During prior economic downturns, state and local government spending and hiring acted as counterweight to the slowing growth. The sector contributes about 11% of real GDP. This relationship reversed in the most recent downturn because falling home prices reduced property tax revenues, and the severity of the job losses ate away at sales and income taxes. State and local governments were forced to reduce services and lay off workers. Now in our 74th month of continual economic growth, it may be time to ask whether state and local governments have reversed course. Well, the National Association of State Budget Officers’ (NASBO) 2015 annual State Expenditure Report shows that states alone increased their spending 6.2%, which is the largest margin increase in 20 years. However, the good news comes with a big caveat. The chart below shows that the majority of spending growth came from Medicaid spending under the first year of full implementation of the Affordable Care Act. As a result of the federal government’s transfer payments, Medicaid spending grew at a rate of 15.1% year-over-year. The second largest increase in spending, at 7.8%, comes from the catch-all category, “All Other”. All Other includes activities such as the Children’s Health Insurance Program as well as pension and health benefit spending. Also in the report, NASBO estimates general fund revenue growth continued to fall below the historical growth rate of 5.5%, with 2014 coming in at 3.9% and 2015 revenues at 4.9%. The report mirrors some of the trends we see in the municipal market. Those trends are: (1) mandatory spending on healthcare and pensions are driving out other forms of spending, and (2) slower economic growth is resulting in below trend revenue growth. The implications of these trends are that the municipal market will likely have fewer resources to invest in infrastructure projects, which may cause a decline in new bond issuance. Though less issuance wouldn’t do much to stimulate economic growth, it would serve as a technical backstop and be supportive of pricing going forward.
Sources: National Association of State Budget Officers (NASBO), SNWAM Research