Overview

To keep the state budget in balance over the long term, Minnesota must better manage the spending side of the ledger.  Over the past 40 years, total state expenditures from all funds increased at double-digit rates in all but four biennia.  These increases occurred through DFL, Republican, and Independence administrations without much pause.  State expenditures tend to grow without regard to what party controls the governor's office in part because growth is essentially institutionalized into the budgeting process.[1]  In addition, tools meant to instill discipline, transparency, and accountability in the budget process have all been too weak.  To control spending, Minnesota must adopt bold new budget tools and processes.

The Budget Process Institutionalizes Spending Increases

Minnesota-as is the norm in virtually all states-relies primarily on an incremental budget process.  Under this method, the starting point for each new budget is the preceding budget, and appropriations in the new budget are increased or decreased incrementally over time from the preceding budget. 

The problem with this approach is that starting with the preceding biennium's budget effectively makes the status quo, plus inflation, the baseline for budget conversations.   A report by the National Conference of State Legislatures dating back to 1995 explains why this is a problem:

This approach is likely to take previous policies and programs for granted, and discourages rigorous or fundamental review of priorities, program effectiveness, or service outcomes.

These practices are under attack because they are said to foster a business-as-usual approach to government at a time when the public is challenging how state governments operate, questioning their efficiency and effectiveness, and expressing distrust of representative government itself.

Line items focus on what money buys (an input) rather than on the service that is provided (an outcome). An input could be tons of asphalt for state highways or new computers for property tax assessors. Outcomes are less likely to be considered . . . .

Using the status quo as a baseline without any rigorous review of past practices institutionalizes substantial budget increases.  For lawmakers, rubber stamping the baseline presents the path of least resistance all too often.  If there's a modest or even moderate shortfall, finding new or temporary revenue is usually easier than reassessing (and reducing) spending.  Deciding what programs to cut is difficult when there are little data on outcomes-what is and what is not working.  In the case of a surplus, lawmakers tend first to consider what this new money can buy.  And once spent, this new revenue incrementally steps up the baseline for the next budget.

Current Budget Tools Don't Influence the Budget Process Strongly Enough

Minnesota does employ an assortment of budget tools to encourage informed and fiscally sound decision-making.  These mechanisms include state agency performance reports; price of government reporting; a website that discloses information about state spending; program evaluations by the Legislative Auditor; a legislative advisory commission; a legislative commission on planning and fiscal policy; and a constitutional ban on long-term debt.  However, these tools have proven too weak to discipline the state policymakers' spending impulses.[2]   This is largely because most of the tools are purely informational and, therefore, don't directly affect the budget process.  The only mechanism that directly forces fiscal discipline is the ban on long-term debt.  But even this constitutional requirement can be subverted through various budget gimmicks.

Minnesota Can No Longer Rely on Tax Revenue Growth

Until recently, state revenues managed to keep pace with double-digit spending growth.  This feat owes to both tax increases and economic growth, depending on the political and economic circumstances of the day.   Tax increases played a particularly prominent role from 1970 to the mid-80s, at which time economic growth kept revenues in step with spending. 

The days where Minnesota can rely on tax increases and economic growth in similar ways are past.  Global competition all but makes it impossible for an already high-tax state to raise taxes further.  Minnesota's economy has outpaced the region and the nation in large measure through gains in education and a buildup of the workforce.  But while Minnesota might retain a highly educated population, demographic realities guarantee a shrinking workforce.

Recommendations

If tax revenue promises to be restrained in coming years, then spending must also be restrained.  This new era requires a much higher level of analysis in order to judge where and how spending should be curbed.  To provide this analysis and to institutionalize a more fiscally sound budget process, lawmakers should adopt the following recommendations.

• Direct the Office of the Legislative Auditor to develop and administer a second generation of actionable performance measures for each agency.  State agencies began measuring performance as far back as 1975.  Thirty-five years later, at a recent forum previewing the 2010 session, Rep. Jean Wagenius (DFL-Minneapolis) admitted, "We're not there yet."  She added that "we need to get down to what this dollar will buy for Minnesotans."  Indeed, present measures generally fail to identify the cost of achieving a particular result.  Currently, it's too easy for agencies to avoid measures that might be too revealing and, instead, they pick measures that make them look good.  After not getting there after over three decades, it's time to put someone else in charge.  Accordingly, an entity that is separate and insulated from state executive agencies should be directed to develop and administer a second generation of actionable performance measures.  The Office of the Legislative Auditor is the most logical entity to take up this charge as it already evaluates state programs.[3]  Indeed, the office was created in 1973 to provide lawmakers and the public with an "independent, or ‘arms length,' examination of the executive branch."  As a non-partisan office, it is more insulated from politics than most, which adds a valuable check on political incentives to conceal lackluster performance.[4]  
   
• Publish a biennial report, ahead of each budgeting year, ranking spending priorities.  To inform the budgetary process, Minnesota Management and Budget should issue a biennial report that evaluates all state programs and gives each one a priority ranking.  (Legislators, of course, might have different rankings in mind.)  Washington State's Office of Financial Management began publishing such a report in 2002, with categories such as "High," "Low," "Buy Next," and "Don't Buy."[5]  The priorities are based on how well programs perform and how well they help Washington achieve ten statewide goals.  Setting priorities prior for each budget will encourage a continuous reevaluation of programs as opposed to the current process that's stuck in the status quo.   Importantly, a transparent priority-setting process will lessen the likelihood of arbitrary or excessively partisan cuts.
   
