February 2012 Forecast

November 2008

HIGHLIGHTS
Lower Spending Estimates, Small Revenue Gains Improve State Finances Minnesotas budget outlook has improved by $323 million. General fund revenues for FY 2012-13 are forecast to be $33.793 billion, $93 million (0.3 percent) more than in November and spending is expected to be $230 million (0.7 percent) less than Novembers estimates. Forecast Balance Triggers Partial Buyback of School Aid Shift The entire forecast balance is automatically allocated under current law. The first $5 million is added to the budget reserve bringing it to $653 million. The remaining $318 million is directed to reducing the school aid shifts enacted in recent legislative sessions. Repaying part of the shift increases overall FY 2012-13 education spending and increases the states current year payment to schools from 60 percent of the entitlement to 64.3 percent. After this action, $2.4 billion in school payment shifts remain to be bought back. Economic Outlook Improves, Possibility of 2012 Recession Declines Global Insights baseline forecast has changed only slightly since November. Februarys baseline calls for real GDP growth of 2.1 percent in 2012 and 2.3 percent in 2013. The November baseline called for real growth rates of 1.6 percent and 2.5 percent respectively. The probability of a recession in 2012 has been reduced from 40 percent to 25 percent while the probability that the economy will outperform the baseline has increased from 10 percent to 20 percent. FY 2014-15 Estimates Improve Slightly, $1.1 Billion Shortfall Projected Planning estimates for FY 2014-15 show a projected shortfall of $1.103 billion, down from Novembers estimate of $1.300 billion. Federal policy unknowns, such as post-election fiscal policy and state policy choices related to the implementation of the Affordable Care Act, have increased the likelihood of significant changes to the 2014-15 budget outlook.

400 CENTENNIAL BUILDING 658 CEDAR STREET ST. PAUL, MINNESOTA 55155 (651) 201-8000

February 2012

Minnesota Financial Report

Budget Summary
$323 Million Projected FY 2012-13 Balance Triggers School Shift Buyback Minnesota's financial outlook has improved slightly since November. Forecast revenues are now expected to be $33.793 billion, up $93 million from November estimates and forecast spending is projected to be $33.761 billion, a $230 million decline from previous estimates. These forecast changes result in an expected forecast balance of $323 million. But, after completing a statutorily required transfer to the budget reserve and a partial buyback of school aid shifts, the available balance remains at zero.

FY 2012-13 Forecast
($ in millions) February Forecast $1,289 33,793 33,761 350 648 $323

Beginning Balance Revenues Spending Cash Flow Acct Budget Reserve Forecast Balance Transfer to Budget Reserve School Shift Buyback Available Balance

Change $0 93 (230) 0 0 $323 5 318 $0

More than two-thirds of the forecast gain came from a $230 million reduction in projected spending. Most of the savings come from the Medical Assistance (MA) program where enrollments and costs for the early expansion of MA for adults without children continued to be significantly lower than anticipated. Education and other spending programs showed relatively little change. Forecast revenues increased by only $93 million or less than 0.3 percent. Income and sales tax forecasts were up a total of $71 million, while expected corporate tax receipts fell by $26 million. About one-half of the additional forecast revenue came from changes to the forecasts for all other taxes, non-tax revenue and transfers.

Minnesota Financial Report

February 2012

Available Balance Drops to Zero after Reserve Transfer and School Shift Buyback As in November, current law allocates all of the projected balance to restoring the budget reserve and to buying back of a portion of the K-12 education shifts enacted in the 2009, 2010 and 2011 legislative sessions. The order in which the buybacks proceed are specified in Minnesota Statutes 16A.152 which requires that if there is a positive general fund balance at the close of the biennium, that money be allocated first, to the cash flow account; second, to the budget reserve; third, to repay and reverse school aid payment shifts, and; fourth, to reverse the school property tax recognition shift.

