By Baird Helgeson and Jennifer Brooks

Despite an improving economy, Minnesota state leaders face a new, $1.1 billion budget deficit, according a new economic update released Wednesday.

Minnesota has been pulling itself up during a fragile economic recovery, but the sliver of additional tax revenue is not enough to keep up with rising costs, the numbers show.

The budget numbers, which are always a moving target, are more uncertain than usual as Washington leaders debate the so-called fiscal cliff, which could plunge Minnesota and the nation into another recession.

Minnesota Management and Budget has released the complete economic and budget details. The new budget number will become the foundation of DFL Gov. Mark Dayton’s budget proposal, expected to be released next month.

The improving economy in the current budget cycle will allow the state to repay $1.3 billion borrowed from public schools to balance the state budget. However, the state still owes the schools more than $1 billion and the new deficit means there is no immediate plan to pay back the balance.

“The economy is a little weaker than we thought it would be last February. Not a lot weaker, but a little weaker,” State Economist Tom Stinson said.

The uncertainly around the fiscal cliff is a bigger drag on the economy, Stinson said. If President Barack Obama and Congressional leaders fail to strike a different budget deal, a menu of tax hikes and deep spending reductions will kick in and begin tugging at an already anemic economic recovery.

“There’s no reason for us to have a recession in 2013 or 2014,” Stinson said. “And if we do, it will be self-inflicted. But that doesn’t mean we won’t have one.”

If the two sides reach a deal and bring new predictability to taxes and spending, it could unleash a torrent of pent up spending and give a notable boost to the economy in Minnesota and the nation.

“One can imagine increased business spending and increased business hiring once they knew what the rules could be,” Stinson said.

The twice-annual economic forecast takes into account an array of indicators, including local economy, the national economy, even the financial instability spiraling throughout Europe.

Minnesota's economy is already doing better than many parts of the nation. Minnesota’s unemployment rate is hovering around 5.8 percent, about two full percentage points better than the national average.

Minnesota’s construction sector endured the worst of the last recession, and has suffered the most stubbornly high unemployment rates. Stinson said he finally sees that sector improving in a significant way.

“We are expecting the housing sector to begin to turn around and begin to grow over the next couple years,” he said.

The healthcare industry continues to outperform many other sectors, particularly as Minnesota baby boomers edge toward retirement.

Dayton is going to use the budget forecast data to form his budget proposal, which is likely to include a plan for a massive retooling of the state tax system.

The changing economy has left the state relying too little on income and sales taxes and placing too much reliance on property taxes, Dayton has said.

Dayton’s revenue and budget officials want to distribute the tax burden more evenly, potentially lowering some taxes and increasing others.

Stinson said a reshuffling of the tax laws could finally break Minnesota out of the cycle of annual budget deficits that caused years of statewide reductions and borrowing. State leaders haven’t made a comprehensive reform effort since the 1980s.

“We certainly need to make sure that Minnesota’s tax system is appropriate for dealing with the economy that we have in 2012 rather than the economy that existed in 1984,” Stinson said.

Read the full budget forecast documents here.

Full Budget Forecast

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