had been fully accounted for in expenditures, the next biennium's surplus would be $1 billion smaller. But that was on Feb. 28. Already then, the world had changed. My hunch is that a new calculation would yield a surplus that's significantly smaller.

Lori Sturdevant is a retired Star Tribune editorial writer. She is at lsturdevant@startribune.com.