We’re swimming in cash — the state’s budget agency has been underestimating revenue, bigly

Gone are the dark clouds that had me blind
It’s gonna be a bright (bright), bright (bright)
Sun-shiny day

—Written and sung by Johnny Nash, 1972.

This week, the state’s budget agency, known as Minnesota Management and Budget, will issue a November budget forecast for the current and upcoming biennia. This is the major planning document for the executive and legislative branches of state government as they finish preparing for the 2025 legislative session. The parameters set in the November 2024 forecast have an inordinate effect on the perception of the legislative session and on hundreds if not thousands of decisions that will be made by the time the Legislature sets a new biennial budget sometime next year.

There are two critical elements of the budget forecast: anticipated expenditures and projected tax receipts. MMB has an excellent track record of projecting expenditures. MMB has also done well in projecting future revenues. 

Well, that was true up until the past year.

The critical part of projecting state revenue comes down to one number, and that is the state’s Gross Domestic Product. If you know the GDP number, then you have a clear idea of future state revenues.  

As of the third quarter of 2023 Minnesota had a GDP of $472.8 billion, according to the US Commerce Department’s Bureau of Economic Analysis. Based on economic growth since then, Minnesota’s GDP is about $486 billion now. For every 1% growth in GDP, the state nets about $300 million annually in new revenue from its various general fund taxes.

The November 2023 MMB forecast was gloomy, dark and dreary. MMB projected GDP growth of 8.6% over the five year period of 2023-2027 or about 1.7% per year. That wasn’t really their fault, as that forecast reflected the prevailing wisdom of economic forecasters at that moment in time. The economy appeared to be slowing. Many experts, including economist and former Harvard President Larry Summers, said there would even be a mild recession in late 2023 and unemployment rates would rise rapidly. 

But what actually was going on in the economy one year ago was starkly different than what the experts were telling us. In fact, the economy was not stagnant or heading to a recession — the economy was booming! The U.S. economy grew at a rate of nearly 3% in the last half of 2023. And guess what? The economy kept growing at nearly a 3% rate well into 2024. The U.S. economy has been the best performing economy among peer countries in the past two years. And Minnesota has been growing along with it. 

Looking through the rearview mirror at November 2023 Forecast, MMB missed the actual GDP growth by nearly a full 3% over the years 2023-2027. As Joe Biden would say, that’s a BFD. Using my simple math that for each 1% of Minnesota GDP growth, we add $300 million annually to the state treasury, that’s a whole lot of Benjamin’s (in the hundreds of millions if not billions) coming the state’s way.

You can find this in the monthly reports MMB has issued since November of last year.

In February of this year, MMB issued its first 2024 budget forecast. MMB caught wind of the improving economy and updated its GDP numbers. The anticipated GDP number went up by 1.4% to 10% over the period from 2023-2027, or 2% on average. This resulted in a projected increase in revenues of $1.32 billion. MMB told the Legislature the budget was better, but there was still a “structural imbalance” in the FY26-27 biennial budget. The governor and the Legislature decided new spending commitments were inadvisable and hunkered down through May and adjourned with very little in the way of new spending.

But if you read the monthly MMB report in the Spring of this year, you would have seen revenues soaring. When fiscal year 2024 ended on June 30, MMB reported that state revenues had exceeded the February 2024 forecast — just four months later — by $421 million. That’s a booming economy.

The next major update on the revenues came when MMB gave a first quarter of FY 2025 report in early October. That report showed that state revenue for the period of July 1, 2024 to September 30, 2024 exceeded the February forecast by $234 million, or 3.2%. So, for those who are counting, stack nearly a quarter billion on top of nearly one-half billion from June. Not bad. 

In that same October report MMB raised its GDP numbers for the 2023-2027 period by a combined total of 1.1%, now bringing it up to 11.1% over the period of 2023-2027, or 2.22% per year. 

So, in the span of less than one year, MMB has upped the GDP estimate — again, the key metric for the state budget — by 2.5% for 2023-2027. 

There has also been another important factor that has made a significant contribution to the state’s revenues in the last several years. The state started the current biennium off with a budget balance of over $15 billion.

The 2023 Legislature made a number of one-time budget commitments because they knew spending much beyond about $60 billion a biennium would be difficult to sustain. 

But what happened is that that $15 billion budget balance needed to find a home. It did find a very friendly home at the State Board of Investment (SBI). The SBI has a strong reputation for investing state money and pension assets. And the SBI invested that $15 billion surplus wisely, earning the state literally hundreds of millions of dollars because of high interest rates.

And as if all of this is not enough, the same group of expert economic forecasters that just a year ago said things were terrible, just last week issued the updated consensus GDP estimate for the future. This estimate comes from the Federal Reserve Bank of Philadelphia that now has 33 blue chip forecasters, (including MMB’s own firm, Standard and Poor’s Global Management Intelligence). 

That Philadelphia Fed consensus forecast projects that GDP growth for the country from 2023-2027 will be 12%, or an average of 2.4%. That estimate is well over 3% higher than this group predicted just one year ago. And the Philadelphia Fed group is .8% higher than the MMB projection from October of this year. Holy smokes!

We will all know what MMB and its forecaster SPGMI thinks next week. A year ago at this time, when the forecasters and economists were gloomy, the economy had already found its soft landing, inflation was coming down dramatically, job growth was steady and gross domestic product was increasing rapidly. At the time MMB suggested that the state faced a significant structural deficit, and that we could not afford any new spending. 

As we now see, that was misguided. 

I urge the forecasters to listen to the inspiring words of Johnny Nash: Hopefully, they can now see clearly that the rain is gone and there are no obstacles in our way.