Budget: Less pain, some gain

Minnesota took a big step toward economic recovery Monday with welcome news that the projected deficit has fallen by more than $1 billion, prompting Gov. Mark Dayton to quickly back off some revenue-raising plans and spending cuts.

The remaining $5 billion budget shortfall remains an enormous gap to close, but the improved financial outlook could ease a tense legislative session that some fear has been lurching toward a government shutdown.

"It reduces the pressure," said state Rep. Jim Abeler, R-Anoka, who chairs the Health and Human Services Finance Committee. "If we can do this with less pain, that's very good news."

DFL Gov. Mark Dayton said he would nix some of his most controversial budget-balancing proposals, including a nation-leading income tax surcharge on high earners and cuts to health care for the elderly.

Republicans intensified claims that Dayton's proposed tax hikes are an economy-killing fix and that a budget built purely on cuts is the surest cure for the state's economic ills. DFLers called on their GOP rivals to "put up or shut up," and either unveil their proposed cuts or admit their plan is merely unrealistic political bluster.

Dayton said he was happy to withdraw his surcharge proposal. "That was always intended to be temporary. I'm delighted that this revenue picture permits it to be extremely temporary," he said.

The twice-annual economic forecast is a significant political mile marker. It locks in the two-year deficit projection and frames the legislative budget-balancing debate. It also will form the basis of the budget agreement between Dayton and a GOP-controlled Legislature. The two sides have staked out starkly different paths to balancing the budget.

"It's a modest but helpful improvement, but it does not mean the crisis is over," said Minnesota Management and Budget Commissioner Jim Schowalter.

Economists found a lot to be upbeat about. Wages are rising, the stock market is on an upswing and the manufacturing sector is sputtering back to life.

State economist Tom Stinson said the economy is primed for what could be a notable improvement. "All of the pieces are in place for more rapid employment growth," he said.

Stinson warned, however, that a volatile menu of factors could yank the state back into the economic doldrums. The housing market remains in the tank and job growth is sluggish.

Another wild card is that the forecast does not account for the upheaval in the Middle East that has sent gas prices soaring. If gasoline edges toward $5 a gallon, that could wipe out all the economic lift from the payroll tax reductions. A penny increase on a gallon of gas pulls $1 billion out of the national economy, for instance.

The capital gains tax -- profit from investments -- is one of Minnesota's smallest and most volatile revenue sources.

December's federal tax compromise delayed a 5 percent increase in the tax until 2013, which economists believe will cause investors to cash in stocks before the higher tax rate kicks in.

State budget officials estimate increased capital gains will account for a whopping 65 percent increase in adjusted gross income. Between 2009 and 2013, capital gains income for Minnesota is expected to increase more than $4.5 billion -- a jump of 180 percent.

But the perils of banking on such a steep rise in capital gains also significantly increase the risk of the forecast, according to the state's national forecasters, Global Insight Inc. From 2007 to 2009, as the recession took its hellish hold on the nation, Minnesota's capital gains revenue sank a heart-stopping 75 percent.

Budget officials estimate the state's financial ledger has already improved by $264 million, in part due to Dayton's decision to opt into a federal expansion in Medical Assistance.

Stinson noted that while the $1 billion deficit reduction seems like a bright ray of good news, it merely returns the state's finances -- and the deficit -- to where they were a year ago.

Schowalter warned that the state's pattern of shortfalls will continue unless lawmakers make long-term changes.

The remaining $5 billion projected deficit, he said, "will be a challenge for all sides to address."

The budget differences between Republicans and the DFL were on vivid display after the forecast. Both sides seized on details that affirmed their political outlook.

Stinson got the political fires roiling when he said that tax hikes would be "slightly less damaging" to the economy than strictly cutting the budget.

"You are going to need some combination of growth, tax increases and budget cuts to solve the problem," he said. "Now it's time to make those decisions."

Republicans dismissed Stinson's acceptance of tax hikes and noted the state's improved fiscal health is largely the result of something DFLers have long opposed -- tax cuts.

Senate Majority Leader Amy Koch, R-Buffalo and House Speaker Kurt Zellers, R-Maple Grove, said that when they release their budget proposal next month, it will cut spending and reform government.

Zellers checked off a few measures that would slim the number of state employees or automate state functions, though he admitted it falls far short of balancing the budget.

"If you don't start with that little bit, you are never going to get to the big part," Zellers said.

"Beginning now, the clock is ticking for the GOP to propose their property tax-raising, all-cuts budget," said House Minority Leader Paul Thissen, DFL-Minneapolis. "There's no more room for stalling."

Baird Helgeson • 651-222-1288 Rachel E. Stassen-Berger • 651-292-0164