Adages may be old, but they still can be wise. “Don’t count your chickens before they are hatched” should be a foundation stone of good economic policy.
However, financial prudence does not seem to be a virtue of baby boomers and succeeding generations, so this good advice often is ignored. Case in point is what the Minnesota Legislature and governor are proposing to do with the projected budget surplus.
If we only were willing to learn from our own state’s history and that of our national government and of other states, we would not be so precipitous in trying to use up this money as fast as possible.
Yes, we do have a projected budget surplus for the next two years. Yes, the state economist and staff who put the economic forecast and budget projections together are very capable and do an admirable job. And yes, having such projections helps us manage public funds better, at least if we use the information wisely.
But as eggs in the coop are not chickens, a projection is not money in the bank. It is folly to add major spending programs based on even a very good forecast. And it is double folly to make major permanent cuts in taxes based on the same tenuous estimates.
Economic forecasting is inexact. Economist’s models are pretty good at predicting variations in output and employment as long as the general trend remains the same: If the economy is growing and continues to grow, good forecasts can be made on the magnitude of that growth and of variations around the general trend. Ditto when an economy is shrinking.
However, none of these models is good at calling turning points, when economic activity switches from expansion to contraction or vice versa. Few modelers or forecasting firms predicted the financial crisis that began in 2007 or the recession that followed. The top researcher at the Minneapolis Fed still was saying we could avoid a recession a couple of months past the date where after-the-fact work by the National Bureau of Economic Research showed that a slump already had started.
Moreover, Minnesota’s state government revenue and outlays are highly sensitive to variations in the overall economy. This is a built-in feature of the exclusion of many “necessities” from sales taxes and the conscious concentration of the state income tax on high-income individuals. When the economy slows, revenue falls sharply and outlays increase. When the economy speeds up, outlays ease and tax revenue rises sharply. Fluctuations in the budget are sharper than in the underlying state economy.
Furthermore, the performance of the state economy depends enormously on what happens to the U.S. and global economies. So unrest in the Mideast or a disorderly Greek exit from the euro or the inevitable slowing of China’s economic growth can negate our state models in a hurry.
Finally, there is an unexploded land mine in the forecasts themselves. By state law dating from 2002, these forecasts must take into account the effects of inflation on revenue growth but must ignore effects of the same inflation on spending. Bill Melton, formerly the highly respected chief economist for American Express Financial, now Ameriprise, and a member of an advisory board for Minnesota management and budget, has been articulate in pointing this out, apparently to little avail. This statutory restriction on the state’s forecasters ensures a systemic overestimation of future surpluses. And if actual inflation turns out to be higher than levels incorporated in the estimates, magnitude of the problem increases.
The governor and the leadership of both parties understand this problem. Yet they act as if it does not exist. Yes, cumulative consumer inflation over the past five years is only 9 percent. But it is dangerous to assume that inflation will not be a factor going forward. Even at a couple of percent a year, the statutory divergence between inflated revenues and uninflated spending can grow large. Melton has demonstrated that this factor alone wipes out most of the surplus projected for 2020.
All this is particularly galling in terms of the fiscal history of the state over the past 15 years. In the late 1990s, with a booming state and national economy, Minnesota ran successive budget surpluses. We hailed “a boatload of money,” and “rebate” checks were mailed out. Now, most of this was the result of a seldom-to-be-repeated economic boom, but we did continue to increase outlays and cut taxes. When the economy first slowed in the new century, and then crashed after mid-2007, we were in a situation of large budget deficits. This was not only entirely predictable, but had been predicted.
To paper over the results of our folly, we engaged in all sorts of ad-hoc budgeting gimmicks and shameful stiffing of local governments. Economic growth and an increase in the income tax rate for the highest-earning households finally brought us back to balance. But we don’t yet have large amounts of money in the bank. It is clear that if we adopt the new spending favored by the governor and the DFL together with the tax cuts pressed by the Republicans, we are going to be back in fiscal crisis within a few years.
The tax cuts are particularly problematic because they will remove one of the most stable components on the revenue side. The tax on business property fluctuates less with the business cycle than do sales and income tax revenues. Eliminate that, and we will be even more dependent on revenue that inevitably whips up and down more than the underlying economy.
Patience is not a virtue of our age. But why can’t we just wait one legislative cycle to see how revenues and outlays actually turn out? Is it really impossible to not gobble the marshmallow right away?
The ideal, as I have argued before, would be to have some sort of independent board mandated to oversee a large reserve fund and certify a true structural surplus situation before taxes could be cut or new spending programs implemented. That, obviously, isn’t going to happen. But that doesn’t prevent the Legislature from simply showing maturity and discipline in fiscal matters for a couple of years.
There is no statutory impediment to our running a temporary budget surplus if, in fact, tax revenues, inflation and spending all turn out as well as incorporated in the latest forecasts. Yes, money in state coffers won’t earn high investment returns from fund managers. But waiting to watch the chicks hatch before we start dividing them up might well keep us from relapsing into the wasteful gimmickry we resorted to five years ago. The return to society from fiscal prudence would be great.
This is not to resort to wild-eyed “coming crash of 2016” scenarios, but there are many uncertainties in the economy, and the dangers are larger and more numerous on the downside than on the upside. This is the time for bipartisan maturity and restraint, and not fiscal binges on either the spending or taxing sides of state finances.