Dayton drops 'surcharge' on rich plan as deficit shrinks

Gov. Mark Dayton said Monday he will restore proposed cuts to nursing homes and eliminate a temporary surcharge on the wealthiest Minnesotans after a new budget forecast showed the state's deficit should shrink by more than $1 billion.

An improved economic picture and a compromise in Congress over tax cuts will make the two-year budget deficit $5.03 billion rather than $6.2 billion, state officials predicted Monday.

Dayton said the revised budget proposal will prevent Minnesota from becoming the state with the highest income tax rate in the country.

Dayton will still propose increasing top-tier income taxes to avoid cuts to programs, but he will eliminate a proposed 3 percent income tax surcharge that would have temporarily subjected those earning $500,000 or more to a 13.95 percent tax. Under Dayton's proposal, the proposed top-tier income tax rate would be 10.95 percent, which would still be the second-highest state income tax rate in the country.

Dayton's office also said his revised budget will:

• Restore proposed cuts to metro and rural transit to avoid the need for fare increases

• Restore cuts to fire safety training

• Increase research and development credit

• Provide $5 million to the Department of Employment and Economic Development for the Minnesota Investment Fund and DEED Redevelopment fund

Republican legislative leaders said they were pleased Dayton is rolling back part of his tax hike proposal, but they still oppose the proposed increases because they believe tax increases would hurt jobs growth. They want to balance the budget through cuts alone.

Republican leaders pointed to one of the reasons for economists' improved forecast: Congress extending some of the George W. Bush-era tax cuts as part of a compromise with President Barack Obama in December.

State budget officials expected the capital gains tax cuts under Bush would expire, causing fewer people to cash out capital gains. When people cash out capital gains, it brings more revenue to the state because people's taxable incomes are higher.

Congress kept the capital gains tax at 15 percent rather than raising it to 20 percent as state officials expected. The lower federal tax on capital gains is causing more people to cash in, helping the state, State Economist Tom Stinson said.

"Tax relief, plus certainty equals economic growth," said Deputy Senate Majority Leader Geoff Michel, R-Edina. "That is a really important formula for us to remember."

"It was what the private sector did with the money in their pocket," added Senate Majority Leader Amy Koch, R-Buffalo.

Republican leaders are expected to release their budget proposal within the next two weeks. Legislative committees would act on budget bills by March 25.

Dayton planned a news conference later Monday, but his budget commissioner said the state still must do something about its structural deficit -- Minnesota is expected to have a $4.4 billion budget deficit in 2014-2015.

"There is a substantial correction that we need to make," Minnesota Management and Budget Commissioner Jim Schowalter said, characterizing the smaller deficit as a "modest and certainly helpful improvement."

Stinson said the forecast provides some reason for optimism, but he noted that political unrest in the Middle East -- and a possible impact on oil prices -- was not part of the forecast released Monday. If oil prices were to spike, the state's budget deficit could grow because of higher gasoline prices. He also said there's uncertainty about revenues from capital gains taxes.

"It's nice for Minnesota to get more revenue because of federal action or inaction on tax law but it's a pretty slim reed to base your future revenues on," Stinson said.

(MPR reporter Tim Nelson contributed to this report.)