CHICAGO – Minnesota Gov. Mark Dayton’s administration heads into court-ordered mediation with GOP legislative leaders this week to resolve what boils down to a political conflict over how much the state can afford in tax cuts.

The Minnesota Supreme Court ordered the mediation to resolve a feud that prompted Dayton to veto the legislature’s spending appropriation in the new biennial budget. It comes just after state officials met with rating agencies ahead of its annual general obligation bond sale. The state will take competitive bids on nearly $847 million of general obligation bonds Sept. 27.

Dayton is a member of the state’s Democrat-Farmer-Labor Party, and the GOP holds the legislative majorities.

While the veto involves just a small $82 million piece of the state’s $46 billion two-year budget, it has entangled the near-term repayment of $80 million of state-backed bonds repaid using lease payments from the Senate’s budget, issued to finance a new Senate building.

The state’s top fiscal manager says he’s hopeful the mediation -- ordered by a court that said Dayton acted within his power on the vetoes -- will work but the divide remains deep.

Minnesota Management and Budget Commissioner Myron Frans
Minnesota Management and Budget Commissioner Myron Frans says Gov. Mark Dayton's administration is working to maintain long-term structural budget balance.

Despite its flush coffers, the administration is firm in its position that the state can’t afford three tax-related pieces of the package that account for $143 million of the $650 million in GOP-sponsored tax breaks. The GOP says the $650 million is affordable and should go back to taxpayers. The state’s annual February forecast projected a $1.65 billion revenue surplus.

The annual revenue hit from the GOP proposals is projected to reach $1 billion by 2021. “One billion is too much,” Minnesota Management and Budget Commissioner Myron Frans said in an interview Friday. “We don’t want to get so close that we flip the structural balance” and land again in a situation where “expenditures are growing more than revenues if we have a downturn.”

The state lost its triple-A ratings by turning for years to one-shots – such as reserve use, tobacco borrowing, and delays in school aid distribution – to erase billions in red ink during times of divided leadership.

With DFL majorities, Dayton won an income tax hike on top earners in 2013. The new revenue along with strong economic growth allowed the state to eventually structurally balance its books and it won back one of its triple-As last year.

THE DISPUTE

Dayton signed the budget package to avert a government shutdown but issued a line-item veto of the legislature’s appropriation in an effort to force the GOP back to the negotiating table over the size and nature of the tax relief and several policy issues.

The move raised concerns over whether the lease payment needed for debt service on the Senate’s office building debt would be made after Senate leaders said its priority was covering operating expenses like payroll. That prompted S&P to put the state’s AA-plus general obligation rating on CreditWatch.

Republicans launched a legal challenge to the vetoes and the two sides reached a funding agreement that expires Oct. 1. If left intact – and there’s a legal question over whether it will be -- it would fund Senate lease payments due through the June debt service payments. S&P took the state off watch after the agreement was reached.

A lower court judge later ruled that Dayton overstepped his authority on the vetoes. The appeal went directly to the state Supreme Court and in a preliminary decision earlier this month it found Dayton had acted within his constitutional right. It did not send the case back to the lower court, instead ordering mediation.

The two sides have agreed to the choice of retired judge Rick Solum as mediator and negotiations begin Thursday. A status report is due to the high court by Sept. 29.

The high court in its opinion raised questions on the legality of the legislative funding agreement.

“In fact, our cases suggest that the judicial branch does not have the inherent power to appropriate money,” the court wrote and ordered the two sides lay out their arguments. The two sides submitted written arguments Friday.

Because of the lower court’s decision, the appropriation is technically intact and a decision on the funding agreement is not under appeal so no action is needed, the legislature's argument said. “The district court never decided the ability of courts to order such funding….at this point in the litigation, this court has no district court decision on court-ordered funding to review,” it said.

Dayton's filing takes a different tack, arguing that the court can intervene in the absence of an appropriation to protect critical core services, which, it asserts, applies to legislative functions.

“Where there is a conflict between a lack of funds and the constitutional rights of the people, the latter wins,” the administration's filing says. “The Minnesota Constitution was drafted to effectuate the operation of government, and it empowers the judiciary to order funding to achieve that end.”

The Senate and House had combined funds of nearly $17 million as of Sept. 1, according to a court-ordered filing submitted Monday. It warns that without a resolution the Senate will exhaust funds by Dec. 1 and the House by Feb. 1. Employees would then be furloughed.

Frans said he expects mediation will solve the problem over the Senate lease payments. In the absence of an agreement, the state has some options but Frans stopped short of saying they offer a guarantee of payment because that’s part of negotiations.

The lease payments are set aside to cover the December payment. There are a number of ways the June payment could be handled either through mediation or an emergency appropriation, but those require some action either by the court or legislature.

“I can’t give legal assurance that any of these things would happen,” he said. “We have to let the process play out,” he said, adding that ultimately the lease payments that go to debt repayment are the Senate’s responsibility.

Fitch Ratings rates the state AAA and Moody’s Investors Service has the state at Aa1. Neither raised prior concerns over the appropriation issue, saying the state had time to resolve questions. The state has the option to fund COP debt service from either the Department of Administration's budget or the Senate's budget, Fitch previously said.

LEGISLATIVE VICTORIES

Moody’s Investors Service has previously cited a “history of gridlock” that had “led to structural imbalanced budgets and on two occasions, late budgets and government shutdowns” in 2005 and 2011. Last year, analysts said a failure to implement balanced budgets or political intractability that disrupts the budget process could contribute to a downgrade.

Frans acknowledges the difficult balancing act, but he also sought to highlight the areas where the administration and GOP reached agreement this year and he believes there’s been a sea change among lawmakers of both parties.

“I think the culture has changed,” he said. “There’s a recognition” of the need to better manage state finances and fend off problems by maintaining strong reserves and keeping spending in check with revenues.

“We accomplished a lot and agreed on a lot,” he said citing passage of a nearly $1 billion capital budget that’s known locally as the bonding bill. The state typically passes a big public works program in even years and the biennial operating budget in odd years but last year political differences stalled such a package. He expects another big package in 2018.

The administration and legislature were close on pension changes that relied on higher employer and employee contributions and changes to the discount rate and cost-of-living adjustments.

The legislative leaders added in a so-called preemption measure that would have stripped local governments of autonomy, so Dayton dropped his support. “Our position is to continue to work on the same package,” Frans said.

The system covers three statewide funds. The largest is the Minnesota State Retirement System which was 78.4% in fiscal 2016 on a market value, down from 89% last year. The system said it will again push for reforms in 2018.

Frans said he stressed with the rating agencies the state’s strong economy and growing cash on hand and rainy day reserves that are at about $2 billion. Under the state’s revised reserve policies, 33% of a forecast balance is transferred to the formal budget reserve until a set target – now at just over $2 billion -- is reached.

The bond sale includes three new money series -- $312 million of various purpose bonds, $114 million of GO-backed trunk highway paper, a $27 million taxable various purpose series. Two series will refund bonds – a $312 million various purpose tranche and an $81 million trunk highway bond tranche.

Public Resources Advisory Group is advising the state.

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