California and New York released executive budget proposals for the forthcoming fiscal year. Both states are projecting revenue surpluses thanks to growing economies and higher tax rates. However, the two states, the nation’s largest municipal debt issuers, have different priorities and ideas on how to spend the extra revenue. California is proposing its largest general fund spending ever, with $106.8B in expenditures. The revenues would go toward welfare programs, K-12 and community college districts and healthcare, while pouring $1.6B into the state’s rainy day fund. This rainy day appropriation would be the first that California has added to the fund since 2007. In addition, California is proposing to pay off the Economic Recovery Bonds sold to balance its 2004 budget. These actions, if agreed upon and implemented, would be a significant credit positive and a marked change in management practices. California has a long history of using one-time revenue sources to fund permanent programs. Because of this history, and the resulting volatility in operating performance and bond prices, the state has a high hurdle to overcome before we will feel comfortable approving its debt obligations for our client accounts, though we continue to find value in many other issuers within the state that are not directly secured by the state’s general fund. New York, on the other hand, is taking a different spending path with its projected $2.2B surplus. Instead of increasing expenditures, it is seeking to cut taxes. This is also a credit positive in our view because New York is a high tax state. Reducing taxes would increase potential revenue capacity for future years and provide a more competitive business climate. According to a December report by the National Association of State Budget Officers, 23 states have cut taxes or taken steps that reduced revenue this budget year. Recall from our note a few weeks back that revenue and budget proposals do not use accrual accounting and can easily be manipulated. While these are promising indicators of an issuer’s credit worthiness, no budgets have been finalized and, because budgets use cash accounting practices, they are not a substitute for a thorough analysis of annual financial results.