Modest budget surplus overshadowed as Minnesota projects $5 billion deficit down the line

Minnesota budget officials Wednesday projected a surplus of $616 million for the next two-year budget cycle, and a multibillion-dollar deficit looming in the following years.

The modest surplus was overshadowed by the revelation that Minnesota could face a projected $5.1 billion budget deficit in the 2028-2029 biennium. That prompted Gov. Tim Walz and DFL legislative leaders to defend the spending decisions they made over the past two years while they held full control of state government.

"We put money into things that have improved people's lives and built for the future," Walz said. "We created and passed middle-class tax cuts, we put millions into public safety, we've rebuilt our roads and infrastructure at a faster rate than we have in decades, we invested in making child care cheaper and easier to access."

State budget officials said long-term care for people with disabilities and special education costs are the biggest drivers of the deficit projected for 2028-29. Minnesota Budget Commissioner Erin Campbell urged legislators to "take the long view when making budget decisions this year."

At the same time, officials said the state's budget reserve reached a record high of more than $3.5 billion. Tapping that could help legislators minimize potential budget cuts or tax increases.

Walz and lawmakers must craft a new two-year budget in the legislative session that begins Jan. 14. An updated budget forecast will follow in February.

The governor said everything — from spending cuts to tax increases — is on the table to stave off a shortfall.

"We have time to address this structurally without negatively impacting the services that we're providing to people, but it's going to take some hard decisions," he said.

GOP legislative leaders quickly called for spending cuts and showed little appetite for tax increases. They blamed Walz and the Democrats for using up most of the state's previous $17 billion surplus while also raising some taxes.

"Now we have that looming $5 billion deficit projected in just a few short years," said House GOP Leader Lisa Demuth.

Republicans and Democrats are poised to share power in the Minnesota House next year, after the GOP gained three seats in the November election that brought the chamber to a rare 67-67 tie, pending the outcome of one contested recount. That will place a check on the agenda of Democrats who still control the Senate and governor's office.

"We have to stop the spending spree. We have to be responsible," said Demuth, R-Cold Spring.

What is driving future deficit?

The more than half-billion dollar surplus projected to be left over at the end of the 2026-27 budget cycle is $1.1 billion less than previous estimates, the state's budget office said.

In their forecast, state budget officials wrote that Minnesota's slowing wage growth and cooling labor market are significant factors in their estimates.

The forecast predicts increased inflation, higher interest rates and slower economic growth if President-elect Donald Trump implements the tariffs he championed through his campaign. But the analysis does not include detailed predictions of how those tariffs, which are U.S. taxes on imported goods that are typically passed on to consumers, will hit Minnesota.

Already, inflation is one of the major factors pushing the state toward a projected structural deficit in the 2028-29 biennium, budget officials said in their forecast.

Projected inflation alone will increase the budget by nearly $1 billion in the next biennium, and state economists predict inflation could add more than $1.3 billion to the budget in the following two years.

State budget officials also expect lower revenue from income and sales taxes.

On the spending side of the equation, the biggest drivers are special education services for students with disabilities, and long-term care for adults with disabilities.

Special education costs are expected to rise more than $900 million in the 2026-27 biennium. Forecasters said the expense is rising because more students are being identified as needing services, and the cost of those services and transportation is rising quickly.

The cost of long-term care for adults with disabilities is also going up fast enough to be a major deficit contributor. Officials project a $190 million increase in the cost of those programs.

House DFL leader Melissa Hortman said those two budget areas are among the biggest sources of state spending. The Legislature will have to look at them closely with the future deficit in mind and be "very innovative," Hortman said.

"We have to figure out, how do we take care of people, especially the most vulnerable … and do that in a way that respects those people and the values that we have?" said Hortman, DFL-Brooklyn Park. "We have the resources to take care of those folks. It will be a very tough job to figure out how to manage it for the long term, but I think our values say we are going to take care of those folks."

Demuth said Republicans will do "everything within our power to take care of the most vulnerable in our state." She said leaders should look to cut spending across state government, not just in special education and long-term care for adults with disabilities.

"We don't just want it focused in one area," Demuth said. "We want to make sure that we are meeting the needs of Minnesotans across the state in a fair way."

The possible $5 billion structural deficit in fiscal years 2028-29 is not a certainty, officials wrote in the forecast, noting that longer-term projections are inherently unpredictable.

"We also have ample time to take action and change the trajectory," Campbell said.