MuniLand: State Revenue Outlook Dims, Projecting Proves Difficult and Neutral Sector Outlook Is Maintained

Morgan Stanley is reporting that early April readings suggest weaker state revenue growth ahead. The limited sampling is comprised of six large states, like IL, MA, PA and TX, which helps with the forecast reliability. April is tax season, historically the largest tax collection month for many states, so a drop off in April revenues could be a sign of stress ahead. Supporting Morgan Stanley’s analysis is the State of California’s Legislative Analyst’s Office (LAO) “Tax Tracker” for personal income taxes. The preliminary April “Tax Tracker” shows about a $1 billion shortfall versus the projected personal income tax revenue. 

Revenue forecasting is a difficult job. Actual results often surprise because of volatility in capital gains and variability in corporate tax receipts. In April, California’s LAO observed, "Normal stock market volatility and relatively modest changes in the direction of the economy and tax collections could easily increase or decrease 2015-16 revenue estimates by a billion or two, and, similarly, 2016-17 revenue estimates could easily go up or down by $3 billion or $4 billion." So the $1.0 billion preliminary shortfall is not surprising and within a normal range for California. The Rockefeller Institute of Government drives home the difficultly of estimating state income tax returns in its recent report, “Will April Income Tax Returns Surprise States?” Figure 1 from the report (below) shows how equity market volatility and federal tax policy can swing final income tax returns year-to-year. Obviously, states with personal income taxes are more levered to equity market volatility than states without income taxes, and capital gains revenues are more important to some states than others. The map, also from the Rockefeller Institute, indicates that California, New Jersey, New York and Oregon are most levered to capital gains revenue. The question is: do the earlier indications of potentially slowing state revenues change our state sector outlook?

At the beginning of May, our Muni Credit Team published a bullet on the State General Obligation sector and recommended a neutral weight to the sector for a number  of reasons. The sector has maintained relatively high credit quality, except for isolated cases.  State revenues are generally derived from a diverse tax base, and the states have more revenue raising authorization than most other levels of government. Furthermore, the sovereign powers of states allow them to better control expenditures than a local government or school district. Even if revenue projections are overestimated, expenses can be reduced and budgets balanced. In all, we are comfortable with our current positioning but will continue watching these trends carefully to assess whether any change is warranted. 

Source: Rockefeller Institute of Government:
CA Legislative Analyst's Office:
Morgan Stanley Muni Monday Morning 05/16/2016
SNWAM Research