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Minnesota's budget outlook: Smaller surplus, deficits down the road, as much as $5 billion • Minnesota Reformer [1]

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Date: 2024-12-04

With a multi-billion dollar deficit looming in a few years, the divided state Legislature must decide next session whether to address the imbalance immediately, or delay potential budget cuts or tax increases until 2027.

That’s the prognosis of the state’s budget agency, which released a detailed forecast on Wednesday. Budget analysts project that state lawmakers will have a $616 million budget surplus when they begin crafting their two-year budget in January; however, the state’s increasing costs — especially on programs for the elderly and children with special needs — will outpace revenue, potentially causing a $5.1 billion budget deficit during the two years beginning in July 2027.

In odd-numbered years, Minnesota lawmakers negotiate a two-year budget to fund state government, everything from schools to roads to state parks. The Democratic-Farmer-Labor trifecta in 2023 approved a $72 billion budget fueled by a $17 billion surplus, a large increase in state spending that included lots of one-time spending. Minnesota Management and Budget now says lawmakers won’t enjoy a large cash heap like they did two years ago, and lawmakers need to be careful about ongoing spending, otherwise Minnesota could end up $5 billion in the red.

“Clearly a deficit of this magnitude would prove to be a considerable challenge for future lawmakers,” MMB Commissioner Erin Campbell said after presenting the November budget forecast. “Not only do we have advanced notice about a problem on the horizon, we also have ample time to take action and change the trajectory.”

While state revenues are increasing, expenses are growing even faster, driven largely by rising costs and enrollment in special education and disability services.

MMB economists are tasked with forecasting state income and spending over the next 31 months, even as the country faces uncertain inflation rates, growing federal debt, and an incoming president whose economic plans could spike consumer prices and lower federal aid to states.

Lawmakers will wait until MMB releases its February forecast before they start budget negotiations in earnest, as projections can change significantly in a matter of months. MMB has consistently underestimated state revenues over the past year; the state brought in nearly $1 billion more than expected this year.

The Minnesota House is tied between Democrats and Republicans 67-67, which will complicate budget negotiations. Republicans were quick to blame Democrats for causing the looming deficit, while Democrats were at times defensive about the DFL trifecta’s budgeting but pledged to work with Republicans to craft a responsible budget.

The budget outlook could quickly change based on Trump policies

MMB experts prepared the November budget forecast without taking into account the sweeping economic policies and federal spending cuts President-elect Donald Trump has promised.

The state — and the public — don’t know what the promised import taxes and spending cuts will look like, and how they’ll impact the economy. The right-leaning Tax Foundation and a dozen other economic experts predicted widespread tariffs would lead to a reduction in U.S. economic output, which would translate to lower government revenues.

Increases in inflation, whether from tariffs, rising interest rates related to the federal deficit or other economic factors, could also quickly add to the projected deficit.

MMB predicts how much money the Legislature would need to set aside to cover inflation-related cost increases. Democrats added the inflation adjustment to budgeting in 2023 in an effort to show the true cost of government programs. The agency said Wednesday lawmakers would need to pay $926 million over 2026 and 2027 to cover inflation, and $2.2 billion the following biennium, accounting for more than 40% of the projected deficit. Those numbers are based on S&P Global estimates of inflation over the next several years, which predict steady and relatively low inflation rates, but S&P says its predictions are uncertain due to the lack of details of Trump’s plans.

Trump has also promised to reduce federal spending, which could mean Minnesota gets less help from the federal government when paying for health care, education and infrastructure.

The federal government covers more than half the cost of Medical Assistance, Minnesota’s Medicaid program, which is responsible for a significant portion of growth in spending. Even small cuts at the federal level could have large ramifications for Minnesota’s budget, as the state would have to take on higher costs just to maintain the same level of service, on top of growing demand and per-person spending. Health care costs have traditionally grown far faster than inflation.