Statutory Allocation of Forecast Balances

($ in millions) November Forecast Forecast Balance Statutory Allocations: Cash Flow Account Budget Reserve K-12 Shift Buyback $876 255 621 ---February Forecast $323 0 5 318 Total Allocated $1,199 255 626 318

The first $255 million of Novembers $876 million forecast balance was transferred to the cash flow account increasing it from $95 million to the $350 million ceiling in statute. The remaining $621 million was added to the budget reserve increasing it to $648 million -- $5 million below its $653 million statutory amount. Februarys forecast balance of $323 million provides an additional $5 million to complete the restoration of the budget reserve to $653 million. The remaining $318 million is automatically allocated to reversing school aid payment shifts. It will be added to K-12 education aids spending in FY 2012-13, changing payment percentages from 60 percent in the current year and 40 percent as a settle-up payment in the following year to 64.3 percent and 35.7 percent. The $318 million buys back slightly over 11 percent of the $2.75 billion outstanding in school payment and property tax recognition shifts. After this partial buyback, $2.4 billion would be required to reverse the remaining shifts. The amount needed to return payment percentages to the original 90-10 payment schedule would be $1.869 billion; the amount required to fully reverse the existing 50 percent property tax recognition shift is estimated to be $563 million.

February 2012

Minnesota Financial Report

Economic Outlook Improves, Probability of 2012 Recession Down Consumers appear to have more confidence in the future than they did last fall. The Eurozones sovereign debt problems now seem a little less frightening; domestic fiscal policy problems, a little less intractable; and a follow-on recession a little less likely than was thought three months ago. Most important, the labor market is again showing signs of improvement. Januarys payroll survey showed that jobs had increased by an average of 201,000 per month over the last three months. And, the national unemployment rate has fallen by 0.8 percentage points since September. Januarys reading of 8.3 percent was the lowest since February 2009. But, forecasts for real GDP growth in 2012 and 2013 have not improved as much as a casual observer might have expected. Part of the reason is that forecasts last fall never fully reflected the publics negativity. Economists reflected much of their concern through the probabilities they assigned to a 2012 recession, not in the growth rate called for in their baseline forecasts. In November, economists were assigning much heavier than normal weights to recession scenarios and lower probabilities to their slow growth, baseline scenarios. By February most believed the probability of recession had fallen substantially and the probability of more optimistic outcomes increased, but they upgraded their baseline growth for 2012 only modestly.

Little Change in Global Insight Forecast For Real GDP Growth in 2012 and 2013

Like most other forecasts Februarys baseline from Global Insight Inc. (GII), Minnesotas national macro-economic consultant, calls for growth to be only slightly stronger than was projected in November. Real GDP growth in 2012 and 2013 is now expected to be at annual rates of 2.1 and 2.3 percent respectively. In November, growth rates of 1.6 percent and 2.5 percent were projected. GIIs outlook for 2012 and 2013 is very similar to the Blue Chip Consensus, which calls for 2.2 percent growth in 2012 and 2.6 percent growth in 2013. 4

Minnesota Financial Report

February 2012

The probability of a 2012 recession has been reduced from 40 percent to 25 percent. Global Insight now assigns a probability of 55 percent to their baseline forecast, and a 20 percent probability to a scenario in which the economy grows at an annual rate of 3.3 percent in 2012 and 4.2 percent in 2013. In November the optimistic scenario was assigned a probability of just 10 percent. Minnesotas Labor Market Appears Stronger than the Nations Minnesotas December unemployment rate of 5.7 percent was well below the 8.5 percent national rate. Over the past 40 years Minnesotas unemployment rate has averaged about 1.4 percentage points less than the U.S. average, so that 2.8 percentage point difference is much greater than normal. The states unemployment rate also appears to be falling faster than the national average. Since December, 2009, Minnesotas rate has fallen by 2.1 percentage points while the U.S. rate has fallen by 1.5 percentage points. Household survey estimates show that 2.777 million Minnesotans were employed in December, 2011, 20,000 (0.7 percent) less than at the start of the recession in December 2007. Nationally 3.7 percent fewer individuals were employed in December than were working four years earlier when the Great Recession began.

