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By Clay Masters and Brian Bakst

Minnesota lawmakers will have far less fiscal wiggle room and might have to take steps to head off a potential deficit, according to a new economic forecast that will set the tone for budget discussions that start in January in a politically reconfigured state Capitol.

The projection shows that the next budget period is on course to have just a $616 million cushion by the end, barring changes. That’s $1.1 billion below a prior forecast for the budget period that ends in June 2027.

State budget officials pointed to reductions in sales and income tax projections along with higher spending for long-term care and special education as factors that will strain state finances.

Speaking to reporters following the presentation, Gov. Tim Walz told reporters he was confident in Minnesota’s financial strength.

“This is not a rainy day, this is an over-the-horizon budget issue of growing costs in an aging population and more people accessing services, especially around autism, and things that are being negotiated,” Walz said of the forecasts. “So very clearly, those things are going to have to be addressed. But this is not light your hair on fire.”

State law requires at least one-third of any excess dollars projected in the end-of-year forecast to be moved automatically into the reserves. With that $264 million shifted into the rainy day fund it leaves the budget reserve at more than $3.5 billion — an all-time high.

The availability of that account could be on lawmakers’ minds as they set a budget, perhaps leading them to avoid severe cuts or tax increases to close any future gap.

Without a change in course Minnesota could face a $5 billion shortfall in the 2028-29 fiscal years, according to MMB’s presentation.

Numbers set the stage for coming session

The report comes a month before the Legislature returns for a 2025 session where setting the next budget will be the main task.

After two years of all-Democratic power, lawmakers will face a divided Legislature. DFLers continue to hold a one-seat advantage in the Senate and currently the two major political parties are on course for a 67-67 tie in the House.

Republicans are using the courts to try to shave the Democratic headcount and give them the majority heading into the new session.

The party configuration matters because the majority gets to set the chamber agenda and write budget bills that will eventually prompt negotiations with the Senate and Walz. That task starts early in the new year — and this forecast will help set the tone.

After seeing the new projections Wednesday, House Republican Leader Lisa Demuth said budget cuts will be necessary.

“While the budget is stable in this biennium, it’s obvious that spending reductions are needed to prevent a deficit down the road,” Demuth, R-Cold Spring, said in a statement.

DFL House Speaker Melissa Hortman and Walz later said that while the new forecast was cause for concern, the state’s financial situation remained strong.

“In a tied House, we need to and will operate in a bipartisan fashion to get our work done,” Hortman said in a statement. “We are prepared to work together with legislators on both sides of the aisle who are willing to collaborate and compromise.”

Future of federal funds uncertain

The forecast estimate is a dose of cold water after recent updates from state finance officials showed the state on a strong path. Erin Campbell, the state budget commissioner, also noted that the projections released Wednesday do not factor any potential changes in federal funding driven by the incoming Trump administration.

The latest quarterly economic update, released in October, projected Minnesota’s net general fund receipts for the first quarter of the 2025 fiscal year were $234 million more than forecast in February, or about 3 percent higher than previously predicted. The following month’s revenue intake was also higher.

This forecast provides more details compared to updates posted each month that capture revenue trends. Those don’t get into spending patterns and whether programs are consuming more or less money than expected.

If nothing changed, the state budget would amount to about $67 billion for the two years starting July 1. That’s smaller than the current budget and reflects that many things the prior Legislature did were temporary in nature.

The worry, though, is that those same things would add up to $73.4 billion for 2028-29 due to inflation and other built-in growth in program spending that. That’s where the $5 billion potential shortfall comes into play.

Walz had been reluctant to predict what the forecast would show. He planned to discuss the report later Wednesday.

Ahead of Thanksgiving, he did offer a warning about the possible tariffs that incoming President Donald Trump has said he’ll impose on Canada, Mexico and other trading partners.

“[If] we end up in a trade war with our biggest trading partners, agriculture pays the heaviest price,” Walz said. “States like Minnesota pay the heaviest price for that.”

In some ways, this forecast is more crucial for Walz than state lawmakers. He will use the projection when fashioning a budget plan he must submit to the Legislature early in the session. Lawmakers can wait until a February revision to map out their competing proposals.

The current two-year budget added up to nearly $72 billion but some of that was one-time spending that automatically comes off the books for the new budget. It’s possible 2025 could be a rare time when the next budget is fairly flat or even smaller than the last.

Tom Hanson, a former finance commissioner under Republican Gov. Tim Pawlenty, points out that this report is the first of a two-part forecast rollout with another estimate due in February.

“The beauty of having two forecasts is they can get some numbers and get the budget process started this week, but then they will have better data by the end of February,” Hanson said. “We may know by then whether the president will implement tariffs.”

Myron Frans, a former finance commissioner under DFL Gov. Mark Dayton, said the growth of the state’s gross domestic product will be affected by federal tariffs if they’re implemented on foreign imports, which could prompt retaliatory charges on products made here and sent abroad. But it’s virtually impossible to know just how those tariffs will affect the state budget at this point.

“I think that’s one of the real challenges for the MMB team,” Frans said about the uncertainty. “I think you just have to go based on what you know now.”

He added, “The economy looks good and it’s growing and inflation seems to be coming down.”