State economist Tom Stinson said Minnesota is in a mild recession that could last six months. He said problems in the housing industry, and a reluctance by creditors to loan money have caused problems for the national economy.
On the state level, Stinson said income tax collections are down. He said both individual and corporate income tax collections have fallen since November. He said individual income taxes have fallen 2 percent because of slower wage growth and decreases in capital gains, dividends and interest payments.
"This is generally a widely dispersed reduction in revenues," he said. "It's across the board. It's not just a one tax problem. It's a problem in the economy."
Stinson said the federal economic stimulus plan will keep the current recession short, but he said other factors like high energy costs could drag down the economy again.
The drop in tax collections means less money is projected to come into the state treasury -- $935 million less, to be exact.
Gov. Pawlenty and state lawmakers are required to balance the books by the end of every two-year budget cycle. That means they have two choices -- raise revenue or cut spending.
This is the final budget forecast until November, so the governor and state lawmakers will use this figure as a blueprint to balance the books.
"I would describe this deficit ... as serious but solvable," Pawlenty said.
Pawlenty said he will not support any tax increases to balance the budget. He repeated his now familiar theme that state government spending is growing too fast and needs to be controlled.
Pawlenty said he will offer a mix of other options when he releases his budget proposal sometime next week.
"We're going to move forward and solve this deficit in a number of ways," Pawlenty said. "First of all, we're going to reduce spending. That would slow down the rate of spending increases that I referenced earlier. Number two, we'll use some of the reserves, but not all of them. Number three, we'll make use of some other funds as appropriate as well."
Pawlenty said he would propose 2 to 3 percent cuts to many -- but not all -- state programs. He will not accept cuts to schools, but said he may trim some funding within the Department of Education.
Pawlenty also said he is open to cutting some taxes to try to foster job growth in the state.
The governor and DFL legislative leaders had big disagreements over the budget last session. Pawlenty vetoed DFL-backed legislation that would have raised income taxes on Minnesota's top earners.
DFL House Speaker Margaret Kelliher said it is unlikely that Democrats would push for tax increases this year.
"We are going to have probably a tier of the toolbox removed by his insistence on that," Kelliher said. "However, there are a lot of tools left for us to examine. One of those would have to be a scissors. We think it should be a scissors and not an axe, however, so we're not axing Grandma out of the nursing home."
Like Pawlenty, Kelliher said Democrats want to protect classroom funding.
Here's the problem for Pawlenty and lawmakers. Since this two-year budget cycle began on July 1, 2007, one-third of the two-year budget has already gone out the door. If you take billions in education funding off the table, there isn't much left to work with.
Republican House Minority Leader Marty Seifert said he's worried that additional state payments will go out the door between now and the end of June. He said he hopes lawmakers act quickly.
"It's going to be a tough month of March, because I would say that we should be wrapped up with this budget by mid-April in terms of what we're doing," Seifert said.
Seifert wants across-the-board spending cuts to state agencies, the use of a portion of the state's budget reserve, and cuts to the health and human services budget to balance the books.
DFL Senate Majority Leader Larry Pogemiller said he would wait for the governor's budget before making any decisions on the best way to move forward.
"His budget is not dead on arrival," Pogemiller said. "His budget will be the object of scrutiny for three weeks, at least, so we can corroboratively work together to try to find solutions that are in the best interest of Minnesota."
DFL legislative leaders said they are looking at two potential revenue-raisers. One is closing a so-called tax loophole on corporations that operate overseas. The other is collecting taxes on business executives who work in Minnesota but declare residency elsewhere.