Minnesota lawmakers have an estimated state budget surplus of more than $1.3 billion to work with as they tee up new spending or tax cut proposals for the 2020 legislative session.

The expected surplus, while good news for Minnesotans, sparked an immediate debate at the Capitol over fiscal priorities, with Democrats and Republicans offering sharply contrasting responses to the new revenue figures announced Thursday.

Republicans, who control the state Senate, suggested potential tax cuts. Democratic House leaders urged caution and said more revenue is needed to cover $1.2 billion in estimated inflation in 2022 and 2023.

DFL Gov. Tim Walz was more hesitant to give specific ideas for the surplus but said he was open to legislators’ suggestions. However, he emphasized the need for a “robust” bonding bill, which allows the state to borrow to pay for improvements to transportation, wastewater systems, state and university buildings and other infrastructure. He also underscored the importance of maintaining a strong budget reserve to protect the state’s fiscal stability.

“We must think to the future,” Walz said. “We must ensure Minnesotans are in the best position possible to weather whatever economic uncertainties may come our way. We need to think about, and budget for, the next generation.”

Senate Majority Leader Paul Gazelka, R-Nisswa, was quick to suggest some potential uses for the surplus, including removing the state tax on Social Security income, reducing vehicle tab fees, improving school safety or improving roads and bridges.

“If you have an excess you should think about giving that back,” he said.

But Democrats warned that, because inflation is not factored into the next two-year budget, there could be less to the surplus than meets the eye.

“Our surplus story is really more of a fiction, and our fantasy forecast is not going to allow us to invest in core services,” said House Majority Leader Ryan Winkler, DFL-Golden Valley.

The biggest clash Thursday came after House Minority Leader Kurt Daudt, R-Crown, proposed ending a 2% tax on health care providers. Lawmakers agreed to extended the tax last session after heated negotiations.

“Really?” Walz asked incredulously when he heard Daudt’s suggestion. He said a repeal of that tax is not happening.

Slower growth on horizon

Gazelka and other Republicans credited federal and state tax cuts for the economic and revenue growth.

State Economist Laura Kalambokidis said federal tax cuts did boost economic growth, particularly business investments, in 2018. But she said the trends of growing wages and steady employment started before Minnesota made its recent tax cuts.

Budget officials attributed the surplus to higher than expected income and sales tax collections, which more than made up for corporate tax revenue lagging behind expectations. A stronger-than-anticipated close to the last two-year budget cycle, which ended in June, and a slight drop in spending also contributed to the surplus.

This spring legislators finalized the $48.5 billion general fund budget for 2020 and 2021, but they could alter it in the upcoming legislative session based on the additional money. Walz and the politically divided Legislature spent the past session battling over starkly different spending plans, and those clashes appear likely to start anew once the Legislature resumes work Feb. 11.

Much of the upcoming session will be spent determining the size of the infrastructure borrowing bill and which projects should be included. Winkler noted that DFL Rep. Mary Murphy, who is chairwoman of the Capital Investment Division, is suggesting a $3.5 billion bill. But Republican legislators said Thursday that $2 billion is too large.

Walz jokingly said his bonding bill would fall somewhere between the $1.27 billion proposal he suggested last year and the $5.3 billion in bonding requests the state received from local governments, universities, state agencies and other entities.

Lawmakers in both parties highlighted the importance of maintaining the state’s full reserves, saying they want to be prepared amid continued warnings of slower economic growth on the horizon.

The twice-a-year forecasts are just best guesses. The $1.3 billion estimate could rise or fall depending on various factors outside lawmakers’ control. Potential risks include trade policy uncertainty, consumer confidence, a slowdown in business investments and global politics, according to the forecast by the Minnesota Department of Management and Budget.

“Much will change between now and when we gather in February,” Walz said. “That means that we need to make sure that those budget reserves are healthy … It brings stability and confidence to businesses and Minnesotans to know that we’re there. And know that those essential services, and the things that grew this economy, will not be pulled out from under them.”

The $1.3 billion surplus is what’s left after the state set aside money to fill its reserves to the recommended level of nearly $2.4 billion.

Walz inherited a stable budget and strong reserves from his predecessor. When former Gov. Mark Dayton left office last year the state’s reserves were at their highest level ever and Minnesota had a run of budget surpluses.