REGIONAL – Despite an improving economy, Minnesota faces a $1.1 billion budget deficit for the upcoming biennium, according to state officials.

In addition, Wednesday’s revenue forecast is shadowed by budget negotiations in Washington, D.C. Talks over a long-term deficit fix will determine whether across-the-board tax increases and automatic spending cuts are triggered in 2013.

“If we’ve gone full-speed over the edge of the fiscal cliff in Wile E. Coyote style, in February the forecast will be less optimistic than this one,” state economist Tom Stinson warned.

“In all my years, I’ve never seen a budget forecast with so much uncertainty,” said Senate Majority Leader Tom Bakk, DFL-Cook. “If we go over the cliff and the federal government can’t agree on a deficit reduction plan, we’re looking at adding another $1.7 million to our deficit.”

“We are dependent on many of the actions taken by the federal government,” added state Rep. David Dill, DFL-Crane Lake. “Especially in health and human services for things like nursing homes and Medicare.”

Still, there is a silver lining in the economic news. Minnesota Management and Budget officials say that revenue in the current biennium should allow a $1.3 billion payback of the $2.4 billion owed to schools.

The twice-annual economic forecast takes into account an array of indicators, factoring in the financial instability spiraling throughout Europe as well as local and national economic growth.

Minnesota’s economy is already doing better than many parts of the nation. The state unemployment rate is hovering around 5.8 percent, about two full percentage points better than the national average.

The state’s construction sector endured the worse of the last recession, and has struggled with high unemployment rates. Stinson said he finally sees that sector improving in a significant way.

“We’re expecting the housing sector to begin to turn around and begin to grow over the next couple years,” he said.

Dealing with deficit

Gov. Mark Dayton and lawmakers use the forecast as the basis for the next two-year state budget. Dayton, who faces a Jan. 22 deadline to propose a budget to the Legislature, has signaled that he wants to use a mix of new revenue and additional spending cuts to address the shortfall.

Dayton proposed a similar approach in the last biennium, calling for the creation of a fourth income tax bracket that would impose a 10.95-percent rate on single Minnesotans earning more than $150,000, heads of households making more than $200,000 and joint filers earning more than $250,000 annually — all after deductions. The increase would have affected about two percent of the state’s 2.4 million citizens filing income taxes.

At a news conference on Wednesday, the governor said he is very likely to revisit that proposal, but offered no other specifics on how to deal with the budget shortfall. He noted that the wealthiest Minnesotans are paying much less in income taxes than they were 20 years ago.

Fiscally irresponsible budgets from the past two years that used accounting shifts to cover the deficits were responsible for the new deficit, said Dayton. He promised no more “gimmicks” to solve this year’s budget problem.

Stinson said a reshuffling of the tax laws could finally break Minnesota out of the cycle of annual deficits that have caused years of statewide reductions and borrowing. State leaders haven’t enacted comprehensive reform since the 1980s.

“We need to make sure that Minnesota’s tax system is appropriate for dealing with the economy that we have in 2012 rather than the economy that existed in 1984,” Stinson said.

Bakk said without income tax reform, property taxes would continue to soar. In the past decade, he said, property taxes have risen from $4 billion to more than $8 billion statewide.

He was scheduled to meet with the Minnesota Chamber executive committee on Wednesday to discuss taxes. “There is just too much volatility in our revenue stream,” Bakk said. “We can’t keep going like this. If we’re going to lower property taxes, we’re going to have to replace that revenue somewhere else. We need comprehensive tax reform.”

Although DFL legislative leaders have not yet committed to raising taxes, Dill said that with the DFL controlling both houses of the Legislature, Dayton’s proposal has a better chance of success. Republican lawmakers have opposed tax increases, saying they hurt job creation.

Stability in budget

Tax reform, however, won’t be enough to address the state’s shortfall. Dayton also asked his staff to examine how a five-percent reduction in state government would look and will likely propose additional spending cuts.

Legislative leaders, who start their session on Jan. 8, will wait until the release of the next economic forecast in early March before making any of their final tax and spending decisions.

Dill said there have already been significant cuts in personnel in state government. “In 2007, I had three staffers working for me,” he said. “ Now I have one-fourth of a person.”

ASFSCME Council 5, a union representing 43,000 public workers in Minnesota, called on lawmakers to raise $6 billion in revenue to restore cuts backed by Republicans.

“We need $6 billion to dig ourselves out of the hole and pay for things Minnesotans care about — brainpower, schools, middle-class jobs, safe transportation and property tax relief,” the union’s director Eliot Seide stated in a news release.

Dill said the state must pursue a balanced approach of finding more efficiencies in its operations and identifying new revenue streams.

“We can’t continue with this metronome on the piano where we swing back and forth between having money and then not enough,” he said, making the case for revising how the state collects and spends money.

“We need to have a serious conversation about spending and taxes, no different than the one going in Washington now,” he said.

Bakk also argues for more long-term stability in the state’s budget. He noted that in eight of the last 11 years, the state has faced a deficit. Too many budgets have relied on accounting tricks, such as shifting aid payments to local schools, to balance the books, he complained.

It may not happen in one biennium, he said, but the state needs to move toward a more sustainable budget solution. “By 2016, I’d like to see the state be able to maintain a balanced budget,” Bakk said.

Minnesota Public Radio contributed to this report.