Smart Use of Surplus? You decide
After a decade balancing recurring budget deficits, this year legislators faced a more pleasant, but equally daunting task. Thanks to the budget balancing accomplishments of the 2013 session and improvement in state’s economy, the 2014 legislature had a projected $1.233 billion surplus for the current (FY 2014-15 biennium).
The following summary of the distribution of the FY 2014-15 surplus is based on the preliminary end-of-session general fund budget tracking sheet projections prepared by Senate Counsel, Research, and Fiscal Analysis and other sources. The chart below shows the distribution of the $1.233 billion surplus for the FY 2014-15 biennium.
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A total of $550 million of the FY 2014-15 $1.233 billion surplus was returned to taxpayers in the form of tax reductions through two tax acts. The first omnibus tax act of 2014 provided the lion’s share of these reductions: $446.7 million. Just over $200 million in tax cuts were distributed by changing Minnesota’s tax code pertaining to the marriage penalty, the Working Family Credit (WFC), student loan interest deduction, the dependent care credit, business depreciation, and other areas to conform to the federal tax code; these provisions not only provided tax relief, but also simplified tax filing for Minnesota taxpayers.
The first tax act also eliminated three unpopular business-to-business sales taxes that were enacted during the 2013 session, at a cost to the state of $232 million in FY 2014-15 in foregone revenue. In addition to WFC federal conformity, this act also increased the credit, thereby providing additional tax relief to low-income working families.
The second omnibus tax act of 2014 provided $103.3 million in additional tax relief in FY 2014-15, including $45 million in reductions in June accelerated sales tax payments by Minnesota businesses, which were explained in a May 9 Hindsight post.
The second tax act also included a $17 million annual increase in the agricultural homestead credit that will reduce taxes on farm land beginning in the current year and a one-time $25 million increase in the homestead credit refund and the renters’ property tax refund, which will target tax relief to low- and moderate income homeowners and renters. Other major provisions of the second tax act, including an expansion of the local government sales tax exemption (also described in the May 9 post) and a $7.8 million Local Government Aid increase (whittled down from $10.1 million from an earlier tentative agreement) will have little or no impact on general fund finances until FY 2016-17.
Both the first and second tax acts contained some provisions likely to rankle Minnesota progressives. The first act cut the estate tax and eliminated the gift tax, thereby reducing state revenue by $43 million in FY 2014-15 and by about $200 million per biennium by the time the estate tax reductions are fully phased-in. The estate and gift taxes are highly progressive taxes that offset regressivity in other parts of the state tax code; the large cuts to these taxes will have the effect of increasing tax regressivity, although the first tax act in its entirety is likely to reduce overall tax regressivity (at least in the short term) due to other progressive features of the act.
The second tax act contains a one-time $2.8 million tax credit to subsidize private tutoring for students that have been tested for, but not determined to have, a learning disability related to reading. This credit, which is not targeted based on income, clutters the tax code with another special tax break and subsidizes participation in a largely unregulated private market.
In addition to tax reductions, the first tax act increased the state budget reserve by $150 million, increasing total state reserves (including both the budget reserve and the cash flow account) to $1.16 billion. This increase in the state’s reserve marks progress toward the goal of achieving a $2 billion reserve as recommended by the bi-partisan Budget Trend Study Commission and will help the state manage volatility in future state revenue collections. The first tax act also dedicates a portion of future budget surpluses to beefing up the budget reserve.
A portion of the $1.2 billion surplus is also dedicated to spending; most of this spending—$261.9 million—is concentrated in the omnibus supplemental finance bill and includes $103.9 million for health and human services, $54.3 million for E-12 education, $22.3 million for higher education, $35.0 million for judiciary and public safety, $19.8 million for jobs and economic development, $15.3 million for transportation, and $10.6 million for environment, economic development, and agricultural.
Approximately nine-tenths of the $41.9 million “other” category in the above chart is comprised of spending from smaller bills outside of the omnibus supplemental finance bills. In total, new ongoing state spending will comprise about $300 million in FY 2014-15.
The legislature also used $198.7 million of the surplus to pay cash for long-term capital investment projects that ordinarily would have been paid for in the state bonding bill. Conservatives in the legislature balked at the notion of a bonding bill in excess of $850 million and because passage of a bonding bill requires a 60 percent majority in both bodies, they were able to block passage of any bonding bill they deemed too big. As a result, progressive legislative leaders opted to pass an $846 million bonding bill and to pay for nearly $200 million in other capital projects through a separate bill paid for with cash instead of bonding; because this separate bill did not involve bonding, it could be passed with a simple majority and thus did not require conservative support.
The combined tax cuts, spending increases, budget reserve increase, and “cash for bonding” provisions passed during the 2014 session add up to less than the $1.233 billion surplus. The remaining portion of the surplus—$30.5 million—will be carried forward into the next biennium in the form of a positive budgetary balance.
In final analysis, approximately 45 percent of the FY 2014-15 surplus will be distributed in the form of tax reductions, while about 25 percent will be in the form of new ongoing expenditures. This increase in spending is justified in light of the significant decline in real (i.e., inflation-adjusted) per capita general fund spending that occurred over the course of the preceding decade. The remainder of the surplus is divided between a needed increase in the state budget reserve and cash investments in long-term capital projects, with a small portion carried forward into the next biennium.
Returning to a theme heard repeatedly during the “no new tax” era, Minnesota conservatives clamored to “give back” the entire $1.233 billion surplus. The “tax-cut-as-solution-to-every-problem” strategy may have worked well politically for conservatives during the last decade, but it also lead to recurring budget deficits, perennial property tax increases, and real cuts in funding for education and other critical state assets. The balanced approach chosen by progressives during the 2014 session—consisting of a mix of tax cuts, public investments, and an increased state budget reserve—will better serve the interests of the state in the long term.