Balanced State Budgets Offer Some Stability in a World of Volatility

As most states closed their books on the 2016 fiscal year last week, all but three of them started on July 1 with enacted budgets for the new fiscal year. According to the National Association of State Budget Officers (NASBO), only Pennsylvania did not have an enacted budget on July 1, and two states had enacted partial-year budgets, a six-month budget in Illinois and a one-month budget in Massachusetts.

Most states were able to enact balanced budgets on time despite a slowdown in revenue growth over the last year. While states will need to continue to balance the potential impacts from lower revenue growth rates and greater pressures to increase expenditures, the minimal delays in adopting balanced budgets provides evidence of the relative stability of state general obligation bonds. As such, we continue to maintain a Neutral weighting of state GO debt in tax-exempt portfolios.

The relative stability of state GOs was reflected in Moody’s confirmation of its stable outlook on state credits on June 27. While the ratings agency noted that state revenues face economic headwinds, and that it expects revenue growth to be less than 4% over the next 12 to 18 months, it still expects the level of revenue growth to provide fiscal stability for states. Though levels of revenue growth declined in the 2016 fiscal year, we have seen significant variability in that revenue growth based on timing and location.  For example, the Rockefeller Institute of Government reported that year-over-year state revenue growth in Q4 of 2015 fell to 1.9%, but many states still had robust revenue growth, including the state of Washington, which had double-digit revenue growth. That robust growth was offset by double-digit declines from energy-dependent states that were impacted by declining oil prices. State revenue growth remained at 1.9% in Q1 of 2016, as reported by the Rockefeller Institute, despite a rebound in oil prices that helped improve collections for energy-dependent states. The downturn in equity market prices during the quarter caused a drag on state tax collections for states dependent on income tax revenues.

While most states go into the new fiscal year having managed their budget risks, Illinois, Massachusetts and Pennsylvania still have serious work to do. Illinois, which operated the entire 2016 fiscal year without a budget, adopted stopgap measures at the end of the legislative session so it could pay some of its 2016 bills. Illinois also approved a six-month budget for the new fiscal year, providing a temporary spending plan that will remain in effect through the November elections—after which it may be easier for the Republican governor and Democrat-controlled legislature to reach a budget compromise. Massachusetts adopted a temporary, one-month budget, which allows time for the governor to review a full-year budget that was amended to reflect last minute adjustments in revenue estimates. In Pennsylvania, lawmakers approved a budget and sent it to the governor on time, but the governor has withheld his signature, as the proposed budget was delivered with a $1.2 billion gap between expenditures and revenues.

Source:  The Bond Buyer, Moody’s, National Association of State Budget Officers, Rockefeller Institute of Government