Minnesotas Unemployment Rate Was Well Below the National Rate at the End of 2011

Payroll employment growth in Minnesota is expected to track that of the rest of the nation during the next two years, ending 2013 3.3 percent above the level observed at the close of 2011. Nationally, employment is projected to grow by 3.1 percent over that same period. Minnesota personal income is forecast to grow by 8.7 percent over the next two years and total wages in the state are expected to increase by 12.7 percent between now and the fourth quarter of 2013. National wage growth is expected to lag Minnesotas, increasing by 10.9 percent. U.S. personal income is expected to grow by 8.4 percent over that same two year period.

February 2012

Minnesota Financial Report

Significant Unknowns Cloud Future Economic, Revenue and Expenditure Forecasts Policy assumptions normally are not a major concern in economic, revenue and expenditure forecasts. Analysts can set their models to reflect current law, or they can calibrate their models to produce estimates for a scenario reflecting other likely policy alternatives. As long as the policy alternative is well specified and the change from existing policy small, forecasts can be made using statistical models based on historical data. Occasionally, however, policy alternatives are not clear, or changes in key parameters so large that historical statistical relationships no longer hold. When this occurs estimates of economic growth rates and revenue and spending changes will be much less precise. This appears to be one of those times and state policy makers should recognize that current forecasts for fiscal 2013 and beyond have a substantially larger margin of error. Part of the problem is that future federal tax and spending policies are likely to change after Novembers election, but no one knows how. The Congressional Budget Office (CBO) notes that future fiscal policy is likely to differ from that embodied in current law, and that alternative policies would lead to significantly different economic outcomes. CBO estimates that replacing their current law scenario with an alternative containing fewer federal tax increases and smaller spending cuts than currently scheduled for 2013 would materially increase economic growth in 2013. In their alternative policy scenario which has only minimal changes from tax and spending policies in place in 2012 they estimate that real GDP would be between 0.5 percent and 3.7 percent higher by the fourth quarter of 2013 than in their current law forecast. Global Insights February baseline forecast also recognizes the policy uncertainty for 2013. It assumes that the President and Congress reach a grand bargain in 2013 which replaces the automatic spending cuts and tax increases scheduled to begin in January 2013 with more modest spending cuts and a smaller increase in individual income taxes beginning in 2014. They estimate that maintaining current law rather than reaching a grand bargain would reduce their forecast for real GDP growth in 2013 by 2.5 percent. Minnesotas revenue outlook for fiscal 2013 and beyond also depends on future federal capital gains tax rates and on changes in taxpayer behavior that occur in response to rate changes. Neither is known at this time, and uncertainty about the rate for tax year 2013 is unlikely to be resolved until after Minnesotas November 2012 forecast has been released. Minnesotas future budget outlook will also be affected by coming major changes in the structure of the states health care system. The federal Affordable Care Act and state policy choices associated with it will significantly impact eligibility for state health care programs and the corresponding state and federal revenue streams that finance those programs. These policy decisions will likely produce major changes in how individuals and families access state health care programs, changes that will not be predictable using existing statistical models.

Minnesota Financial Report

February 2012

FY 2012-13 Revenue Forecast Up by 0.3 Percent General fund revenues for the 2012-13 biennium are now forecast to total $33.793 billion, $93 million (0.3 percent) more than projected in November. Changes in the states three major revenue sources were extremely small on a percentage basis, and partially offsetting. Slightly stronger economic growth produced very modest increases in projected receipts for both the individual income tax and the sales tax. Those revenue gains were partially offset by a small reduction in expected corporate income tax revenue. Other tax and non-tax revenues showed the largest dollar change, up $48 million (0.8 percent) from Novembers estimate. General fund current resources are now forecast to be $71 million (0.2 percent) more than was projected at the end of the 2011 special legislative session. Current resources for the 2012-13 biennium are now expected to exceed those in the 2010-11 biennium by $2.989 billion or 9.7 percent.

Forecast Revenues FY 2012-13

($ in millions) February Forecast Individual Income Sales Corporate Subtotal Other Taxes All Other Total Revenues $16,262 9,362 1,799 27,423 3,838 2,532 $33,793 Change from November $48 23 (26) 45 34 14 $93 Percent Change 0.3% 0.2 (1.4) 0.2 0.9 0.6 0.3%

February 2012

Minnesota Financial Report

Forecast Spending Decreased $230 Million before School Shift Buyback General fund spending for the biennium is forecast to be $33.761 billion, down $230 million (0.7 percent), from Novembers estimate. However, buying back a portion of the K-12 education payment shift adds $318 million to K-12 education aids in FY 2012-13, increasing total spending to $34.079 billion, $88 million more than Novembers estimate.