MMB officials say they expect to know more about the potential impact of Trump’s policies before the February budget forecast, which lawmakers will use to craft the next two-year budget.

Increased health care, special education spending mostly responsible for projected deficit

More children are receiving special education services in schools, and more Minnesotans are enrolling in certain disability programs.

Those two state services, plus inflation, are why projected expenses are higher than revenues, according to the economic forecast.

MMB expects education spending from the state general fund to increase by more than 9% — $2.3 billion — between 2024 and 2029. Most of the increase will be due to special education spending; special education enrollment increased from 148,000 in 2019 to 165,000 in 2024 and is expected to continue growing, Campbell said.

The federal government is supposed to pay for around 40% of states’ special education costs, but currently contributes an average of 13% nationwide.

State officials are expecting even faster growth in Minnesotans’ use of disability waivers, which pay for in-home or community care options in lieu of nursing homes or hospitals.

Between 2024 and 2029, MMB anticipates a 25% increase in the number of disability waivers issued. At the same time, the per-person cost of care is expected to increase by around 32%.

A combative Walz won’t rule out tax increases to offset potential deficit

Gov. Tim Walz after the budget presentation painted a rosy picture of the state’s economic outlook, but often turned combative when pressed by reporters about the looming deficit.

“This is not like your hair on fire… This is a stable, balanced budget,” Walz said.

When asked whether he would consider tax increases, Walz said it was too early to say, but both tax increases and spending cuts are on the table.

House Speaker-designate Lisa Demuth, R-Cold Spring, said Republicans won’t support new taxes.

Walz said his administration was prepared for Wednesday’s less-than-ideal budget news, as costs for education and health have been increasing.

“We knew that this was coming, because these long-term changes in these major programs. We’re an aging population. We’re seeing more kids with mental health issues and autism. Those things are massively expensive,” he said.

Walz cited autism as an example of rapidly increasing costs. Federal investigators are examining potential Medicaid fraud in the state autism program, but when a reporter asked him about it, Walz appeared to not know what the question was referring to.

“As far as autism being people not claiming that they have autism?” Walz asked, seeking clarification on the question.

When the reporter said there’s been concern about fraud in the state autism program, Walz responded: “We always investigate it and those people go to jail.”

(An FBI investigation into fraud in the autism program is ongoing; no arrests have been reported.)

How will the Legislature save money?

House Speaker-designate Melissa Hortman, DFL-Brooklyn Park, emphasized that the potential deficit is “a long time into the future.”

“We’ll certainly have our eyes on ‘28 and ‘29, but it would be very premature to start budgeting for a budget period that’s beyond the horizon,” Hortman said.

Senate Majority Leader Erin Murphy, DFL-St. Paul, said lawmakers will be looking everywhere to see where they can save money, but did not provide any specifics.

“We will be wise in terms of the entirety of the budget to make sure that we’re not making cuts that slow growth in the economy or hurt families,” Murphy said.

Demuth said Republicans will begin to evaluate the efficiency of the state’s agencies to identify areas that could be cut. She said Republican leaders will send letters to agencies asking how many of their full-time positions are unfulfilled, how much they are spending on leases and how many diversity, equity and inclusion employees they have hired statewide.

“Given the fact that we have a budget crisis on the horizon, we need to start working now to evaluate the efficiency of our state programs and working to root out the hundreds of millions of dollars in fraud that is still likely going on across state government,” Demuth said.

It’s unlikely that cutting governmental positions and eliminating leases will make a major dent in the state’s financial woes, however, given the makeup of the state budget: The vast majority is payments to school districts, as well as health care and disability service providers. About 40% of the state budget goes to K-12 education alone, and lawmakers of both parties have been loath to cut funding to schools in their districts.

For now, legislators said they haven’t made any decisions on what the Legislature can get done in the 2025 session.

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[1] Url: https://minnesotareformer.com/2024/12/04/minnesotas-budget-outlook-smaller-surplus-deficits-down-the-road-as-much-as-5-billion/

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