Tax panel talks possible uses for state’s $2.8 billion federal windfall

Everything changed on Monday.

As legislators gathered in various conference committees, the looming topic was how soon legislative leaders and the governor would agree to budget targets that would send negotiations into overdrive for their respective omnibus bills.

But then the long-awaited guidance came down from the federal government about how much Minnesota would receive as part of the American Rescue Plan Act. The state’s total will be $2.83 billion, with the money intended to help the state respond to COVID-19, fill revenue shortfalls, and support the populations most harmed by the pandemic.

Where does that fit into the state budget? And who gets to decide where it goes? Those questions will enter into many a discussion between now and Monday’s constitutionally mandated adjournment date.

What the federal guidance says and how it should be interpreted was the chief topic of Tuesday’s Tax Conference Committee meeting. Two state commissioners were on hand – Jim Schowalter of Minnesota Management and Budget, and Robert Doty of Revenue – and each cautioned their departments would need more time to dig deeper into the federal guidance to determine what’s permissible spending.

But, after persistent questioning from the committee’s co-chair, Sen. Carla Nelson (R-Rochester), both agreed that the guidance seems to say the state can fully conform with federal tax policy regarding forgiven Paycheck Protection Program loans and unemployment benefits without fear the feds will come back later asking for the money back.

So that would mean the House could adopt the Senate position of making forgiven PPP loans fully tax exempt and the Senate could accept the House position of making unemployment insurance benefits tax exempt up to $10,200.

When does the money come and how can it be spent?

That $2.83 billion is coming to the state in two increments. Half of it is expected to arrive this month or next, with the second half coming one year later. Here’s how the U.S. Treasury Department lays out the intent of the funds:

• support urgent COVID-19 response efforts to continue to decrease spread of the virus and bring the pandemic under control;
• replace lost public sector revenue to strengthen support for vital public services and help retain jobs;
• support immediate economic stabilization for households and businesses; and
• address systemic public health and economic challenges that have contributed to the unequal impact of the pandemic on certain populations.

So where does that intersect with state tax policy? When it was signed into law March 11, one stipulation was money going to states couldn’t be used for tax cuts. But there are rules and rates you encounter when filing your federal taxes, and Minnesota could decide to adopt the same rules and rates when you file your state taxes. That’s called “conformity,” and it certainly makes filing simpler.

But what if your taxes consequently go down? Does that constitute a tax cut?

The commissioners believe it doesn’t, therefore, Minnesota is free to conform to the federal tax code without penalty.

But, as Doty said at Monday’s committee meeting — about an hour after the guidance arrived in his inbox — five federal acts affecting taxation have been signed into law since late-2019, containing at least 100 provisions to which Minnesota has yet to conform. So there clearly would be a lot more work to do on a tax bill to reach the “full conformity” to which legislators frequently refer.

Schowalter said the money must be used to deal with expenditures incurred on or after March 3, 2021, and the state has until Dec. 31, 2024, to use it. He said the focus of the funds should be on public health response, addressing negative economic impacts, serving the hardest hit, and premium pay for essential workers.

“If this sounds familiar, it’s because these are the same priorities the governor set out in his budget,” Schowalter said.

He described the formula Minnesota Management and Budget is using to calculate “lost revenue,” involving actual collections from 2019 vs. projections of ensuing years.

“Funds to replace lost revenue can be used broadly to support government services,” he said. “The state has substantial flexibility to use it as it sees fit.”

Among the eligible uses emphasized in the federal guidance are water, sewer and broadband. Rep. Cheryl Youakim (DFL-Hopkins) asked if counties could use federal money for those purposes instead of instituting local option sales taxes. Schowalter said, “Absolutely.”

Youakim was referring to a separate pot of money. In addition to the $2.83 billion for the state, $1.11 billion will go to counties, $644.2 million to metro cities, $376.9 million to other local units of government, and $178.9 million for capital projects.

But Schowalter emphasized the funds are not available for other infrastructure or to offset a tax cut. Nor can they be deposited in pension funds, bolster rainy day reserves, or used for debt service payments.

Sen. Tom Bakk (I-Cook) asked if the money could be used to replenish dedicated accounts that may have lost revenue in the past year, such as airport or transportation funds. Schowalter said he was unsure on airports, but trunk highway funds seemed to clearly qualify.

A topic raised by Youakim, Sen. Ann Rest (DFL-New Hope) and the committee’s co-chair, Rep. Paul Marquart (DFL-Dilworth), was if the money could be used to fund the working family tax credit, with Rest saying she believes it qualifies as both COVID-related and a conformity item. Both Schowalter and Doty said they interpret that as an eligible use.

Rep. Greg Davids (R-Preston) expressed concern that deadlines for tax filing and legislative adjournment are both next Monday, and wondered what would happen if the Legislature doesn’t take action on how to use the funds.

“This feels like 2018, when the executive branch ran out the clock. Can the governor take care of all of this himself?”

“Absolutely, we need the Legislature,” Schowalter replied. “It’s a big part of what the priorities will be. … We wanted to make sure to get this information to you as soon as we got it. This isn’t a race to spend. We have three years to use these dollars.”

“We need more information on does this cover all conformity, like tax extenders or temporary versus permanent changes,” Doty said. “Looking at the time frame out to 2024, what does that mean for some conformity items?”

Both agencies expect to be offering further guidance in the coming days.