Forecast Spending, FY 2012-13

($ in millions)

February Forecast K-12 Education Property Tax Aids & Credits Health & Human Services Debt Service All Other Forecast Total Education Shift Buyback Revised Total $13,623 2,832 10,884 456 5,966 $33,761 318 $34,079

$ Change $(30) (7) (180) (18) 5 $(230) 318 $88

% Change (0.2) (0.2) (1.6) (3.8) 0.1 (0.7) -0.3

A $180 million reduction in the forecast for human services programs accounts for nearly 80 percent of the total decrease in projected spending. The majority of the savings, $108 million, relates to the Medical Assistance (MA) early expansion group (adults without children) where lower projected enrollments and lower fee-for-service costs are expected. This change reflects the trend observed since last February which has reduced the enrollment forecast for this group by approximately 16 percent (15,215 and 17,652 monthly average eligible recipients in FY 2012 and FY 2013). Changes in all other general fund spending were modest. K-12 education estimates decreased $30 million reflecting small downward revisions in forecast enrollment projections. However, the $318 million allocated for K-12 payment shift buyback will now add to K-12 spending, beginning with the March 15th payment to school districts. This additional funding increases K-12 spending for the biennium to $13.941 billion. That bottom-line total for K-12 education aids, including the shift buyback, is used in comparative tables in the remainder of this document, except where explicitly noted.

Minnesota Financial Report

February 2012

FY 2014-15 Planning Estimates Improve Slightly The longer term outlook for the state has improved. But, Minnesota still faces a structural shortfall of $1.1 billion. When the 2012-13 budget was enacted, the planning estimates showed a structural gap of $1.9 billion for the 2014-15 biennium.

Change in FY 2014-15 Planning Estimates

($ in millions) End-ofSession Projected Revenues Projected Spending Difference $35,296 37,187 $(1,891) November Change $421 (170) $591 February Change $44 (153) $197 February Forecast $35,761 36,864 $(1,103)

Projected revenue planning estimates for FY 2014-15 are now $44 million above November estimates, while expenditures are $153 million lower. Current law planning estimates for FY 2014-15 continue to show a structural gap between current law revenues and expenditures of $1.1 billion, a slight improvement from a $1.3 billion gap projected in November.

FY 2014-15 Planning Estimates

($ in millions) FY 2014 Revenues Spending Difference Inflation $17,525 18,370 $(845) $349 FY 2015 $18,236 18,494 $(258) $709

As required by current law, expenditure projections for the next biennium do not include any adjustment for inflation. Estimated inflation, based on GIIs baseline forecast of the Consumer Price Index (CPI), is projected to be 1.9 percent in both FY 2014 and FY 2015. Recognizing inflation at the projected CPI rate would add $349 million to FY 2014 spending and $709 million to FY 2015, increasing biennial spending a total of $1.058 billion.

A complete version of this forecast can be found at the Minnesota Management & Budgets World Wide Web site at -- www.mmb.state.mn.us. This document is available in alternate format.

