By Ricardo Lopez and Patrick Condon

A strong state economy helped double Minnesota's projected budget surplus to $1.9 billion, setting off a new political battle over how to carve up the windfall in an election year.

"The credit belongs to the people of Minnesota … and the businesses who have decided to locate or expand here," DFL Gov. Mark Dayton said after the state budget and economic forecast was released Thursday. "Now it's our responsibility to use that money in ways that are going to better the future of our state."

Republicans said the large surplus is fresh evidence that DFLers have held taxes too high.

"We have over-collected taxes," said House Majority Leader Joyce Peppin, R-Rogers.

Some of the extra money must by law go to pump up state budget reserves, which will reach nearly $2 billion, the most in state history. Legislators and the governor will be able to spend the remaining $1.2 billion.

Budget officials' state economic forecast was mixed and reflected weaknesses in the U.S. economy that could reverberate locally. Falling crude oil prices have resulted in low gas prices, boosting consumer spending but hurting capital investment by businesses, the forecast said.

A weak global economy and strong dollar have also diminished demand for American exports.

Minnesota's diverse economy has continued expanding despite a slowdown in manufacturing, mining and farming.

A tightening labor market is expected to produce modest wage growth, but full employment has been partly hampered by geographic labor shortages and persistent mismatches between job seekers' skills and current job opening requirements.

Dayton called for the surplus to be spent on improving roads and bridges and expanding early childhood education.

He cautioned against cutting taxes too dramatically or using too much state money for roads and bridges, warning that overspending could lead to deficits in coming years.

"I intend that an important part of my legacy will be responsible financial management," Dayton said.

Divisions, but signs of accord

Minnesota's political leaders appeared split over what to do with the surplus projected for the remainder of the two-year budget period that ends in mid-2017, although there were a few signs of bipartisan agreement.

Dayton, for instance, said he would support tax reductions in some form, and surprised some by dropping a key component of his transportation spending proposal from last spring: a gas tax.

"I think the gas tax increase is dead with the surplus available," the governor said.

Dayton and Senate DFL leaders said they could support paying cash for some of the state's transportation needs, potentially opening a pathway to a new agreement.

"That's the best news I heard today," GOP House Speaker Kurt Daudt said after Dayton dropped the gas tax proposal.

Dayton, Senate DFLers and House Republicans also agreed on some form of tax reduction proposal, but sharp disagreements loom over how deep to cut and who should benefit.

Dayton and Senate DFLers said that property tax reductions would also be a top priority next year, particularly since local property taxes are projected to rise more than $400 million in the upcoming year, according to preliminary estimates.

The governor also said "I will insist" that any tax cuts be roughly matched with corresponding increases in education funding, with an emphasis on what has become his signature second-term priority: early childhood education.

Dayton also said he would propose spending $100 million to expand broadband high-speed Internet in rural Minnesota.

House Republicans, who initially proposed nothing for rural broadband last year, said the state's existing broadband grant program needs an overhaul.

"What we need to do is reform our state grant program to make sure that it complements the federal grant program, or leverages the federal grant program to get Internet to people who don't have it," Daudt said.

Dayton also said the Legislature will probably have to set money aside to pay for court-ordered reforms of the Minnesota Sex Offender Program.

Already, several interest groups were clamoring to spend more on schools, local government aid and services for residents with disabilities, among other priorities.

The forecast is a twice-yearly snapshot of the state's budget, factoring in the latest trends in the state and local economy.

Since February, when the state budget agency released its previous forecast, the state's economy has performed well and mostly met expectations.

Warning signals

There are signs of weakness, however; the pace of hiring in Minnesota has slowed in recent months, the housing market has been stymied by a significant share of underwater mortgage loans and the state's manufacturing sector has softened.

Wage growth was also downgraded from the previous forecast, from 5.4 percent in 2015 to 4.9 percent next year. Future projections for wage and salary growth were called modest.

Also of concern to economists are the effects of record high student loan debt on the housing market, which has been further stymied by the slow growth of new households.

Between 2011 and 2014, census data showed that an average of 9,000 households formed per year. That's far fewer than the 24,000 expected.

"The leading cause of the unexpected slowdown appears to be due to an increasing rate of young adults sharing homes, perhaps the result of poor wage growth and heavy student loan debts," the forecast said.

Budget officials also highlighted reduced spending by the Department of Human Services, the result of lower health care costs for the state.

The amount the state spends paying debt also showed a decline.

State spending on education is expected to rise because Minnesota projects the number of students will grow by several thousand by 2019.

Highlighting deepening mining troubles on the Iron Range, the state expects that revenue from taconite taxes will be 90 percent less than projected in the previous forecast, bringing in $31 million.

State Economist Laura Kalambokidis cautioned that the forecast covers a two-year budget period that "just began a few months ago."

"So there's a lot of [tax] receipts left to be collected in the time remaining," she said. "A lot can happen."

Ricardo Lopez • 651-925-5044

Patrick Condon • 651-925-5049

How to spend it?
• Roads and bridges
• Property tax reductions
• Early childhood programs
• Education
• Statewide broadband high-speed Internet
• Minnesota Sex Offender Program
• Bigger statewide borrowing package for new projects
Off the table:
• Proposed gas tax