Consider the following statements made between November 1998 and February 2002:
- By fiscal year 2003, the balance will grow to $876 million.
- $1.94 billion budget deficit projected for 2002-03.
- Minnesota’s budget deficit is now expected to reach $2.29 billion by the end of the 2002-03 biennium.
Who do you suppose made these widely disparate estimates, a bunch of economics dropouts?
No, these are successive economic forecasts made by the state Department of Finance. And they were solid projections made by very capable people using the best available information and methods.
The lesson here isn’t that econometric forecasting is a futile or fraudulent endeavor.
It is rather that, while economic projections are a very valuable tool in the effective administration of public resources, in the real world fate throws curveballs that no forecaster could ever anticipate.
Moreover, the abrupt change in the financial outlook for our state over the last 18 months illustrates how sensitive modern state government is to fluctuations in the broader economy. Most people don’t realize how much sales and income tax revenues fluctuate with the business cycle.
Part of that results from the way we structured the state sales and use tax in an effort to be fair.
We don’t tax food, rent or clothing. Those things that most households buy when times are good or bad. Yes, when someone’s overtime hours are cut their kids may not go to school wearing the latest fashion. But household purchases of necessities don’t vary much.
Sales of cars, boats, snowmobiles, entertainment centers and other luxuries, on the other hand, are highly sensitive to consumer perceptions of their personal economic outlook as well as that of the nation.
These big-ticket items are all subject to the sales tax. So sales tax revenues can fluctuate much more violently than the incomes of Minnesotans as a whole.
Income tax revenues fluctuate similarly as the top marginal tax rate that applies to overtime hours and bonuses tends to be higher than the average rate on all income.
We’ve been particularly hurt by the specific circumstance that many of Minnesota’s job losses since Sept. 11 have been at Northwest and Sun Country airlines. These laid-off transportation workers generally earn more than the state average. Therefore, the loss of taxes on that income is greater than if an identical number of lower-wage workers had lost their jobs.
The solution isn’t to change the tax system to depend on items that don’t vary with the economy. During the Great Depression, the biggest tax paid by most households was the real estate tax. Real estate taxes don’t vary with GDP or disposable income, but millions of families were unable to pay their taxes in the 1930s and many faced losing their homes for tax delinquency.
No, revenue and spending variations for state government are things that we have to live with. There are ways in which we can do a better job of coping, though.
One is to make sure that we don’t make a fetish of the revenue projections. They are a tool, an extremely useful tool, but not an end in themselves.
One of my disappointments with the current antics in the state Capitol is that many of the parties involved are concentrating on gimmicks to meet a limited-term shortfall rather than thinking of what is healthy and sustainable for the state economy over the longer term.
These are not code words for tax cuts. Republicans at the state and federal level who see tax cuts as a universal panacea for every problem are painting themselves into an intellectual and political corner.
Some day they will regret it.
But Democrats need to realize that not all state spending is effective.
From 1955 to 1980 we built more post-secondary campuses than we can sustain over the long run. We spend far more on overhead maintaining those institutions in nearly every statehouse district. And the money drained into various economic development schemes, particularly on the Iron Range, has produced precious little bang for the buck.
We need larger and better-administered state budget reserves. If we hadn’t paid out quite as much in rebates over the past six years, we would not have to face tax increases or painful cuts now.
But we have no institutional structure to effectively insulate prudent reserves from those legislators who want to cut taxes or spend every cent in sight.
This recession is not all that bad in comparison to many others our nation has experienced. And our state budget problems are less severe than those we repeatedly faced in the 1980s.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.