• Establish a commission to study a transition to a budgeting process that institutionalizes periodic reviews of agency spending.  Lawmakers should end the presumption that the programs in preceding budgets merit continued funding with only incremental changes.   Ending this presumption will require a transition to a new budgeting process that provides periodic reviews of agency spending.  The just-recommended performance measures and priority rankings will provide the foundation for this new process.  At its most advanced, this might be a zero-based budgeting process where discussions would begin at zero and require that each spending program be justified.  This level of detail is probably impractical, but there are various other methods of setting budgets without assuming the status quo.  Agencies, for instance, could be required to construct multiple requests tied to various percentages of immediately preceding budget totals.  And/or, agency budgets could be subjected to thorough reviews every other, or perhaps every third biennium.[6]  
   
• Impose spending limits through statute or constitutional amendment.  Thirty states operate under some type of tax or expenditure limitation.  Minnesota does not.   Decades of expenditure growth that consistently and substantially overshot inflation suggest that Minnesota lawmakers need help reigning in their good intentions.  Late last year Governor Pawlenty proposed to limit general-fund spending constitutionally, to the level of the previous biennium.  While this is the right general idea, it's applied too narrowly-the general fund accounts for only 61 percent of state spending-and  does not allow for inflationary or other types of adjustments.  Ideally, a spending limit would allow for adjustments based on inflation plus population growth.  In addition, research shows that the most effective spending limitations also provide for automatic tax refunds in surplus years.[7]  Though a constitutional limit would be more permanent, a statutory limit might be a more practical option.
   
• Review the proportion of recommendations that  are implemented from the Office of the Legislative Auditor's state program evaluations.   The Office of the Legislative Auditor periodically publishes "Evaluation Impacts" that review whether or not recommended changes were implemented.  However, these reviews are done for only a limited number of evaluations.  Therefore, it's difficult to know whether these evaluations are making a substantial impact on government operations and the budget.  To judge the impact of program evaluations, the Office of the Legislative Auditor should publish a Program Evaluation Implementation Report that reviews the proportion of recommendations that agencies and lawmakers have implemented.[8]  Where appropriate, this review should estimate the financial impacts of recommendations.  If such a review finds that recommendations are too often ignored, then steps should be taken to assure that policymakers give future recommendations fuller consideration.[9] ■

 

Notes

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[1] It's worth noting that, since 1973, Republicans controlled the House each time total expenditure increases were held below double digits.  It would be serious mistake, therefore, to discount party control entirely.

[2] Current budget tools fall short on a number of fronts.  Performance measurements generally fail to measure outcomes in terms of efficiency and value, opting to simply measure raw output.  Also, there are no consequences when state agencies fail to meet performance goals.  Ineffective state programs-such as the JOBZ rural economic development program and the racial integration revenue program-remain largely intact despite severe criticisms from the Legislative Auditor.  Finally, the constitutional ban on long-term debt fails to bar long-term loans disguised as payment shifts. 

[3] In fact, the Office of the Legislative Auditor specifically evaluated how well state agencies measure performance in two reports in the mid-1990s.  See Office of the Legislative Auditor, State of Minnesota, Development and Use of the 1994 Agency Performance Reports, July 1995, available at http://www.auditor.leg.state.mn.us/ped/pedrep/9522all.pdf; and Office of the Legislative Auditor, State of Minnesota, Performance Budgeting, February 1994, available at http://www.auditor.leg.state.mn.us/ped/pedrep/9402all.pdf.

[4] It should be noted that the Office of the Legislative Auditor is not entirely insulated.  It resides in the legislative branch and legislators may wish to shield certain programs-especially programs that they sponsored-from criticism.   This sort of influence is lessened by the bipartisan makeup of the Legislative Audit Commission-the overseer of the Office of the Legislative Auditor.

[5] Washington State Office of Financial Management, 2009-11 Priorities of Government Final Report, at http://www.ofm.wa.gov/budget/pog/finalreport2009-11.asp.

[6] For a brief review of federal and state efforts to implement various forms of a zero-based budget, see Ron Snell, Zero-Base Budgeting in the States, National Conference of State Legislatures, 2009, available at http://www.ncsl.org/?TabID=12578 .  See also, Michael D. LaFaive, "The Pros and Cons of Zero-Based Budgeting," Testimony before the Michigan House Appropriations Subcommittee on General Government, Mackinac Center for Public Policy, Nov. 4, 2003, available at http://www.mackinac.org/article.aspx?ID=5928.

[7] Michael J. New, Limiting Government through Direct Democracy: The Case of State Tax and Expenditure Limitations, The Cato Institute, Policy Analysis No. 420, December 13, 2001, available at http://www.cato.org/pub_display.php?pub_id=1279.

[8] For an example, see, Washington State Auditor, Status of Performance Audit Recommendations through June 30, 2009, Report No. 1002767, December 2009, available at http://www.sao.wa.gov/AuditReports/AuditReportFiles/ar1002767.pdf.

[9] For instance, the Connecticut legislature created the Legislative Program Review and Investigations Committee with the power to introduce legislation based on program evaluations.