Minnesota's record $9.3B surplus estimate stands out in Midwest

Stronger than expected economic growth and a deluge of federal cash have boosted state budgets nationwide. But in that sea of surpluses, Minnesota appears to stand out from its neighbors.

State budget officials estimated Monday that Minnesota will have a historic $9.3 billion surplus, equal to nearly 18% of its two-year budget of $52 billion. While every state budgets differently, the forecasted sum looks larger than those of most other Midwestern states.

"It's hard to compare snapshots," Management and Budget Commissioner Jim Schowalter said, but even so, "Minnesota is likely to outperform some of our neighboring states simply because of our tax system. Our decisionmakers have put together a balanced system that weathered the pandemic really well."

While the scale of the extra funds may vary from state to state, many of the same debates are playing out as leaders consider how best to use the unexpected — and in some cases, unprecedented — financial boon.

"What this gives us is an opportunity, as Minnesotans, to make sure we're investing in Minnesotans right now," DFL Gov. Tim Walz said after the latest budget forecast, expanding his push for one-time rebate checks. "This gives us the opportunity to get those checks right in the hands of folks."

Other governors are considering similar one-time or short-term measures. In Illinois, Democratic Gov. J.B. Pritzker proposed about $1 billion in temporary tax cuts on grocery and gas purchases and a property tax rebate boost. In some states, like Indiana, high tax revenues trigger automatic rebates.

But Republican lawmakers in Minnesota are sounding a different message than Walz as they consider the massive excess state revenue.

Republicans from Idaho to Nebraska who see significant surpluses are suggesting tax cuts. In Iowa, Republican Gov. Kim Reynolds vowed to make additional tax cuts after the state hit a record surplus at the end of its last fiscal year. On Tuesday, she signed into law a measure that will shift the state to a flat tax where everyone pays the same percentage regardless of income, rather than have higher earners pay progressively more.

National researchers who focus on state finances are warning against either permanent large cuts or major ongoing spending. State surpluses have been largely propped up by temporarily high tax revenue and one-time federal funds, experts said, at a time of uncertainty about the economic effects of the war in Ukraine, the future of the pandemic, inflation and workforce shortages.

States need to analyze what their budgets will look like after federal aid expires and revenue growth returns to historic norms, and then determine whether they can continue to cover new commitments, said Josh Goodman with the state fiscal health project at the Pew Charitable Trusts.

Lucy Dadayan, who leads the State Tax and Economic Review for the Urban-Brookings Tax Policy Center at the Urban Institute in Washington, D.C., took a harder line: "These are very turbulent times and it's not the time to cut taxes."

Dadayan said one-time rebates are more prudent, noting that when the next recession comes it will be difficult to increase tax rates. Nonetheless, she said she is seeing many states cut taxes and that most of the cuts benefit higher-income taxpayers.

Many proposals bubbling up around the country are targeted at specific areas such as gas, grocery or property tax cuts, or relief for retirees and small-business owners, said Brian Sigritz with the National Association of State Budget Officers. A number of states are phasing in cuts and tying them to revenue growth and economic conditions to ensure the state can support them, he said.

Leaders in various states are proposing spending on a wide range of initiatives, including education, workforce development, the environment and public health, Sigritz said. But he noted a lot of places are making one-time investments in broadband, housing and other infrastructure, rather than in ongoing programs.

In Minnesota, Republicans want to permanently lower the state's first-tier income tax rate, a change that would cost an estimated $8.5 billion over the next three years. Democratic legislators and Walz are pushing for $1 billion in one-time funds for pandemic frontline workers, along with spending on child care, education, housing and other areas. Both GOP legislators and Walz want to use $2.7 billion to pay off unemployment insurance debt and replenish the state fund used to cover the benefits.

Minnesota's recent surplus figures appear to be one of the largest among a dozen Midwestern states, though differences in timing and the elements of a state budget used in estimates make comparisons difficult.

Wisconsin and North Dakota recently projected smaller surpluses in their current two-year budgets. Iowa and South Dakota ended the last fiscal year with surpluses of $1.2 billion and $86 million, respectively, compared to more than $4 billion in Minnesota.

"That's a significant driver in this, because persons with middle and upper incomes tended to do just fine during this pandemic period. We didn't anticipate that, but that was definitely part of the lessons learned," said Schowalter. "The sales tax continued performing well, along with the corporate tax."

States that rely heavily on one sector, especially tourism, tended to struggle more during the pandemic. But Minnesota's economy "is really diverse," Schowalter said. "We've got retail, we've got agriculture, we've got mineral resources, we've got manufacturing. And that ecosystem is what really did really well."

The Pew Charitable Trusts plans to release a report soon that will show Minnesota's tax revenue growth has been "middle of the pack" looking back over the last two budget years, said Justin Theal, an officer with Pew's state fiscal health project.

Minnesota is one of 38 states where tax-revenue gains have made up for initial losses during the pandemic, but Theal said it lags behind nearly half the states in returning to its pre-pandemic revenue-growth trend.

While surpluses vary and states are at different stages of using their federal aid, Sigritz said he has heard a common theme while reviewing recent State of the State speeches delivered by the governors.