Budget Deficit: Significant but Solvable?

Some have been referring to the day that the forecast was announced as Black Wednesday.  But, not because it signifies that the state is in the “black” but because of the pall it has cast over the capitol because of the extreme challenges it poses.  The November state budget forecast with its $1.203 billion deficit will not only set the framework for the upcoming session, it will likely define the issues in the upcoming elections and will impact, both negatively and positively, political careers.

For the current biennium ending June 30, 2011 (FY2010-11), the deficit is projected to be $1.203 Billion which is primarily the result of $1.156 billion in lower than expected revenues, combined with the $91 million deficit from the previous biennium, and lower than expected spending of $44 million.  As explained in the forecast documents, most forecasters agree that the “Great Recession” is over because the country has seen positive real GDP growth in the third quarter of 2009.  This growth was accurately forecasted last February.  However, job losses and income projections were not as accurate, causing the change in the November forecast.

The state works on a two year budget cycle or on a biennial basis with the current biennium scheduled to end on June 30, 2011. The state constitution requires that the state’s budget be balanced for the current biennium. If the Legislature fails to balance the budget for the current biennium or if the Governor deems unilateral action is necessary, the Governor has the statutory authority to unallot (take back state money that was authorized to be spent, but that has not yet been legally committed) when the Commissioner of the Minnesota Management and Budget Department determines that the budget will be in deficit after taking into consideration the state’s budget reserve.

With the recent deficit news, the main purpose of the 2010 legislative session will be to balance the forecasted budget deficit and to pass a state bonding bill.  The session will begin on February 4, 2010 and is set to adjourn by constitutional mandate on May 17, 2010. After May 17, the Governor may call a special session of the legislature, if necessary.

Solving the $1.203 billion budget deficit can be done by legislative action, unallotment by the governor, or a combination of the two.  After the forecast release, the Governor issued a press release calling the deficit “significant, but solvable.”  Governor Pawlenty went on to request “that legislative leaders start committee hearings immediately to craft budget reductions that could be enacted promptly at the beginning of the legislative session.”  He also left unallotment, prior to the legislative session, as a possible partial solution as he “directed his cabinet members to begin working with legislators to discuss that potential unallotment [of local government aid] and other possible solutions.”

Additionally, Governor Pawlenty ordered state government agencies to place a hold on spending, targeting 3 percent of unspent operating funds in the current budget period. 

The governor’s press release lays out a possible scenario, through implication,  on how the deficit may be resolved.  First, it appears that the governor will likely unallot a portion of the Local Government Aid payments that are due to be made at the end of this calendar year.  Second, it appears that he will allow the legislature to act prior to further unallotments.  He may either make his own proposal for balancing the budget and present it to the legislature for action, or he may “request” that the legislature develop its own solution (as can be inferred from his Press Release).  Finally, if the legislature is not making sufficient progress in solving the deficit problem, the governor, as he did at the end of last session, may act unilaterally by unalloting.  If the governor proposed a budget solution to the legislature, that solution would likely be a roadmap to where the unallotments would be made.

One potential problem with this scenario, is that there is currently a lawsuit challenging the validity of the unallotment process followed by the governor earlier this year.  If the courts intervene and find the unallotment process invalid, the governor and legislature would have to agree to a solution, which would appear very difficult, if not impossible prior to the elections.  It is also possible that a legislative/governor fix could be delayed until the next legislative session with a new array of legislators and a new governor. 

Reaching a legislative solution that meets the governor’s requirements will be difficult because the governor will not support anything that can be portrayed as a tax increase.  This is consistent with the position he took last session and with his appeal to many prospective GOP presidential electors.  At the same time, the legislature and its leadership have been just as adamant that a solution to the deficit requires a balanced approach of tax increases, spending reductions, and finding more government efficiencies. 

To further complicate matters, in this election year, with various officials vying for political party support, they will be less likely to be swayed to the “political center” in search of a compromise for risk of damaging their respective endorsement chances among the party faithful.

Also, there are fewer “easy” budget balancing options.  For example, the budget reserve was depleted at the end of the 2009 session when it was used for the prior deficit as a prerequisite to the governor’s unallotment actions.  Another factor to consider is that as of January 1, 2010 there is only 75% (18 months) of the biennium remaining and much of the spending has either been committed or will not be immediately available because of notice requirements or system changes. This typically leaves “grant” programs the most exposed for potential budget cuts.  If for some reason a budget fix is not enacted prior to the elections, this challenge becomes even more pronounced.

In addition to the challenges posed by the current biennium, the next biennium will likely be even more vexing.   For the 2012-2013 biennium, the projected structural shortfall has now climbed an additional $995 million to $5.426 billion. These projections assume current law and do not take into consideration inflation or any statutory changes that may take place during the 2010 legislative session. The important takeaway from this planning estimate is that the deficit is seen to be long-term and will not resolve itself without more permanent systemic changes. For example, although one-time shifts or the use of budget reserves may be helpful in solving a budget deficit in one biennium, those temporary solutions will not help with the next biennium.

Unlike the 2010-2011 Biennium, there is no constitutional mandate that the state budget be balanced in the outlying biennium. So, it is possible that the legislature may adjourn with a balanced 2010-2011 budget, but that the 2012-2013 budget projections would still show a deficit. This is not out of the realm of possibility as that is what has happened the past two sessions. 

Before the legislature will take final action in addressing the deficit another forecast will be released in February.  Let’s hope that the economy will bounce back quicker than expected and be reflected in that forecast.