Budget and Tax Decisions Held Center Stage

Faced with a daunting $6.4 billion projected budget shortfall for the upcoming 2010-11 biennium, the Minnesota Legislature and Governor Tim Pawlenty were unable to resolve their differences regarding how to balance the budget.

Minnesota's budget gap was the largest in the nation on a per capita basis. The federal stimulus legislation provided $2.6 billion to Minnesota to help resolve the budget problem. Governor Pawlenty proposed a mix of budget cuts ($1.5 billion), one-time monies ("tobacco bonds") and some budget shifts. The DFL majorities in the House and Senate proposed a mix of budget cuts ($1.6–$2.4 billion), tax increases and budget shifts.

The most contentious issue was where to find new revenues and whether the state budget must be balanced for the next two years or four years. The governor proposed a bond issue that would be paid for by existing and forecast revenues from the tobacco settlement—a one-time fix disliked by some because it aimed to use long-term borrowing to pay for current state operations. The DFL majority in the House and Senate proposed a variety of new taxes and tax increases to provide new revenues.

In the closing days of the legislative session, it became clear that an approximately $3 billion gap remained between projected revenues ($31 billion) and the state's expected operating expenses ($34 billion). The governor said "no" to all of the DFL legislators' tax proposals and the legislators said "no" to tobacco bonds. The Legislature adjourned on May 18 at midnight, and it is not scheduled to return until February 4, 2010.

No New Taxes—House Republicans Uphold Tax Vetoes

While House and Senate DFLers proposed many new taxes and tax increases, none became law. Twice the House and Senate passed tax bills that increased top-tier individual income taxes, increased alcohol and tobacco taxes, and placed a surcharge on lenders charging interest rates greater than 15 percent. The governor vetoed both of these bills. House Republicans stood unified on a veto override attempt on the first tax bill and vociferously objected to the passage of the second tax bill in the waning minutes of the session.

Unallotment—What Is It?

In a move that caught most by surprise, including the DFL legislative leaders, the governor signed all the appropriation bills sent to him by the Legislature. He used his line-item veto power to reduce some spending, but the appropriation bills contain about $3 billion more in spending than the state is projected to receive in revenues in the next two years.

With spending in place for the next biennium, the governor announced that he would not call for a special session. Instead he will reduce state spending with a rarely used tool called "unallotment." The statutory power of unallotment allows the governor and his administration to reduce spending in the 2010-11 budget to levels that match the estimated revenues, thus eliminating a projected budget deficit. The governor can begin this unallotment process as early as July 1, 2009.

In Search of New Revenue—DFLers Propose Many Taxes, Tax Increases, Some Tax Decreases

The DFL majority in both the House and Senate supported "shared sacrifice" and a mix of spending cuts and tax increases in order to eliminate the $6.4 billion budget shortfall. The House position was that the elimination or reduction of existing tax breaks and incentives for individuals and businesses was better tax policy. Included in the various tax House and/or Senate tax proposals were the following:

• Increase the individual income tax to 9 percent (House) and 9.25 percent (Senate) on the top tier of earners
• Increase the current income tax rates for all income taxpayers (Senate)
• Eliminate the tax deduction for mortgage interest for many homeowners; replace the deduction with a targeted credit
• Eliminate the tax deduction for real estate taxes
• Eliminate the tax deduction for charitable donations; replace with targeted credit
• Eliminate the tax credit for education expenses
• Double the gross-receipts tax and increase the excise on alcohol and beer, and more than double the excise tax on cigarettes
• Impose a surcharge on lenders charging interest greater than 15 percent
• Increase commercial and industrial property taxes by a projected $300 million in the 2010-11 biennium
• Allow counties to exercise the option to impose a ½ cent sales tax to compensate for loss in county aid
• Eliminate the tax exemption for interest on municipal and 501(c)(3) bonds
• Eliminate the foreign royalty subtraction and foreign operating company provision in corporate income tax
• Eliminate the credit for organ transplants
• Tax as income a portion of most tax increment financing and tax abatement subsidies
• Tax sales of remote sellers by expanding the definition of a company's nexus
• Impose a sales tax on digital downloads
• Eliminate some of the incentives for JOBZ, or eliminate the program entirely
• Allow the creation of "street improvement districts" by cities to assess fees at uncapped levels for transportation improvements

In addition to proposed new taxes and tax increases, the House and/or the Senate also proposed to accelerate to 100 percent the single sales factor, increase the R&D credit and convert the capital equipment sales tax refund to an upfront exemption. The business community expected an expansion of the state's sales tax base to be included in the final list of tax proposals, but neither the House or the Senate included this proposal in its final tax bill.

When the Legislature adjourned on May 18, legislators had approved, and the governor signed, a noncontroversial tax policy bill. This bill does include some helpful federal update provisions and a clarification of the definition of "institutions of purely public charity" for property tax purposes.

Voters Said Yes to Legacy Amendment—Did Legislators Get It Right?

