What factors are influencing Minnesota’s potential $5 billion budget deficit? – InForum

ST. PAUL — A

shrinking surplus

coming into 2026 and a $5 billion deficit ahead in 2028 raise important questions about how and why Minnesota has arrived at this point after

an $18 billion surplus in 2023.

After Minnesota Management and Budget released its November forecast, some lawmakers quickly jumped on the opportunity to point fingers, saying state spending is the reason Minnesota may see a $5 billion shortfall, and others stood on defense, saying every penny spent was worth it and that national financial trends concern them more.

Minnesota economy experts pointed to a few primary factors as the cause for the potential shortfall: fewer federal funds, sales and income tax decreases, inflation and government overspending.

During the height of the COVID-19 pandemic, federal funds poured into states, allowing the growth of many programs, wiggle room in budgets and looser purse strings for consumers. With the federal government hitting the brakes on that money, Minnesota is part of a national trend of budget shortfalls.

Falling state revenue and moderate inflation rates are adding nearly $3 billion to the state’s projected deficit.

Minnesota Management and Budget Commissioner Erin Campbell said the state is not alone, as many others are facing some “significant economic and financial headwinds,” in part because of halted money that flowed from the federal government during COVID-19.

“One major economic underpinning that states have in common is that in recent years, federal economic stimulus dollars aimed at offsetting some of the financial impacts of the pandemic have boosted personal and business spending and related tax revenues,” Campbell said. “But as the pandemic had ebbed and stimulus spending has fallen, states across the nation, including Minnesota, began seeing revenues return to pre-pandemic levels.”

Revenues in Minnesota for the fiscal years of 2026-27 are expected to be $63.8 billion — $32.8 billion is expected to come from individual income tax, $15.8 billion from general sales tax, $6.3 billion from corporate franchise tax and $8.8 billion from “all other” revenue.

Another national trend Campbell pointed to was inflation rates. Though rates have gone down from 6% in 2022 to almost 3% in 2024, experts said the rates forecast as “moderate” will still be a large driver in the state budget.

Campbell said that if the forecast were to eliminate inflation from the equation, Minnesota would see a projected deficit in 2028 of about $2 billion, but adding in inflation, the state is left with a deficit of $5.1 billion.

The budget forecast also indicated one of the largest contributors to the impending deficit is an expected decrease in income and sales tax for Minnesota.

State Economist Anthony Becker said the income tax forecast decreased due to lower expected capital gains and reduced wage growth, and the sales tax drop is driven by lower-than-expected sales tax receipts and a shift in consumer spending from goods to services on a national scale.

Becker also explained the income tax revenue decreases in the context of one particular trend in Minnesota:

“A crucial variable influencing Minnesota’s individual income tax liability is total wage and salary income as employers work harder to fill open positions, and businesses make investments in technologies that enhance productivity,” he said.

Becker said that while wage and salary income per worker will increase in 2025, the long-term reality of Minnesota’s shrinking workforce could limit the state’s overall income tax.

“The demographic reality of Minnesota’s baby boomers aging out of the workforce continues to limit employers’ ability to add jobs,” he said. “Slow employment growth, together with stable wage and salary growth, means that average wage growth per worker, rather than growth in the number of workers, is expected to be the primary driver of growth in total wage income through our forecast horizon.”

The total amount of wages and salaries paid to workers in 2024 is expected to increase by 5% compared to the previous year, while increases in wages by 2027 are predicted to increase by 3.7%.

Becker said that in the longer term, there are indications of a cooling labor market in Minnesota, and the forecast is for real GDP growth to slow over time. He noted Minnesota has a tight labor market with approximately 1.8 job openings available for every unemployed worker in the state.

Even if wages drop in Minnesota and the labor force shrinks, the forecast showed Minnesota’s unemployment rate fairly low at 3.4% coming into the end of 2024 compared to the national 4.1%, ranking Minnesota 21st among U.S. states for unemployment.

“The high labor force participation rate and relatively low unemployment rate means that growth of Minnesota’s labor force is constrained,” Becker said. “Domestic or international migration of working age people into the state could ease that constraint.”

Minnesota’s spending was a major focus of the gloomy budget forecast. Campbell warned that growth continues to exceed revenues throughout the budget horizon, creating a structural imbalance in 2026-27 and the projected deficit in 2028-29.

The largest projected categories in Minnesota’s spending are education at $25 billion, and Health and Human Services at $23 billion. Within these categories, respectively, special education and long-term care are expected to make up the bulk of spending.

While Minnesota is expected to enter the fiscal years of 2026-27 with a smaller surplus of $616 million, expected revenues are projected to be around $63 billion, and total spending around $66 billion.

Walz stood on defense at the Dec. 4 presentation of Minnesota’s budget forecast, as his governorship passed Minnesota’s largest budget bill in 2023 of $70 billion.

“We take care of our own in Minnesota, but with that comes a cost,” he said during Wednesday’s gathering. “We’re not going to compromise our values. We’re going to make sure that we protect people and things they need.”

Walz said nothing is off the table when it comes to building this year’s budget, but he plans to make measured, responsible, bipartisan decisions.

One positive note from the budget forecast highlighted that Minnesota’s reserve, otherwise known as a rainy day fund, is projected to hit an all-time high of $3.5 billion coming into 2025.

State law requires a minimum of one-third of extra dollars in the end-of-year forecast to be moved automatically into the rainy day fund. Minnesota lawmakers could look at tapping into this fund if they don’t want to cut spending or increase taxes to prevent the deficit.

“Clearly, we have to realign the budget to make sure that spending and revenues match,” said Minnesota Management and Budget Commissioner Campbell. “We have plenty of time to do that, and we have a lot of information to do that. … I am confident that we can address the problem.”