Why Minnesota could soon face a budget shortfall

The good news delivered by Minnesota leaders Wednesday is that the state projects a $2.4 billion surplus for the two-year budget cycle that began in July.

Then came the bad news: Lawmakers might not get to spend it, a disappointing revelation for constituencies who are amassing legislative wish-lists.

How could that be? The surplus will be consumed in the coming years by rising costs of state services, such as long-term care for people with disabilities and free school meals for everyone. If lawmakers spend the surplus elsewhere, state officials said, Minnesota could face a $2.3 billion shortfall starting in July 2025.

Gov. Tim Walz and legislative leaders have acknowledged they must show some fiscal restraint when they return to the State Capitol in February. This year, the DFL-controlled Legislature used a much larger $17.5 billion surplus to pass a slate of progressive policies and a two-year $72 billion budget — the largest in state history.

GOP legislators blamed Walz and the Democrats last week for the projected deficit, saying they squandered the larger surplus and put the state in a financially precarious position.

Minnesota Management and Budget Commissioner Erin Campbell said "some of the drivers come from decisions that were made last legislative session, but that's just a part of the story."

Her department's lengthy economic forecast report shows a mix of factors. Here's what's driving Minnesota to swing from a projected surplus into a shortfall, according to the state budget agency.

FY24-25 projection: $205 million above budget

FY26-27 projection: $112 million above budget

Enrollment in Minnesota schools is about 5,000 students higher than expected, state officials said, and many of them are non-English speaking pupils who require more help.

A universal school meals program offering free breakfast and lunch to all Minnesota students is costing more than anticipated, too. The program, which the Legislature created this year, was initially forecast at about $400 million over two years.

The free meals are more popular than the state anticipated. The program is estimated to cost an additional $81 million over the next two years and $95 million more in the subsequent fiscal biennium, Campbell said.

The governor said he would not entertain scaling it back.

"We're seeing more children get healthy meals in school so they're ready to learn," Walz said. "That's an investment that I will defend all day."

FY24-25 projection: $495 million above budget

FY26-27 projection: $564 million above budget

A sizable projected increase in health and human services spending stems mostly from rising costs of home- and community-based care for people with disabilities, state budget officials said.

Home health aides and other long-term care services provided in lieu of nursing homes are projected to cost $355 million more than previously estimated in this current two-year budget cycle and $513 million more in the next fiscal biennium.

More Minnesotans are using these services while the costs of providing them are rising.

"We have seen increases in both the number of people being served for these programs as well as the average cost per person," state budget director Ahna Minge said.

Mark Haveman, executive director of the nonpartisan Minnesota Center for Fiscal Excellence, said legislators must resist thinking of the latest $2.4 billion surplus as a "mini windfall" to spend.

"We need to be really, really cautious," he said.

Haveman said he's concerned that officials might be underestimating the cost of future state employee labor contracts, which could change the budget projections.

A Minnesota Management and Budget spokesman said the latest economic forecast tries to account for labor contract increases by incorporating inflationary estimates.

But Haveman said state officials are assuming an inflationary growth rate of 2.2% in fiscal year 2026 and 2.4% in fiscal year 2027. Future labor contracts will likely include larger pay increases than that, he said.

"Employment cost growth is higher than the standard inflation that they're measuring," Haveman said.

He said Minnesota is poised to grow its government workforce at the same time, with more employees needed to run newly created initiatives, such as a state-paid family and medical leave program, and an office to oversee the legal marijuana market.

Walz and DFL legislative leaders said they hope the budget they enacted this year will help stimulate the economy with increased workforce participation and reductions in child poverty.

They said increased local government aid will help keep down property taxes, a new child tax credit will help cut poverty and the free school meals program will amount to a "lunchbox tax cut" for Minnesotans.

State economist Laura Kalambokidis said those initiatives "may be creating benefits now."

"But it takes a while before it shows up in the economic data," she said. "I need to see the economic data showing evidence of increased labor force participation, things like that."