February 2012

Minnesota Financial Report

FY 2012-13 Current Biennium Forecast Comparison

February 2012 General Fund Forecast - After Statutory Allocations
($ in thousands) 11-11 Fcst FY 2012-13 Actual & Estimated Resources Balance Forward From Prior Year Current Resources: Tax Revenues Non-Tax Revenues Subtotal - Non-Dedicated Revenue Dedicated Revenue Transfers In Prior Year Adjustments Subtotal - Other Revenue Subtotal-Current Resources Total Resources Available Actual & Estimated Spending K-12 Education K-12 Ptx Rec Shift/Aid Payment Shift Subtotal K-12 Education Higher Education Property Tax Aids & Credits Health & Human Services Public Safety Transportation Environment, Energy & Natural Resources Agriculture Economic Development State Government Debt Service Capital Projects Estimated Cancellations Subtotal Expenditures & Transfers Dedicated Expenditures Total Expenditures & Transfers Balance Before Reserves Cash Flow Account Budget Reserve Budgetary Balance * * 1,288,673 31,181,960 1,450,994 32,632,954 1,200 1,015,887 $50,000 1,067,087 33,700,041 34,988,714 14,520,262 (866,726) 13,653,536 2,565,517 2,839,097 11,064,055 1,814,510 125,658 257,758 79,876 176,632 912,936 474,148 45,219 (20,000) 33,988,942 1,527 33,990,469 998,245 350,000 648,245 0 2-12 Fcst FY 2012-13 1,288,673 31,261,788 1,471,617 32,733,405 1,200 1,011,646 47,031 1,059,877 33,793,282 35,081,955 14,493,250 (551,912) 13,941,338 2,565,517 2,832,328 10,883,913 1,814,510 125,658 257,768 79,876 176,632 919,069 455,600 45,219 (20,000) 34,077,428 1,527 34,078,955 1,003,000 350,000 653,000 0 $ Difference 0 79,828 20,623 100,451 0 (4,241) (2,969) (7,210) 93,241 93,241 (27,012) 314,814 287,802 0 (6,769) (180,142) 0 0 10 0 0 6,133 (18,548) 0 0 88,486 0 88,486 4,755 0 4,755 0 % Change 0.0% 0.3% 1.4% 0.3% 0.0% (0.4%) (5.9%) (0.7%) 0.3% 0.3% (0.2%) n/m 2.1% 0.0% (0.2%) (1.6%) 0.0% 0.0% 0.0% 0.0% 0.0% 0.7% (3.9%) 0.0% n/m 0.3% 0.0% 0.3%

$323 million forecast balance for FY 2012-13 is allocated by statute: $5 million to the Budget Reserve and $318 million to K-12 Education shift buyback.

10

Minnesota Financial Report

February 2012

FY 2014-15 General Fund Planning Estimates Comparison

February 2012 Forecast vs. November 2011 Forecast
($ in thousands) 11-11 Plng Est FY 2014-15 Actual & Estimated Resources Balance Forward From Prior Year Current Resources: Tax Revenues Non-Tax Revenues Subtotal - Non-Dedicated Revenue Dedicated Revenue Transfers In Prior Year Adjustments Subtotal - Other Revenue Subtotal-Current Resources Total Resources Available Actual & Estimated Spending K-12 Education K-12 Ptx Rec Shift/Aid Payment Shift Subtotal K-12 Education Higher Education Property Tax Aids & Credits Health & Human Services Public Safety Transportation Environment, Energy & Natural Resources Agriculture Economic Development State Government Debt Service Capital Projects Estimated Cancellations Subtotal Expenditures & Transfers Dedicated Expenditures Total Expenditures & Transfers Balance Before Reserves Cash Flow Account Budget Reserve Budgetary Balance Structural Balance 998,245 33,847,410 1,246,925 35,094,335 1,200 571,973 50,000 623,173 35,717,508 36,715,753 2-12 Plng Est FY 2014-15 1,003,000 33,901,530 1,239,869 35,141,399 1,200 568,723 50,000 619,923 35,761,322 36,764,322 $ Difference 4,755 54,120 (7,056) 47,064 0 (3,250) 0 (3,250) 43,814 48,569

15,301,534 (156,151) 15,145,383 2,565,266 2,761,929 11,766,783 1,814,025 180,060 263,748 77,592 165,270 910,231 1,329,956 55,668 (20,000) 37,015,911 1,200 37,017,111 (301,358) 350,000 648,245 (1,299,603) (1,299,603)

15,247,120 (118,314) 15,128,806 2,565,266 2,769,890 11,624,521 1,814,025 180,060 263,748 77,592 165,270 907,298 1,330,759 55,668 (20,000) 36,862,903 1,200 36,864,103 (99,781) 350,000 653,000 (1,102,781) (1,102,781)

(54,414) 37,837 (16,577) 0 7,961 (142,262) 0 0 0 0 0 (2,933) 803 0 0 (153,008) 0 (153,008) 201,577 0 4,755 196,822 196,822

11