In 2008, Minnesota voters approved a constitutional amendment to increase the state sales tax by an additional 0.375 percent in order to fund the Outdoor Heritage, Clean Water, Parks and Trails, and the Arts and Cultural Heritage Funds. Legislators devoted hours of discussion and public testimony to answer the question of what types of projects the Legislature should fund. In the end, a $234 million funding bill was signed by the governor with only one line-item veto, and it appears to have been well received by the public.

Capital Projects—Governor Slims Down Bonding Bill With Veto Pen

The Legislature did pass a $300 million capital budget bill—generally known as the bonding bill—which mostly included funding for higher education facilities and transit/transportation projects. The governor used his veto pen to eliminate $86 million; $2 million of this cut was funding for the Shubert Performing Arts Center. The Central Corridor light rail line received the last $8.5 million needed to complete the project, and intercity passenger rail received $26 million for projects that may receive federal funding. In addition, $12.5 million was appropriated to the Metropolitan Council for other transit projects as determined under the Transit Capital Improvement Program.

Policy Bills Garnered Much Attention

With spending opportunities severely curtailed, legislators turned their sights toward policy initiatives. Given the economy and the state's budget problems, legislators considered most policy initiatives with an eye on the impact they might have on the state's budget and on the wallets of consumers and businesses. Among the policies considered were the following:

• Consumer Product Bans—Many proposals banning various types of consumer products were heard. In the end, the only product bans enacted by the Legislature were for baby bottles and cups containing the controversial chemical bisphenol A (BPA) that are marketed for kids age 3 or younger. The ban enters into force in January 2010.
• Recycling—Legislators considered proposals to ban certain types of packaging and containers, but all proposals were either defeated outright or amended to require agencies to study and determine whether products actually pose hazards to waste and recycling programs.
• Health Care Reform—Federal stimulus funding required a complicated "maintenance of effort" calculation—meaning some existing programs must be preserved in order to be eligible for the federal assistance. In addition, legislators looked for ways to lessen the burden of health care costs on local governments by reducing or eliminating health care mandates. No major health care reform initiatives were adopted.
• Financial Institutions—Foreclosure assistance and increased regulation of foreclosures received substantial legislative focus. The governor vetoed legislation that mandated that financial institutions offer mediation to homeowners in default on their mortgages. He also vetoed legislation that would have increased current regulation of reverse mortgages.
• False Claims Act—The Legislature approved a new false claims cause of action that imposes civil penalties and treble damages against contractors who make false claims to public bodies in Minnesota.
• Cap and Trade—The Legislature held an informational hearing on cap-and-trade pollution permitting programs. Legislators were encouraged to consider a state or regional cap and trade program. Although no legislative action was taken, it is possible that there maybe federal action, or a regional proposal from the Midwest Governors' Association.
• JOBS Coalition Legislation—A very active coalition of architectural firms, construction companies, and labor organizations were successful in passing a Vertical Construction Stimulus Bill through the Senate, but the legislation did not receive House approval. The legislation includes a loan guaranty fund and other incentives to stimulate this sector of the economy.

A New Minnesota Miracle for K-12 Education—Lost in Budget Woes

The governor proposed a small increase to K-12 education funding, the House held its K-12 budget at current levels and the Senate reduced K-12 spending by 3.2 percent. The House's "New Minnesota Miracle" would have increased K-12 funding by one-third or $2.5 billion annually, but not until the 2012-13 biennium. The final omnibus K-12 education bill generally held funding at the same level as the last biennium, but this includes budget shifts in this area. The final bill did not include the "New Minnesota Miracle."

Nuclear Power—Strong Support for Ending the Moratorium

The Senate approved a repeal of the moratorium on building new nuclear power plants by a vote of 42-24. The House narrowly defeated a similar provision by a vote of 72-60. This is an issue that will certainly be considered again next year.

Higher Education Funding

Funding for the University of Minnesota and the Minnesota State Colleges and University (MnSCU) system was reduced by about 6 percent. These reductions were less than anticipated because of "maintenance of effort" requirements attached to the federal stimulus monies. The state grant program saw an increase of $70 million over the next biennium due to an increase in the federal Pell program funding. Additional budget cuts for higher education were proposed by the governor as part of end-of-session negotiations, and may be part of his unallotments.

Aid to Counties and Cities

During budget negotiations during the legislative session and in subsequent comments outlining his unallotment plans, the governor indicated his intent to reduce state aid to counties and cities. Counties and cities are predicting property tax increases as a result of these anticipated reductions.

In Summary…

Most Capitol observers sum up the 2009 legislative session as a lost opportunity. The case for tax reform was made through two special commission reports provided to legislators—the Legislative Budget Trends Commission and the Governor's 21^st Century Tax Reform Commission. All seemed to point toward tax reform as an important component of Minnesota's economic prosperity. The budget negotiations between the Legislature and the governor never seemed to get off the ground, and the Legislature adjourned with no agreement on tobacco bonds, no tax reform, nor any new source of revenue—permanent or otherwise—to solve the budget deficit. The governor was left to unallot spending for the 2010-11 biennium. A $3.2-4 billion deficit looms for the 2012-13 biennium.