Wednesday’s announcement that Minnesota faces a $701 million budget surplus is very good news. It takes pressure off budget cuts, provides money for unanticipated high energy costs and returns some help to local governments. It also allows the Legislature to unwind budgetary shenanigans used to paper over gaps in the last budget session.
More importantly, the projected surplus demonstrates that Minnesota has recovered quite nicely from the post-millennium recession. The surplus is almost entirely due to improving economic conditions and resulting stronger tax revenues, not to lower spending or higher taxes.
But we should not get too comfortable. If we don’t learn from recent experience, we could be back to years of deficits again before we know it.
The first projected surplus after four years of deficits marks an end to a full business cycle. In the late 1990s, when the economy was booming in Minnesota as well as the nation, we had a series of budget surpluses. Back then, the revenue commissioner once said the state had “a boatload of money.” Rebates to taxpayers became the usual thing.
If the late 1990s were the proverbial fat years, the past four certainly were lean ones, with bitter squabbling in the Legislature on how to deal with large deficits. Sessions ran overtime. Budgetary problems flowed downhill as the state reneged on commitments made to local governments. It is good that this painful phase may be ending.
It’s important to keep in mind the difference between “cyclical” and “structural” budget deficits or surpluses. A cyclical surplus occurs solely because the economy is doing significantly better than its long-run trend; a cyclical deficit happens when the economy is doing significantly worse. A structural surplus (or deficit) is one that occurs even when the economy is neither booming nor in recession, but rather perking along at its long-run average.
This is important because both revenue and spending vary with the business cycle. When the economy is hot, more people have jobs, workers get overtime or bonuses, salespeople earn fat commissions and business owners enjoy high profits. Income tax receipts rise even when rates are unchanged. Real estate and stocks increase in value; when they’re sold, they generate capital gains income, which is also subject to tax. Households spend freely and sales tax revenues increase.
At the same time, economic good times mean that outlays for welfare and unemployment-related programs decrease. The state runs a surplus, not because taxes are too high or spending is too low, but simply because the overall economy is at the top of its cycle.
When a recession occurs, people lose jobs, don’t get overtime or bonuses, scrape to earn commissions and barely make a profit. Capital losses replace capital gains. More people are eligible for unemployment compensation and for Medicaid or MinnesotaCare. More qualify for sundry welfare programs. Surpluses turn to deficits.
If tax and spending levels are such that surpluses during booms just offset deficits during busts, then the budget is in “structural balance.”
Ideally, one should not make drastic changes in taxes or spending just because of a situation that is due to short-term booms and busts. If the only reason you have a budget surplus is that the economy is doing much better than it can last over more than a few years, you should not introduce major new spending, nor should you cut taxes. Neither should you reduce spending or increase taxes just because of a recession.
We didn’t follow those rules. When we had boatloads of money, new spending was attractive. So were tax cuts. If, instead, we had been able to put that money away, the economic slowing that began in 2000 would have been much easier to weather.
But sequestering surpluses to cover eventual deficits is easier said than done. The pressures on elected officials are enormous. A bipartisan core at the political center may favor such smoothing of taxes and spending over the business cycle. But the anti-tax zealots at one end of the spectrum and the “government-spending-can-solve-every-social-ill” true believers at the other have disproportionately loud voices. The electoral harvest that moderates can reap is small indeed.
The general economic news also is good this week. The national gross domestic product report shows stronger-than-expected growth. Energy prices are moderating, and consumer confidence rebounding.
That gives us a window of opportunity not only for some balanced budgets, but for building mechanisms to reduce the boom-bust cycle in state finances. But we should not dawdle. The national recovery is well along and won’t last forever. As my mother often said, “Hope for the best and expect the worst.”
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.