Along with several other states, Minnesota has returned to a budget surplus after some sharp deficit years. Whether that is because of luck or good policy is a matter of divided opinion. But there reportedly is about $1 billion on the table.
Already there are many suggestions on how to “use it” — ranging from tax cuts to new spending. This is premature, fiscally irresponsible and dangerous to the state economy. This surplus is not a long-lasting “structural” one, and that should be taken into account.
We should first build up a reserve fund for the day we go back to running deficits (which we will). But we really don’t have a good statutory way to do that. We should.
The problem is an old one. Finances vary sharply with overall economic activity for virtually every state government as well as for our federal one. This is true both for taxes and spending.
Minnesota, with its heavy dependence on a progressive income tax and on a sales tax that exempts necessities like food and most clothing, has especially volatile finances.
When the economy slows, outlays automatically rise moderately and revenue falls sharply.
By law, we are supposed to have a balanced budget, so we flail around trying to close the resulting gap. We often resort to smoke-and-mirrors accounting tricks like “borrowing” from school districts and moving disbursements on paper from one fiscal year to another. This creates a fiscal mess, and promotes inefficient use of resources and economic waste.
It also is an example of how manure flows downhill. State elected officials crow about their budget toughness while school districts have to scramble to solve a problem crammed down their throats.
When the economy grows, as it is doing now, tax revenue can grow sharply. Some outlays fall, although that is usually hidden by the long-term growth of the state budget, even when that occurs at a low rate. We may achieve a budget surplus, perhaps even enough so that officials can vaunt “a boatload of money.” Republicans claim the surplus is evidence that the state is overtaxed. Democrats are quick to identify social injustices that can only be remedied with new spending programs.
The core of the problem is that elected officials and the state laws governing state finances do not take into account the idea of a “structural” budget deficit or surplus.
In economics, “structural” contrasts with “cyclical.” Cyclical phenomena are those caused by the regular short-term fluctuations in economic activity, growth and recession, which we call “the business cycle.” Structural ones are driven by longer term changes caused by technology or people’s preferences.
A framing carpenter who got laid off when new housing construction collapsed in 2009, but who is being hired back now as building recovers, was cyclically unemployed. The increases in the numbers of people working as coffee-dispensing baristas over the past 20 years or addiction counselors over the past 30 are structural phenomena as was the plunge in steam locomotive mechanics in the 1940s. (My dad was one of them.)
It is only prudent to make big changes in either taxes or spending, taken individually, if you have a structural budget deficit or surplus. A structural deficit is one that you would have even if the economy was at stable full employment, neither in recession nor in the throes of an unsustainable boom. A structural surplus is one that similarly would exist if the economy was at a stable center.
If you have a surplus that would disappear as soon as the economy slows from an overheated state, it is cyclical. Ditto for a deficit that crops up only because the economy is in recession.
Prudently-managed state finances would pile up reserves whenever there was a cyclical surplus to be able to fund the deficits that inevitably occur when there is a recession. There would be no spending increases based on the “we’re-running-a-surplus” argument unless it was clear that surplus was structural and wouldn’t disappear when the boom faded. The same is true for taxes — no cuts would be made unless the surplus clearly was one that would persist across the business cycle.
Of course, you could always have spending increases paired with tax increases and tax cuts paired with real spending cuts.
Moreover, you would have to increase taxes or cut spending whenever there was a structural deficit — one that would not go away even when the economy was on an even keel.
Given how volatile state finances are, it is also prudent to amass much larger “rainy day funds” than we have done in past periods of prosperity. Recent history tells us recessions can last a long time. And there are statutory limitations on borrowing for current operating, so we cannot legally have a “borrow in bad times and pay off the debt in good times” policy (In effective terms, much of what we just did over the past five years really was this, but the borrowing had to be disguised with smoke and was in forms that had a high economic cost.)
The problem with reserve funds is that they are so tempting to legislators. Let a big pot of money accumulate and the tax cutters and new program spenders will both look at it and salivate. You need a credible mechanism to isolate the funds from the ordinary budget process.
One possible measure is to set up an independent board, modeled somewhat on the Federal Reserve Board, that would have to certify the existence of a true structural surplus before additional spending programs could be created or taxes cut. They would manage a large reserve fund that could only be drawn on when the board certified certain statutory conditions were made.
As with the Fed’s board, this panel would be appointed for staggered long terms. It would be as non-partisan as possible. None of its members could be currently elected officials. Ideally, it would be made up of former senior elected officials of the caliber of Al Quie, Dave Durenberger, Walter Mondale or Arne Carlson. It could include respected leaders from other states to give a broader perspective.
Creating a board like this would free legislators, always on a two-year election cycle treadmill, from the siren songs of fiscal populism. It could allow us to use tax dollars more efficiently. Yes, politically it is a long shot.
But our state has taken wise long-term steps before, especially under the leadership of former GOP governor Elmer Anderson and legislative leaders of both parties who focused on the common good. We should do it again.