Amid budget noise, Minnesota's government grows about the same speed as the economy

As Minnesota's legislators hammered out details of the new budget last week, once again they did nothing to change two of the state government's fundamental economic traits.

Government spending remained tied to the health of the Minnesota economy. And it stayed around 10% of the economy, as it has for decades.

Those traits tend to get lost in the political debate that rages when legislators create the two-year budget during their lengthy odd-year sessions. "I've made the point about stability of state spending's share of GDP for years but no one ever believes me," said Louis Johnston, economics professor at the College of St. Benedict and St. John's University and a longtime analyst of the Minnesota economy.

This spring, Republicans focused on inflation rates as they argued for fiscal restraint. Democrats zeroed in on increasingly favorable data on spending as a portion of Minnesotans' personal income.

But the longer-run measure of the Legislature's ability to efficiently manage the state's budget is in how closely spending aligns with the rise and fall of broader economic activity.

From 1999 through 2018, the state's general fund — which legislators control and was at the crux of the compromise with Gov. Tim Walz over the last two weeks — grew at an average annual pace of 4.15%.

The state economy grew at an average annual rate of 4.08% in that period.

Minnesota legislators this weekend formalized two-year spending in the state's general fund of $48.3 billion, almost evenly split between fiscal years 2020 and 2021.

That deal translated into spending growth of 3.5% in fiscal year 2020 and 1.6% in 2021, based on adjusted data from an economic conditions report that Minnesota Management and Budget, the state agency responsible for budgeting, published earlier this year.

Both rates are the lowest since fiscal year 2016, when spending was crimped by a tax shortfall during a manufacturing sector downturn in 2015.

Spending in the general fund tends to lag behind the performance of the broader Minnesota economy by a year or two.

In a downturn, spending falls at a much sharper rate because it is so closely tied to income tax collection.

When the economy rebounds, spending snaps back as sharply as it fell, as the state catches up on payments owed to school districts.

Johnston said the state's dependence on income taxes make such whipsaw movements inevitable.

He and other scholars have argued that Minnesota should shift its revenue structure to rely more heavily on sales taxes and other sources that vary less over time than income taxes. But the state hasn't conducted an in-depth study of its tax system since Gov. Tim Pawlenty ordered one a decade ago.

The general fund accounts for about 55% of all state government spending.

The other spending flows through funds that have designated purposes, such as for clean water or highways. And those funds grew more quickly over the past 20 years — at 4.89% on an average annual basis — because of injections of federal aid during and after the 2008-09 recession.

If the state government were a business, it would be smaller than UnitedHealth Group, Cargill, Target or Best Buy but larger than any other Minnesota-based company.

Since the 1930s and 1940s, when legislators created the framework that gave Minnesota a reputation as a big-government state, the state government's portion of GDP has typically been in the high single digits.

Over the past 20 years, state spending has ranged from 9.5% to 11% of Minnesota's GDP. By contrast, state government spending represented 7% of the economy last year in Texas, which has long had a reputation as a small-government state.

State governments' portions tend to rise the longer that the broader economy is turning upward, then fall again in recession. In Minnesota, that could change in the next two years.

With spending in the state's general fund now budgeted to grow more slowly than the average rate of the past 20 years, faster-than-average growth of the Minnesota economy would lead the state government's portion of the economy to shrink.